Disney’s Stars Align to Sidestep Cable Wars

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Walt Disney  (NYSE: DIS) reported its fourth quarter results for its fiscal year ending Sept. 29, 2012, with a 14% increase in profits to $1.24 billion coming from revenues of $10.8 billion. This took its annual profit to $5.7 billion, an 18% increase, and revenues of $42.3 billion, a 3% increase, over last year. However, the company barely met analyst’s estimates and gave a gloomy outlook as ESPN network, after witnessing declining viewership as Comcast’s (NASDAQ: CMCSA) NBC broadcasted the Olympics (bringing Comcast an additional $1.2 billion in revenues) has not been able to re-assert its pricing pressure and faces negative advertising trends coupled with the falling ratings from ABC.

ESPN’s negative outlook is of particular concern, as the sports giant contributed nearly 75% to Disney’s cable operating income. Its quarterly profits increased by 9.4% to $1.38 billion. While advertising remains fairly constant, the programming costs and competition in the industry is rising.

For the full year, the ‘Parks and Resorts’ segment witnessed the biggest jump in operating income by 22% to $1.9 billion, while income from ‘Media Networks’ increased by just 8% to $6.6 billion.

While the ‘Studio Entertainment’ segment witnessed a 17% increase in annual operating income, its annual revenues fell by 8% to $5.8 billion. The most recent quarterly results were alarming, with revenue and income falling by 4% and 32%, respectively, completely understandable as Q3 has several slow movie months.

But the big news is Disney purchasing Lucasfilm from George Lucas, the creator of the iconic Star Wars franchise, for approximately $4 billion. Disney has also announced, much to the excitement of Star Wars fans, that it will release ‘Star Wars Episode VII’ in 2015, which will be followed by further sequels in the coming years. For Disney’s shareholders, reviving and maintaining the Star Wars brand is a huge opportunity to offset any loss of leverage coming in the attrition of traditional cable subscriptions

The Lucasfilm acquisition is just another in a long-string of high profile acquisitions in the previous years that includes the $7.4 billion deal for Pixar in 2006, the $4 billion acquisition of Marvel Entertainment in 2009, and this year’s purchase of a controlling stake in India’s leading entertainment firm UTV Software Communications. Besides, the company also has a massive capital expenditure plan to revamp its theme parks, including the one in Hong Kong and construction of its first in Shanghai. The company is also planning to launch its much awaited billion dollar ‘NextGen’ system that will allow its theme parks guests to plan their entire trip in advance from their desktop without having to stand in the long queues at the reservation desk.

Like Disney, its rival Time Warner Cable (NYSE: TWC) is also witnessing declining advertising ratess. While the revenues at its network business unit increased by 4%, much to everyone’s surprise, the increase came mainly from subscriptions as quarterly ad-sales fell by 1%, again mainly due to NBC’s Olympic broadcast. Profits increased by 2% to $838 million. However, the revenues from its film unit slumped by 12% to $400 million as this quarter, citing the lack of a Harry Potter film as a contributing reason.  The company has also entered into a nine year agreement with Major League Baseball, which should be reflected in improved performance by the Turner division.

The company is looking forward towards increasing subscriptions for HBO, whose revenues increased by 4% to $3.3 billion; but even HBO witnessed a 1% (or $9 million) decline in ad-sales. However, to counter this trend and to take the company to the next level, Time Warner is aiming to expand its international television operations, particularly in the emerging economies of Latin America, the Middle East, and Eastern Europe.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Disney</strong></p> </td> <td> <p><strong>Time Warner</strong></p> </td> <td> <p><strong>Comcast</strong></p> </td> </tr> <tr> <td> <p><strong>YTD Stock</strong></p> </td> <td> <p>25.48%</p> </td> <td> <p>46.45%</p> </td> <td> <p>52.34%</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>15.04</p> </td> <td> <p>13.35</p> </td> <td> <p>16.49</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>3.13</p> </td> <td> <p>6.98</p> </td> <td> <p>2.19</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>1.30%</p> </td> <td> <p>2.40%</p> </td> <td> <p>1.80%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>7.54%</p> </td> <td> <p>5.72%</p> </td> <td> <p>4.70%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>15.17%</p> </td> <td> <p>28.93%</p> </td> <td> <p>11.84%</p> </td> </tr> <tr> <td> <p><strong>% Margin (TTM)</strong></p> </td> <td> <p>13.44%</p> </td> <td> <p>10.56%</p> </td> <td> <p>9.68%</p> </td> </tr> </tbody> </table>

All three firms have easily outperformed the SPDR S&P 500 ETF, which is up 10.1% in the same period. Both Comcast’s and Time Warner’s stock are way ahead of Disney primarily because the businesses were able to beat analysts’ expectations.

The key for Disney going forward is that it has now built a stable of content creation brands that is unparalleled, and it is through them that they will not only weather but thrive in the changing landscape of content distribution.  Cable will die or morph into something new over time and the obscene margins that ESPN produces will be whittled away as Americans find they cannot afford to support their current entertainment budgets. But by shifting their structure away from cable and back towards content creation, Disney better positions itself for whatever distribution systems win out in the end. 


PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney. Motley Fool newsletter services recommend Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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