Magic Remains In Disney's Kingdom After Strong Results

| About: The Walt (DIS)

Disney (NYSE:DIS) registered overall revenue growth of close to 10% in Q2 fiscal 2013, which is impressive for a company of its size. [1] It primarily operates in the mature market of North America, which accounts for three-fourths of its total revenues. As a result, the company’s performance is primarily tied to the state of the U.S. economy and overall quality of its produced content. It is impressive to see Disney demonstrating growth across all its major segments, except for the weakness in broadcasting. ESPN continued to lead the way with growth in both advertising and affiliate fees. ABC broadcasting saw some weakness due to pressure on ratings, but Disney’s own TV stations did reasonably well. Its parks and resorts business benefited from higher attendance and guest spending, growing its operating income by a staggering 73%. [1]

Overall, we feel that given Disney’s brand strength, successful franchises and market presence, its growth will continue to find support from higher affiliate fees, licensing, syndication and expansion of theme parks.

Cable Networks Getting Support From ESPN And Disney Channel

ESPN, which brought close to $11 billion in revenues for Disney in 2012 as per our estimates, continued its growth in the second quarter of fiscal 2013. The network’s ratings have bounced back after a period of weakness seen in the past couple of quarters, resulting in advertising revenue growth of 4%. [2] For the 3rd quarter of the fiscal year, ESPN’s ad revenues growth are humming along at more than 10%. [2] In addition to this, the network’s affiliate fees continued to grow due to higher subscription fees.

ESPN is benefiting from multi-year programming contracts that specify annual fee increases, sustained high demand for sports programming, rising sports programming costs and its market leading position. However, going forward, the growth in the subscription fee is likely to slow due to pressure from pay-TV service providers and expected competition from NBC and Fox, the latter of which is planning to launch a nationwide sports network to compete with ESPN.

Apart from ESPN, the Disney Channel is doing well and is the company’s biggest global brand. Disney Junior reaches 400 million households in 166 countries, and its branded products are growing rapidly with retail sales expected to increase by 80% amounting to $1.5 billion in fiscal 2013. [2]

Ratings Pressure On Broadcasting Continues

Disney’s broadcasting business saw a decline in profits due to higher cost write-offs for underperforming shows, increase in prime time programming costs and a decline in ad revenues for the ABC broadcasting network. The decline in ad revenues was driven by lower ratings, partially offset by higher ad pricing and growth in online advertising.

The viewership for U.S. broadcasting networks is declining and Disney’s ABC is no different. This secular decline is being fueled by the popularity of cable programming and increased competition from alternative video platforms such as Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN) and others. Unlike broadcasting networks, a lot of cable networks focus on a particular genre, thus creating a loyal viewer base. According to research firm Magna Global, the overall ad commitments for TV’s upfront market for the current year could increase by 2%. [2] While the ad sales for the broadcasting networks will decline by 2%, cable networks will see a growth of 5% in their ad related revenues. [2]

The table below shows the viewership change for the biggest broadcasting networks in the U.S. for the current season. [3]

Viewership Change -3% -7% -23% -8%

We estimate that ABC Networks' average viewership has declined from 3.7 million in 2007 to a little under 3 million in 2012. This is not something that ABC cannot repair. Disney has made some acquisitions in recent years, primarily catering to its movie business. However, the company could potentially leverage these acquired franchises or take inspiration from them and introduce well-scripted programs on ABC Network. The network seems to be doing well among women aged between 18 and 34, but it could expand its appeal to other demographics by introducing relevant programs.

Gaming Segment Could Show Strength

Disney recently announced a gaming agreement with Electronic Arts (NASDAQ:EA) to deliver and publish several new games based on its recently acquired Star Wars franchise. Under the terms of the deal, Disney will retain rights to develop new titles within mobile, social, tablet and online gaming categories as well as the right to develop new titles for the Asian gaming market. Star Wars has a strong global brand and a game based on this franchise could garner success for Disney.

Our price estimate for Disney stands at $66, which is roughly in line with the market price.

In addition to this, the company plans to introduce its "Infinity" game for gaming consoles, PCs and mobile phones this year. The project is big and Disney will look to turn around the losses of its gaming division with this launch. Infinity is similar to the Skylanders game launched by Activision Blizzard (NASDAQ:ATVI) in late 2011, and judging from Skylander’s success, there is a good chance that Infinity can boost Disney’s value by as much as 5% (see What Potential Does ‘Infinity’ Hold For Disney?). That’s a lot considering that Disney doesn’t get any direct financial value from its gaming business, which is currently running losses.

Our price estimate for Disney stands at $66, which is roughly in line with the market price.

Disclosure: No positions.

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