Description

Disney was written up several times on VIC as a long in recent years at prices ranging from $114 to $147. There is also a 'Business Breakdown' podcast on it from March 2023. Given the high profile nature of this name, I assume that readers will be vaguely familiar with the business. 

Today's share price of $89 is meaningfully lower compared to the long pitches versus a strong S&P 500. I think the main culprit for the disappointing performance is the fact that it takes longer to retool Disney's media business from linear TV to direct-to-consumer (DTC). These type of big transitions in the face of disruptive innovations can easily take 5-10 years. Instead of quickly becoming profitable, DTC losses actually worsened, thereby severely depressing group earnings power… This almost decade-long underperformance also creates the type of investor apathy that has the potential to generate meaningful long Alpha.

Direct-To-Consumer EBIT

Group EBITA

Grey = consensus expectations.

So, why might Disney be interesting today? It is a combination of 1) price and 2) progress on DTC.

Thesis

1. Price / Downside Protection From Parks: Disney's Parks & Experiences segment run-rate pre-tax earnings power is >$9bn. Despite the Covid bounce-back likely being over, this should grow to ~$12bn by 2027. Even after $1.1bn in total corporate overhead and 25% tax rate, it would be worth >$180bn on a 22x P/E and thereby close to today's enterprise value. And yes, this is a "you get everything else for free" sum-of-the-parts pitch. This is a hard-to-replicate asset and a great earnings grower historically that warrants a healthy multiple:

2. Progress on DTC To Drive Upside: DTC was heavily loss-making for a long time. Despite Disney's unique content, building this business against incumbent Netflix has cost a lot of money. Just last quarter did they reach break-even and the streaming industry now appears to be focused on fixing its unit economics after years of landgrab. I don't know how quickly earnings will scale, but Disney's media business should generate decent profits. It is certainly worth more than zero. For what it's worth, capitalised content costs are >$34bn. What could the upside be over five years? It is a bit finger in the air, but these are my assumptions: $13bn EBITA for Parks & Experiences, $3bn for sports (ESPN; via streaming or linear), and $5bn for other media (DTC, linear networks, studios) = $21bn. After central overhead, interest, 25% tax, equity income and minorities, and putting it on a 19x P/E equals roughly $260bn market cap. Adding $50bn of FCFE including re-investment = $310bn, or ~1.9x -- decent considering the downside protection. Upside might also surprise. Some pitches for example assume >$10bn in eventual earnings power just for Disney Plus, which is certainly possible though still a bit speculative for my taste.

Potential Risks

I think these are covered by the margin of safety…

• Messy path: Disney still generates a lot of revenues from affiliate fees and advertising. If we were to assume that this is a melting ice cube that goes to zero, there are still a lot of costs to come out that are currently covered by these revenues. While the old media businesses currently generate cash, it is possible that they could become loss-making for a while and/or create significant restructuring costs.
• This also includes ESPN, which is still mostly monetized via affiliate fees and advertising. It has yet to properly transition to streaming. Again, this transition might severely depress earnings power for many years. 
• Weak consumer spend: There have been various earnings misses of consumer-focused names recently. The weaker outlook for Disney's parks business drove the most recent share price weakness. As we cannot predict recessions, all we can do is buy businesses that are resilient or even antifragile with a healthy margin of safety. Note that Disney is reporting results tomorrow but I have no view on the quarter.
• Politics: Disney is obviously politically charged. It should not significantly impact the business, but things might escalate.

Catalyst

Continued rebuilding of earnings power to prior peaks as DTC becomes profitable.