Disney Stock Begins Another Adventure

by Lawrence Meyers | December 11, 2013 1:51 pm

Was that the sound of a whip cracking? Or of Nazis being melted by vengeful spirits rising out of the Ark of The Covenant? No, the sound you hear is more akin to a feast, as Walt Disney (DIS[1]) gobbles up the Indiana Jones franchise, which was sold by Viacom (VIA[2]) subsidiary Paramount Pictures. This bodes extremely well for Disney stock.

[3]Disney stock is already seeing the effects of having purchased the three most famous film studios in contemporary history: Pixar, Marvel, and LucasFilm. Each studio has a track record of generating billions of dollars in revenue from movies and ancillary products — especially toys and games.

In retrospect, all of these purchases make sense. Would News Corporation (NWS[4]) studio subsidiary 20th Century Fox have made more sense for Indy’s new home? What about Time Warner (TWX[5]) conglomerate’s Warner Bros.? Or maybe Lionsgate Entertainment (LGE[6])? No, no, and no.

Fox doesn’t have the verticals necessary to integrate all the various methods of revenue generation. It certainly couldn’t do it the ways Disney can. Lionsgate didn’t have the money. Time Warner might have been capable, but the simple truth is that Disney just made the most sense in every respect. Disney stock has soared for years because it can leverage every aspect of its massive distribution channels to pump out products based on these studios’ films. There is no better home for vertical integration for any great entertainment property than Disney, period.

Think about it: Disney produces movies, TV, theme parks, literary properties, video games, comic books, plush dolls, non-plush dolls, dolls that can shoot real fire from their hands… Well, maybe not, that last one. But the point is that Disney stock responds to these large purchases because the company knows it can generate multiples on its investment.

Disney stock will rise even more with the Indiana Jones franchise. I know many folks are thinking that, after the most recent film, the franchise is dead. No way. In today’s world, a franchise is never dead. What matters is finding someone to re-boot the series in a way that takes it back to its roots — great characters, solid story structure, and real stunts (not CGI). There are plenty of people who can accomplish this. Heck, I’ve got ten stories popping in my head as I write. This franchise just buttresses the already massive line of product Disney produces every year.

The company remains in solid financial shape. It has $3.9 billion in cash[7] on the books, and $12.77 billion in debt. Yet that debt only generated $235 million in interest expense[8] in FY12. That’s almost free money!

Disney stock responds to great free cash flow[9] as well, and that figure has been out of sight for the past few years: $3.5 billion in FY11, $4.2 billion in FY12, and $6.65 billion in FY13. Analysts estimate FY14 earnings will grow from $3.39 to $3.93 per share, or about 16% YOY, with another 15% in FY15. A simple PEG ratio puts Disney stock trading at a bit over 18x earnings.  I give a company generating that much free cash flow a 20% premium, so Disney is trading at fair value.

Nevertheless, I see this as being undervalued over the very long term, and suggest you buy.

As of this writing, Lawrence Meyers was long DIS. He is president of PDL Broker, Inc.[10], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[11] and blogs about public policy, journalistic integrity, popular culture, and world affairs[12]. Contact him at pdlcapital66@gmail.com[13] and follow his tweets @ichabodscranium.

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