Walt Disney Co (NYSE:DIS), laid out a cold $4.06 Billion to purchase Lucasfilm Ltd. in order to acquire the rights to the Star Wars franchise. Approved on December 4, 2012 by the Federal Trade Commission, it only took three years for Disney to come out with the release of the new Star Wars Episode VII – The Force Awakens. Since the deal, the stock skyrocketed up over 100%, turning the company into an attractive growth stock.

Star Wars Episode VII will no doubt be a box office hit. The 6th release of the series earned $850 million in the box office, with production costs at 13.5% of that. With that said, from an investment perspective Disney’s studio entertainment (the segment responsible for movies) is often overrated. Even with Touchstone, Pixar, Marvel and DreamWorks under its belt, the entertainment studio represent a mere 15% of the company’s overall revenues. Disney’s major media networks such as ABC, ESPN and Disney Channel make the bulk of the company’s revenue, representing 43% of total earnings in 2014. Disney’s parks and resorts represent the other 31% of income. This is separated from the global entertainment parks with subsidiaries in the US, France, Japan, China and more. This cash cow is supported by the huge array of Disney’s themed hotels and resorts, and even a four cruise liner fleet.

I can say with full confidence that the next Star Wars trilogy will be a box office hit. Disney’s animation franchise boasts an almost flawless track record. IMDB’s “top 10 worst Disney animated films” includes films such as Robin Hood, Pocahontas, and the bottom rated (5.8) Chicken Little; however, this is not a bad rating at all. The only reason these films made the list is that they are the worst of the best, certainly not box office flops. With that said, it should already become clear that as a long-term value investment, Disney is not just attractive; it pretty much tops the list.

Why Investors Are Selling Disney Stock

There was a major drop in price following August 4th 2015, 3rd Quarter income statement. With quarterly revenues up 5% year to year, in line with the 7% growth of the first two quarters, investors are a little perplexed. So why has the stock since plummeted over 20%? The answer is ESPN. While being valued at over $50 billion alone, ESPN can easily occupy its own article.

What I will share though is the two factors that are scaring the major institutional investors the most. Netflix (NASDAQ:NFLX) has already demonstrated that streaming is taking over cable TV. The company’s growth shows a clear transition in the young generation from paid TV to the internet, and this trend is only getting stronger. In essence, ESPN revenues are divided into two different sources.

  1. TV Subscription Fees: With the most valuable portfolio of sport rights, TV providers from around the world pay a heavy chunk of the subscription fees they collect to broadcast Disney owned material (sports, movies etc). However, with less people watching paid television, broadcasters will not pay as much for these rights. People do not want to pay an annual fee for 10 sports channels anymore when all they actually care about is Formula 1. This means less “global subscription revenues” or paying for a load of stuff to get the little you actually care for.
  2. TV Advertising Fees: Following on the above point, if less people are watching your channel, advertisers are not willing to pay as much. While it seems gloomy, TV advertising revenue has steadily grown and is further projected to continue doing so in the next several years. This in contrary to the wide conception that TV is dead.

So are investors actually over-reacting? Yes, ESPN subscription fees are lucrative, and what I call “global revenues” will take a hit, but sports are not going anywhere. Broadcasters make revenues from advertising, and unlike print media’s unavoidable demise, TV ad revenue still looks bullish. Furthermore, Disney has an unparalleled track record of creativity in adjusting to changing market demand, and always being on top. The Disney channel today looks more like MTV to the 90’s kids than the content they were familiar with, but somehow it seems to work.

Why Disney and Value Go Hand in Hand

Disney seems resistant to inflation: Movie ticket prices have remained more stable than almost any other consumer product out there. Since the beginning of the 1900’s, people have paid the same price for a ticket to the movies. Yes, back then a few cents would have got you into the movies, and today you pay almost $10, but adjusted for inflation people are still paying almost the same price their grandparents did. When adjusted for inflation the original Star Wars (1977) is actually the second highest grossing film of all time.

Globalization is a freeroll for Disney: In a match of poker when the cards are as such that the only two options for you are to split the pot or take it all, it is referred to as a freeroll (you have nothing to lose from it). Disney experiences a similar phenomenon with globalization. Due to their slight monopoly over the market, as global markets become more accessible they have little to worry about from other nations taking over market share. From any expansion they either benefit or don’t, but never lose.

Production costs for movies now often exceed the $100 million mark, but unlike in the past, people everywhere generate revenue for the theaters. This has largely balanced the scales of internet pirating, as the numbers show this market still hasn’t declined (and likely won’t in the near future), even though this was a major fear for a long time.

Disney Interactive: This division holds huge potential for Disney. Currently interactive is only responsible for 3% of Disney’s income. Some of the major rising brands are Disney infinity, which merges the world between toy collectibles and video games, and other separate sites such as club penguin. Both bring in about 20 million visits a month, a figure considerably high for gaming websites. Further, they have shown solid growth in recent months. I do have to mention that even though 25% of Interactive’s staff was laid off, and game production was significantly re-focused, Disney Interactive still seems to waste energy into side projects such as babble.com.

Similarly to subscription licensing, Disney made a 10 year licensing contract with Electronic Arts (NASDAQ: EA) allowing them to release games under the Star Wars brand. This move followed the shutdown of Lucas Arts, the subsidiary developing video games for the brand. Star Wars: Battlefront will release November 17, 2015 and although the company does not benefit much directly, indirectly it will be a huge brand boost for the upcoming movie. It also largely covers the adult segment which the interactive brand does little of.

Bottom Line

There are some major cash flow events coming up with both college football and NFL “Monday Night Football” beginning September 14th. This is supported by the 2% increase in live same day rating last year. Star Wars is expected to generate another $5 billion in consumer merchandise and $500 million in licensing. The movie alone is targeting at $2 billion in revenue, which will result in a $1.2 billion profit. Finally, Disney’s Shanghai Park is set to open next year and could swiftly add another $300 million to fiscal 2016.

In terms of earnings per share, the quarter is expected to end well with the first three being up 23.3%, 13.89% and 12.4% respectively. To put things into perspective, even if Q4 numbers are around Q2 results of $1.23/share, this would still result in an annual EPS of $5.18 and overall 23% growth. This image will be clearer with the next earnings report to release Nov 4-9.

Furthermore TipRanks scores all analysts based on their performance. Two of the best performing bloggers Demitrios Kalogeropoulos of the Motley Fool and Serge Berger of Investor Place posted bullish forecasts in the last 4 days and 8 days respectively. Analysts from top firms currently hold an average price target of $118. With that said the insider trading breakdown does point to some weak points.

Disney is currently valued at $170 billion, and in 2014 was able to generate $7.5 billion in income for shareholders. This follows a 4-year average growth of 16%. If I project these numbers just 5 years forward, Disney will be able to generate about $15.5 billion to shareholders. This would put their P/E ratio at about 10/1. Assuming the stock will trade at an average P/E ratio of 15, it will put the company’s market cap at $238 billion, indicating there is still a 40% upside in 5 years (or 8% annually). This is of course a rough estimate based on recent growth.

Following the 3Q15 income statement, the stock price declined 20%, likely with further down support from the market crash analysts call “black Monday”. Due to the lack of serious fundamental indicators pointing to the need for such a large sell-off, this can largely be interpreted as a price correction (whether correct or not is another debate). This basically sets you off at a 20% discount to what you would have paid a month ago for the exact same stock.

While this is the instant benefit, the short term benefit is no less than Star Wars itself. Statistically speaking there is just no scenario where the movie is not a box office hit, even if the ratings are terrible, the brand will bring the masses. Leading up to the release, the market sentiment should become more and more bullish. Here I must mention that while this is tiny in terms of the overall Disney universe, it is huge in terms of image to investors. In the short term, public appeal of a brand stock like Disney can mean more than cash flow or revenues.

So with the instant and short-term covered, the medium-term becomes the only deterrent. Due to the weakness of television subscriptions and the increase of streaming, this time frame might encounter some bumps. There is no guarantee that the company will adjust its portfolio quickly enough to compete with other brands competing here, but the downside seems relatively digestible.

Long term the company’s ability to not just remain a major player over so many years, but constantly increase its dominance makes it a no brainer. Solid growth supported by dividend payments and near zero risk. Movies are not going away, television is not going away, and theme parks are not going away. Moreover the interactive market is rapidly growing and I expect Disney to follow suit. I will conclude by saying that this is an attractive investment right now. Once the new Star Wars movie releases it can be re-evaluated for its mid-term and long-term potential.


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