Disney (DIS) reports quarterly earnings after-hours today. Analysts expect revenue of 13.3 billion and eps of $1.15. The revenue estimate implies a 7% decline sequentially. Investors should focus on the following key items:
Diminution Of ESPN
Disney is considered old media relative to young upstarts like Netflix (NFLX), Hulu and Amazon (AMZN). For slow growth companies the attractiveness could come in the form of dividends. The company paid out $1.2 billion of dividends through the first nine months of the fiscal year and has a dividend yield of about 1.60%. With the bull market getting long in the tooth I would be concerned about a potential decline in the stock and loss of principal. DIS trades at about 18x earnings despite a stagnant top line and faltering bottom line. The company’s revenue is flat to declining, yet the devil is in the details.
For the quarter-ended July 2, 2017 Parks and Resorts revenue was up 12% Y/Y, which offset declines in Median Networks (down 1%), Studio Entertainment (down 16%) and Consumer Products (down 5%). Parks and Recreations growth was driven by growth at Shanghai Disney Resort and Disneyland Paris.
Media Networks still represents nearly 60% of total revenue. Stagnant revenue was caused by a 3% decline in Cable Networks, slightly offset by a 4% increase in Broadcasting revenue. The cutting of the cord is real and it is impacting the entire cable industry. While I am addicted to cable TV, ESPN, in particular, my son prefers Netflix (NFLX) and Hulu. The trend away from cable towards mobile devices will likely continue.
The story for Disney is its performance below the line, where its operating income fell 10%. Parks and Resorts was the stalwart, growing operating income 18% Y/Y. Operating income from Studio Entertainment and Media Networks was down 17% and 22%, respectively. Studio Entertainment is driven by large, blockbuster movies like the Marvel comics series or Star Wars series which might not occur each quarter. What has been trend worthy is the continued diminution in Media Networks. Cable Networks represents 80% of the segment’s operating income, so as it goes so goes Media Networks.
Disney’s ESPN franchise has been paying up for sports broadcasting rights for years. I never really understood how the math behind the bids worked; as long as it could keep growing subscribers and raising monthly fees everything would balance. That is no longer the case, however. Subscribers, fee income and margins have declined, yet ESPN and Disney are still on the hook for pay outs under the television contracts. Layoffs, which would have been seen as anathema in the past at ESPN, could become a normal occurrence going forward. I expect ESPN’s decline to weigh heavily this quarter.
Potential Acquisition Of Fox Studios
Market chatter suggests that Disney could be in talks to acquire 21st Century Fox’s (FOX) movie and TV studios:
Despite reports of a possible sale of 21st Century Fox’s movie and TV studios to Walt Disney Co., Fox Executive Chairman Lachlan Murdoch said Wednesday that his company is equipped to stay the course in a changing media landscape.“Let me be very clear — Fox does have the required scale to continue to both execute on our growth strategy and deliver increased returns to shareholders,” Murdoch said at the start of a call with Wall Street analysts on the company’s strong fiscal first-quarter earnings. “Our businesses and brands are stronger than ever.”
Fox Studios had a reportedly $839 million in operating income in its most recent fiscal quarter. Combined with Studio Entertainment’s $639 million in operating income the units would have considerable scale. A deal could likely spur cost synergies and jump start growth initially. However, I believe the sole purpose of such a deal would be to help justify Disney’s current overvalued share price.
The company recently invested an additional $1.6 billion for a majority stake BAMTech; this will give it the platform to grow it direct-to-consumer operations. This is exactly what Disney should be doing – adapting to the rapidly changing marketplace. However, BAMTech would not generate enough income to offset the diminution in ESPN. A Fox deal might, at least initially. The question remains, “Is management willing to make a sizeable acquisition at market heights to sell investors on the illusion of growth?”
Conclusion
Investors should ignore deal fever and focus on the fundamentals. DIS is a sell.
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