Disney Q1 2019 Results: Strong Potential

Summary

• Disney repositions for Direct To Consumer service.
• Very strong financial position with which to pursue its DTC opportunity.
• I posit that investors are unnecessarily fearful and disenchanted with Disney.
• Overall, Disney remains meaningfully undervalued.
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Investment Thesis

While Wall Street continues to be passionate and obsessed over Netflix (NFLX), investors are leaving another strong investment opportunity available for patient and contrarian investors.

Disney (NYSE:DIS) is a terrific investment in the space of content providers and distributors. I strongly contend that Disney's shares are undervalued and offer investors a strong opportunity to profit with an upside potential of 35-50%.

Overarching Strategy: Direct To Consumer Offering

The whole story on The Street with regards to Disney continues to be focused on its DTC offering - which is expected to be launched towards the back end of 2019. Despite much chatter, currently, investors remain thoroughly unsure whether Disney will succeed with this new platform.

Thus, despite much attention, ironically, Disney spent its earnings call deflecting as many questions as possible about this new service, with CEO Robert Iger pointing out that more would be disclosed during its investor day in April.

Having said that, a few details did percolate. For instance, during the call, we hear that Disney's control of BAMTech appears to have been a triumph, as BAMTech succeeded in showing strong stability and reliability during peak streaming consumption.

Additionally, echoing Disney's previous earnings call, Iger highlighted that Disney's focus will be less on the volume of content on Disney+ but more closely aligned with new 'skinny' bundle-concept, made up of a fewer but higher-quality Disney shows.

In fact, the platform's focus will be largely on families, which seek a certain type of branded video. And that consumers should only pay for the type of content they ultimately desire. As for other types of consumers, for example, those which are passionate about sports can opt for a different type of package, such as a sporting package, via ESPN+.

Balancing Act For Disney

Next, interestingly, Iger did not shy away from reporting that Disney's DTC will be capital-intensive. And that Disney has essentially been left with two options on the table. To disrupt its own business model or to stand by while Netflix did it for them.

Said another way, Disney has to take hold of its own future now or stand aside and let its most fierce competitor be the determining factor in how Disney will look like 5 years hence.

Moreover, if we step back and recollect, we have already witnessed how Disney had already started phasing out its IP away from Netflix, in order to increase demand for its own platform and to 'starve' fans of its offerings.

Consequently, when all is said and done, Disney is going to have to produce a significant amount of content, and quickly, if it wishes to ramp up its offering, ready for a full launch within roughly than 6 months' time.

Thus, for now, Disney will be temporarily having to outsource its content in an effort to build volume for its DTC platform. Of course, this is not a desirable route for the long term, as it borders on being prohibitively expensive.

Financial Position

Disney is committed to deleveraging post-Fox (FOX) acquisition. When asked for further details, CFO Christine McCarthy was somewhat tight-lipped. Having said that, she did acknowledge that Disney continues to make positive progress in divesting its RSNs and that these divestitures will aid Disney in getting its A credit rating affirmed.

Meanwhile, as of Q1 2019, Disney carries a net debt position of approximately $16 billion, which, given that Disney generates approximately $9.5 billion under normalized trading conditions, demonstrates the flexibility of its balance sheet, so that Disney can fully pursue its DTC opportunity, which, as we have already discussed above, should not be expected to be either easy or cheap.

Valuation

On balance, although Disney continues to have a challenging path ahead, as investors, we can ascertain that this uncertainty is more than accounted for already in Disney's present valuation.

From my perspective, there is largely a binominal result ahead. One way, Disney does not succeed in gaining any market share from Netflix and Amazon (AMZN) Video - which I doubt, given the following which Pixar, Marvel, and Lucasfilm already have, globally, in theatres and through merchandise and elsewhere.

And the other result is that Disney at least minimally succeeds with its DTC platform, in which case, we can expect a slow ramp-up but steady growth for the foreseeable future. In this latter scenario, it is not inconceivable that Disney can reprice with a P/Cash Flow from Operations of at least 15X-17X. Pointing towards at least 35-50% upside potential.

Takeaway

Outperforming the majority of investors requires doing what they are not doing. Buying when others have despaired, and selling when they are full of hope...

John Templeton

Given investors' reaction post-earnings, it shows that investors remain largely detached and unenthused over Disney's medium-term prospects. In summary, value investors know well that when investors become despondent that is code-word for an investment opportunity.

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Disclaimer: Please do your own due diligence to reach your own conclusions.

Analyst’s Disclosure: I am/we are long DISCK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.