Walt Disney Co (DIS) Stock Remains a Fantastic Long-Term Play, Despite ESPN

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If a potential investor did not know anything about Walt Disney Co (NYSE:DIS), by virtue of reading only what the headlines covering DIS stock in the media decide to focus on, they would be inclined to believe that the only line of business DIS has is its cable networks, and more specifically ESPN. The cord-cutting phenomena that has taken hold of consumers with the rise of disruptive entrants such as Netflix, Inc. (NASDAQ:NFLX) and other potentially “cable-killing” companies have spooked investors, and the share price of DIS reflects this sentiment, trading nearly 8% below its all-time high earlier this year.

DIS Stock: Walt Disney Co (DIS) Stock Remains a Fantastic Long-Term Play, Despite ESPN

In this article, I’m going to discuss why I believe the recent dip presents a buying opportunity for long-term investors, and why concerns about ESPN and Disney’s cable business are largely overblown.

Digging Into the Disney Numbers

First of all, I’d like to clarify that the aforementioned cord-cutting phenomena is a real thing, and is something that should certainly be taken into consideration by investors. What I’m arguing, however, is that the reduction in the number of users for platforms such as ESPN should be taken into consideration as a consequential, yet small (and a very profitable piece), piece of a very large pie.

Currently, ESPN is the worst-performing media network among Disney’s cable portfolio, and has been bleeding customers for some time. Due to ESPN’s pricing as a premium channel, major cable companies looking to provide consumers with “skinny packages” or trimmed-down versions of the more traditional “all-inclusive” cable packages have resulted in a consistent outward flow of subscribers, something which has continued despite the best efforts of management to stem the declines.

The company has netted losses of approximately 300,000 subscribers per month, and with a current subscriber base of 90 million, this amounts to a decline of approximately 4% per year.

Cable networks amount to approximately 30% of DIS’ revenue, and approximately 45% of the company’s profitability. The operating margin of DIS’ cable networks segment has declined to 44.1% this past quarter from 46.7% during the same quarter last year, with operating income subsequently reflecting this decline.

The declining operating margin of cable networks, while certainly not a positive for DIS, is more than offset by increases in operating margins across the companies remaining segments. The remaining segments, which account for the majority of DIS stock’s revenue, have continued to outperform, showing strong top- and bottom-line growth supported by margin expansion.

Parks & Resorts saw operating margins increase from 15.9% to 17.4%, Studio Entertainment increased operating margins from 26.3% to 32.3% and Consumer Products & Interactive Media increased operating margins from 30.1% to 34.7%, all substantial increases.

What This Means for Disney

DIS remains a growth machine, and has continued to grow its top- and bottom-line numbers substantially, despite ESPN’s lackluster performance.

The ability of management to take the more than $2 billion in operating profit from cable networks and reinvest this profit into other segments of the business which are becoming increasingly profitable will ultimately determine how successful Disney will be in creating long-term, sustainable free cash flow.

Because of the extremely high level of profitability with respect to DIS’ cable networks as compared to its other operating segments, it appears to me that Disney has a number of strategic options available at the moment which can help to mitigate investor concerns about DIS suddenly losing its ability to create value for shareholders.

The most obvious option available to DIS is some sort of spin off of ESPN (in whole or in part); liquidating the company’s position in a portion or all of its cable networks would free up a significant chunk of capital to be invested into new projects within the firm. Analyst Matthew Harrigan of Wunderlich Securities estimated that ESPN was worth nearly $51 billion two years ago — given a purchase price of $19 billion in 1995, DIS would realize a substantial gain and would need to find ways to replicate the foregone operating margin.

The other option, which I contend makes more sense, is to view ESPN as a depreciating asset with somewhat predictable (and potent) cash flows which can be reinvested into increasing margins in other operating segments. Either way, DIS is in a great position, despite the naysayers.

As of this writing, Chris MacDonald did not hold a position in any of the aforementioned securities.

Chris MacDonald’s love for investing led him to pursue an MBA in Finance and take on a number of management roles in corporate finance and venture capital over the past 15 years. His experience as a financial analyst in the past, coupled with his fervor for finding undervalued growth opportunities, contribute to his conservative, long-term investing perspective.


Article printed from InvestorPlace Media, https://investorplace.com/2017/07/walt-disney-co-dis-stock-fantastic-long/.

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