When Disney (NYSE:DIS) reports earnings later today, investors are going to wonder whether the short-term pain the company will endure from its $71.3 billion deal with Twenty-First Century Fox (NASDAQ:FOXA) and the costs its incurring to ramp up its direct-to-consumer (DTC) video streaming service next year will yield long-term gains and, ultimately, send Disney stock higher.
Disney stock has got more room to run because it doesn’t fully reflect the company’s potential for long-term growth. It recently changed hands at about $116, near its 52-week price target of $120. The shares have gained about 9% this year, outperforming its peers including Comcast (NASDAQ:CMCSA) (down 4%), CBS Corporation (NYSE:CBS) (down 2%) and Viacom (NASDAQ:VIAB) (up 5%). DIS’ price-to-earnings multiple is about 15, which is reasonable compared with peers such as Fox (19.8) and CBS (15).
In a recent note to clients, MoffettNathanson analyst Michael Nathanson makes a persuasive case that Disney stock is on the right track. Of course, integrating the Fox properties, including the storied FOXA studios won’t be easy and taking on Netflix (NASDAQ:NFLX) in the video streaming market isn’t without risks.
That makes now the perfect time to buy DIS stock before the “good news” gets baked into the price.
According to Nathanson, the DTC service will “negatively impact” Disney’s EBIT (Earnings Before Interest and Taxation) by roughly $490 million in fiscal 2019 and by around $1.4 billion in Fiscal Year 2020 through Fiscal Year 2022. The content that will be available on the yet-to-be-named Disney offering will attract a huge audience. Even though it won’t rival Netflix’s 137 million subscriber base, it will become a cash cow for DIS.
“We currently estimate that the Disney DTC product will penetrate 2 percent of U.S. TV households in its first year, equating to 2.4 million subs by year end,” Nathanson wrote. “We think that by FY 2022, penetration can grow to 8%, or 9.5 million subs, leading to domestic revenue of over $735 million. On the international side, we assume the TAM (total addressable market) is twice that of the U.S., at over 235 million homes … [resulting in] $850 million in revenue by FY 2022).”
Bottom Line on Disney Stock
DIS will feel the impact of the Fox assets fairly quickly in its bottom line, gaining $284 million in profit during Fiscal Year 2019, surging to $2.8 billion in Fiscal Year 2022, Nathanson says. The combined company will control about 50% of the box office, with everything from Fox Searchlight’s arthouse pictures to tent-pole franchises such as X-Men. On the television side, Disney would gain hits produced by Fox, including Modern Family, American Horror Story and Empire.
There is plenty for investors to like about Disney stock.
However, the media and entertainment giant raised $35 billion in debt for the Fox deal and will net at least $28 billion from the sale ordered by antitrust regulators of the Fox Regional Sports Networks and from Comcast’s purchase of U.K. pay-TV provider Sky. It should be able to easily pay down the remaining $7 billion debt from the growth in its business.
Disney is spending $100 million on ESPN+, the sports channel’s $49-per-year streaming service that has attracted 1 million subscribers in less than a year. Although the gains from ESPN+ aren’t enough to offset the declines in ESPN, they certainly are helpful. Moreover, ESPN+ will help Disney anticipate problems from the launch of the DTC service in 2019.
As of this writing, Jonathan Berr owned shares of DIS.
