Disney Is Tier 1

"And, by the way, the bulk of the billions in Berkshire Hathaway (NYSE: BRK-B  ) has come from the better businesses...And most of the other people who've made a lot of money have done so in high-quality businesses." -- Charlie Munger 

At Tier 1 Investments, a Motley Fool Real-Money Portfolio, I seek out and invest in elite businesses. These include companies with the most valuable brands, best management, superior products, and strongest competitive advantages. I call these businesses Tier 1 enterprises, and Disney (NYSE: DIS  ) fits that description perfectly.

Timeless brands
Disney, ESPN, ABC, Pixar, Marvel -- Disney has a stable full of world-class entertainment brands that fuel its global marketing machine. Disney's empire includes movies, TV shows, and amusement parks, and the company earns a fortune licensing its vast collection of characters on toys and other items around the globe.

And now, Disney's licensing machine is about to get a huge boost from the recently announced acquisition of Lucasfilm. The House of Mouse is about to gain control of George Lucas' timeless Star Wars franchise, with new films planned beginning in 2015. While the $4 billion price tag  certainly isn't cheap, Disney has shown that it has the ability to purchase top-tier properties at a premium and still generate strong returns on investment, by funneling these iconic franchises through its massive international distribution and licensing network. I expect more of the same with Star Wars.

Great products, valuable assets, and a wide moat
Disney is the world's leading family-entertainment media company. It owns a vast collection of iconic characters that consistently help Walt Disney Studios create box-office hits while also generating a seemingly never-ending stream of licensing revenue. In addition, Disneyland and Disney World are forever popular vacation destinations for parents and their children, and Disney Channel is the No. 1 network with kids 2 to 11 and tweens 9 to 14. 

Crown jewel ESPN is indeed the worldwide leader in sports, with revenues expected to approach $9 billion in the year ahead. The company broadcasts more than half of all the live sports seen in the U.S. and earns one out of every four dollars earned by cable stations in America, causing Businessweek to label ESPN the "Everywhere Sports Profit Network."

Pixar and Marvel have helped to fortify Disney's already strong cast of beloved characters, with smash hits such as Toy Story and The Avengers not only earning impressive box-office revenue, but also driving strong licensing profits. And these are complementary businesses; Pixar added computer-animation muscle to Disney's traditional animation capabilities, Marvel's cast of superheroes helps Disney appeal to older fans, and soon-to-be-acquired Lucasfilm will add perhaps the most beloved sci-fi franchise to Disney's collection -- a popular genre that Disney has been lacking until now.

But it's Disney's ecosystem and distribution magic that help the company harvest the full value of its brands. The company maximizes the value of its properties by using them as characters in their movies and TV shows; attractions at Disney theme parks, resorts, and cruise ships; and centerpieces of its toy and game merchandise licensing strategy. It's a virtuous cycle that feeds on itself, and that ultimately allows Disney to generate strong and growing cash flows that it then returns to shareholders in the form of share buybacks and steadily rising dividends.

Strong leadership
Bob Iger became CEO of Disney in October 2005 and chairman in March 2012. He has instilled in the company a focus on three main strategic areas: generating the best creative content possible, fostering innovation and utilizing the latest technology, and expanding into new markets around the world. Iger has overseen the acquisitions of Pixar in 2006, Marvel in 2009, and Lucasfilm in 2012, all with impressive results. Over that time, Disney's profits  and share price  have more than doubled.

Risks
Unfortunately, Disney's empire is not immune to global economic slowdowns. A cutback in advertising would hurt Disney's media networks, and any substantial pullback in consumer spending would negatively affect sales of Disney merchandise and attendance at Disney's resorts and theme parks. But I see these risks as temporary in nature, since economies eventually recover in time.

If Disney were to begin overpaying for acquisitions, that would cause me to re-evaluate my investment thesis. I typically prefer companies that grow mostly organically, but Iger has a proven track record of strong capital allocation when it comes to acquisitions.

That leads us to what I consider the biggest risk in an investment in Disney. Iger has announced his plan to step down from his role as CEO in 2015, and from his position as chairman in 2016. That gives Disney's board of directors time to indentify Iger's successor, and the company has a strong bench of executives that are being groomed for the position.  With a potential blockbuster new Star Wars film scheduled to debut in 2015 and a host of theme-park renovations and expansions slated to come online by that time, Disney should be well positioned for success regardless of who is named CEO. But this is a situation I will be watching closely, as I am always wary of leadership changes and consider them a major risk until the new chief has earned my trust.

Valuation
Disney is trading at 14 times analysts' earnings estimates for 2013,  above analysts' expectations for 12% annual growth in the next five years.  That's a bit above what I typically like to see, but I believe investors are underestimating the profit potential of Disney's newly acquired Star Wars franchise, making Disney's shares significantly more attractive when based on potential 2015 earnings -- the year the first new Star Wars film is scheduled to open in theaters -- and beyond. And since I consider Disney to be one of the lower-risk businesses among Tier 1 portfolio candidates, I'm willing to accept a slightly lower return potential. But make no mistake: I expect Disney to substantially outperform the market in the years -- and potentially decades -- to come.

The Foolish bottom line
Disney is an elite business, with an enviable portfolio of valuable assets and timeless brands. Although shares are trading near all-time highs, I believe investors are still underestimating Disney's future earnings power. And so tomorrow I will be buying shares in the Tier 1 Real-Money Portfolio.

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  • Report this Comment On November 07, 2012, at 2:21 AM, meatmog wrote:

    if you look at my previous comments you will see that I was quite consistent on the rise of Disney.

    The acquisition of Lucasfilms alone is not the main headline here- it is the commitment to quality output. A robust succession plan is in place along with a blueprint for the next phase of the Star Wars franchise. This is no cynical landgrab but a marriage of two companies that already share a common vision. ILM will continue to work with other studios as an industry leader bringing in significant revenue streams and the LucasArts gaming elements have almost limitless potential.

    This is a $60 stock. The John Carter failure was a surprise to me as the DIS marketing machine has always been formidably effective. I feel that lessons have been learned and future Pixar/Marvel/Lucasfilm output will benefit.

    This series of acquisitions gives DIS large amounts of control over the lucrative 'tweenage' market an area that before the Marvel deal was very lacking. Furthermore each project will be assigned an appropriate budget that will attract the right talent.

    The Marvel success story bodes well for Lucasfilm's future within the House of Mouse

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