(QS) Disney [DIS]

Disclaimer: This post should not be taken as investment advice. It just represents the opinions and perspectives of someone who’s been in finance over two decades.

In this part of our quality series, we will go over a company that went from HQ to Q to HQ again. That company is Disney from 2010-2015, then 2015-2018, and then 2019 onward.

If you need a recap of what has been discussed so far, here are part 1, part 2, part 3, part 4, and part 5.

I’m sure you remember by now but just as a refresher, a quality company has a defensible moat which allows it to generate excess cash flows. Disney fits that criteria. The company has the best IP of any media/entertainment company (Marvel, Pixar, Starwars, etc.) and leverages that IP through all of the media channels (TV networks, Movies, Theme Parks, Consumer Products).

Financially, Disney generates $70B in revenues each year, of which they take $6B-$10B in operating cash flow. Returns on capital have been 10%-15% consistently. Disney has grown revenues each year since 2000, with the exception of 2010 when they shrank by 4.5%.

So is it a high quality company? From 2010 to 2015, Disney was a high quality company. They had just finished acquiring Marvel for $4.2B. With the Marvel franchise under the Disney umbrella, many studio hits would be released, some of which would set box office records. The company still continues to benefit from the Marvel universe IP, as it expands its parks to include Avengers Campuses.

ESPN adoption was steadily growing as cable penetration into households continued to increase each year. Cable networks get a per subscriber fee from their distribution partners, such as traditional cable companies (Comcast, Charter), satellite companies (Dish, DirecTV), wireline providers (AT&T, Verizon) and now OTT providers (YouTubeTV, SlingTV, HuluTV). This segment continued to grow and become a larger portion of the overall company’s earnings.

To reference how important ESPN was to Disney, in 2015, the network contributed 31% of revenues to the company and 51% of operating income, due to the high margins in cable networks.

Why did it go from high quality to quality? What was once a gem at the company started to detract from growth rates. The streaming video effect was taking hold and households were cancelling enough of their cable video subscriptions to make the subscriber count go negative for ESPN.

Essentially half of the earnings power of the business was facing industry headwinds. There were talking heads on TV that thought no one would cancel ESPN due to its focus on sports and live content, but the subscriber count kept declining.

This phenomenon is still happening at the company and for all cable networks, but Disney was able to shift the company in a new direction with its venture into direct to consumer streaming video.

So what happened in 2019? Disney acquired BamTech in 2017 to lay the foundation for its streaming technology and subsequently launched ESPN+ in 2018. The content on the service wasn’t as good as regular ESPN (due to programming deals), but it did produce some original content that was complementary to live sports. Subscriber count for the service is now over 7M.

The big game changer happened in early 2019 when the company announced details around its Disney+ launch. The company planned to aggressively invest in new and original content that would only be available Disney+ and pricing was very favorable to attract subscribers. Disney+ had over 10M subscribers after its first weekend after launch and has over 26M subscribers today.

The stock chart below shows that from 2010-2015, Disney’s intrinsic value compounded at a strong rate. The there was a lull from 2015 to 2019 as the company had to stem the losses coming from ESPN. The spike in 2019, happened after the details of the Disney+ streaming service was announced.

Since Disney is now back to being a high quality company, intrinsic value for the company should compound each year, especially as the streaming services gain traction internationally. The multiple for the stock follows the market’s perception of the quality level of the company.

Happy investing everyone!

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