Is Disney a Buy?

Walt Disney (NYSE: DIS  ) CEO Bob Iger is a thief and poised to make out like a bandit. And you know what? I love that about Iger, and Disney.

I wasn't always this cheerful about the Magic Kingdom. In August, when Disney made a $4 billion bid for Marvel Entertainment, I cried foul. The comic book king had accounted for more than 20% of my portfolio, and was, by my math, still undervalued at $4 billion.

"Disney gets Marvel for just north of 20 times earnings. That sounds expensive, I know. Here's why it isn't: Long before Iron Man was a box-office blockbuster, Marvel was boosting operating income by 28% a year," I wrote at the time.

Marvel officially ceased to exist as an independent company on Dec. 31, 2009. Disney shares have run about even with the market in the months since, which I'm not so sure is fair. Isn't Marvel a catalyst for this business, just as Pixar was? And shouldn't we be encouraged that the largest single shareholder is Apple's (Nasdaq: AAPL  ) Steve Jobs? 

Good questions, all. Let's dig into both the bull and bear arguments for Walt Disney.

The bull argument
Buyers will tell you that Marvel is remaking Disney. "After its acquisition of Marvel, Disney is now armed with tools it has been missing for years and will be able to capture more of the men's (and boy's) entertainment market," wrote Foolish investor ALevolved two weeks ago in this pitch.

Broadly speaking, ALevolved is referring to the entertainment gender gap that the House of Mouse has had trouble bridging. Preteen boys are more likely to gravitate to superheroes and sports than to princesses and Hannah Montana. My daughter loves Disney; my sons prefer Marvel and Hasbro (NYSE: HAS  ) , whose Transformers and G.I. Joe characters are favorites among boys.

Our oldest son (10) is much more likely to get his entertainment from Google's (Nasdaq: GOOG  ) YouTube or News Corp.'s (Nasdaq: NWS  ) Speed Channel than he is anything Disney offers. He's typical in this regard. A 2008 report from Nielsen Online found that kids aged 2-11 spent 118 minutes per month looking at online video. YouTube was by far their preferred streaming source; DisneyChannel.com was a distant second. Disney needs Marvel to attract more of the male subset of this YouTube Generation.

Fortunately, help is on the way. Reactions to the latest trailer for Iron Man 2 suggest a massive opening weekend and perhaps another $300 million box office. If that does come to pass, it will be in no small part due to preteen and teen boys spending to see Robert Downey Jr. and Mickey Rourke swap punches on the big screen. Iron Man 2 opens May 7 nationwide.

The bear argument
If there's a problem with Disney, it's with the valuation. The smart Fools at our Motley Fool Inside Value service still recommend the stock, but they also say, at these levels, the company is fairly valued. New investors shouldn't expect much in the way of immediate upside.

By the numbers, my friends at Inside Value are absolutely right. Capital IQ shows Disney trading for 17 times this year's average earnings estimate, which calls for roughly 9% year-over-year growth. Put in context, this means Disney is more expensive than go-go growers such as Green Mountain Coffee Roasters (Nasdaq: GMCR  ) , which trades for a fraction of the 80% earnings growth analysts expect this year, and Celgene (Nasdaq: CELG  ) , which is priced about in line with the Street's 2010 projections.

Disney's also worth $65 billion in market cap, which puts it at a severe disadvantage, according to one of my Favorite Fools, HollywoodDan. Here's his bearish pitch from early February:

At best, the big guys match the market. You don't grow by paying $11 billion for companies and then trusting that your giant machine can maximize the profits on all the creativity. Far more likely they get nibbled at little by little as generations wake up and realize ESPN and Disneyland are bastions of retardation. Behemoths are logically not likely to prosper in an age that demands speed.

That's a fair point. Over the long term, small caps tend to beat large caps, and large caps don't come much bigger than Disney.

Recommendation: Buy to hold
Disney isn't likely to make much of a move in the short term. Sure, Iron Man 2 looks like a nice catalyst, but it's also a small piece of a very big puzzle in which theme parks and TV networks account for close to 75% of revenue.

Still, Disney is about as stable a media stock as you'll find, and pays a decent if below market 1% dividend yield. Today's buyers should reinvest those payouts over the long term, counting the incremental gains in license revenue and return on capital from the Marvel theft ... I mean, purchase ... as a welcome bonus.

Would you buy Disney at current prices? Discuss in the comments box below.

Apple, Disney, and Hasbro are Motley Fool Stock Advisor selections. Disney is also a Motley Fool Inside Value pick. Google and Green Mountain Coffee Roasters are Motley Fool Rule Breakers recommendations. The Fool owns shares of Hasbro. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He had stock and options positions in Apple and stock positions in Disney and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy wants to know where it can buy suitcase armor. Because, really, nothing says cool like suitcase armor.


Read/Post Comments (11) | Recommend This Article (16)

Comments from our Foolish Readers

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  • Report this Comment On March 23, 2010, at 12:12 PM, manutd45 wrote:

    I would buy Disney at the current price if I had the money. It seems to me that a company composed of the likes of Marvel, Pixar, ESPN and the rest of what Disney has to offer should be worth atleas $40 a share. I know there are many who will not agree with me but the fact remains that many many people will spend money on the Disney brand this year and the company will most likely and again beat the market estimates.

  • Report this Comment On March 23, 2010, at 3:34 PM, esxokm wrote:

    Tim,

    Great article; you represented both sides of the Disney coin in a balanced way.

    Some observations:

    Disney's dividend is deplorable. Check out the cash-flow statement -- they should be paying more, and on a quarterly basis, to boot.

    Disney should see some action from the Marvel buy, but we must, instead of simply counting on a bright future, pontificate on the facts of the past: if you look at the long-term price action, you'll note that the Pixar buy didn't seem to do much. And, going back to the dividend, the payout history is not on par with other blue-chip Dow memembers.

    I do believe Marvel, Iron Man 2, Prince of Persia, and Toy Story 3 will bring Disney shares to $40 by the summer. I can't predict the direction of the market, of course, but if these catalysts don't, then I'm not sure how long-term shareholders can be happy about the Pixar and Marvel purchases. It would almost be a manifest issue at this point to consider that, intended or not, the Pixar acqusition was in essence made for Toy Story 3. For obvious reasons.

    Valuation is tough on the thesis, but perhaps the Mouse deserves the premium. At the very least, it should head to somewhere between $40 and $50 before consolidating. Unless the market simply finds too much risk with the movie business. Keep in mind that Marvel may have been "undervalued" because you really can't predict the movie business -- not only in terms of whether a movie bombs or not on an absolute basis, but whether, over time, a company's model continues to be attacked by talent claims on cash flow. That's the one thing I worried about with Marvel and its famous box-office-to-operating-income chart: how could you truly tell what a movie was worth if you couldn't also define how the stipulations of talent contracts would evolve?

  • Report this Comment On March 23, 2010, at 9:29 PM, jpaa74 wrote:

    Disney has a HUGE moat, but is it worth the price? Not at these levels in my opinion. I'd rather keep waiting for another pitch and not strike out.

  • Report this Comment On March 23, 2010, at 9:29 PM, jpaa74 wrote:

    Disney has a HUGE moat, but is it worth the price? Not at these levels in my opinion. I'd rather keep waiting for another pitch and not strike out.

  • Report this Comment On March 23, 2010, at 10:10 PM, SwampBull wrote:

    Tim,

    I would like your opinion on the Marvel deal with regards to how Disney will receive licensing rights to the mother of all superhero license cash cows, Spider-Man.

    I have read that Disney's deal does not result in an immediate ownership of licensing rights to Spider-Man, who is still pretty much Sony's action-figure-in-chief until otherwise (really don't know the full terms here). On a side note, Universal will have to undergo a major renovation of its Islands of Adventure theme park, which contains a Marvel Superhero Island. How's that for irony - Disney's characters are now prominently displayed in a competing theme park!

    Recognizing that the Spider-Man movies have been played out for the most part, and with rumors abound that Tobey Maguire and Sam Raimi will not return for the 4th installment (might as well go straight to video if that's the case) perhaps Spider-Man matters less to Marvel's revenue stream than Iron Man, Hulk, and the other up and coming film stars. But wait! We're talking about SPIDER-MAN. The AMAZING Spider-Man. Radioactive... you get the point. He's the biggest franchise of the whole Marvel Universe!

    So - what's your take?

  • Report this Comment On March 23, 2010, at 10:23 PM, esxokm wrote:

    Philip,

    You bring up some really good points from a fundamental perspective. In my own comment box, I believe I echoed a portion of your stance, albeit from a decidedly technical standpoint.

    This begs the question: Will shareholders, who, at the end of the day, want to see, at the very least, a higher dividend, ever receive anything from the Pixar/Marvel deals? Is Iger the genius many think he is?

    My argument that Disney should be trading higher than $40 goes a little like this: going over $40 would be breaking through multi-year lows. If Marvel can't at least get the institutions to break through that level by summer, honestly, I see nothing that will. What else can Disney buy?

    To snowballinvestor: Disney does have a moat in terms of brand, so perhaps that could be a justification for valuation. Of course, it is difficult to say how sturdy the moat is; intangible content generation isn't as unique as the secret recipe for Coca-Cola...

  • Report this Comment On March 24, 2010, at 2:28 AM, TMFAdmiral wrote:

    Hi esxokm,

    Yes you could very well be right that the share price could trade higher than $40 in the short term especially if there are a couple of highly profitable Marvel/Pixar movies in a fairly short period of time. But I'm not betting on that and imo even those events don't make Disney much more valuable imo. OTOH if that was allied to a rebound in Theme Parks & Media Networks it certainly could happen. This is a better argument for Disney imo as Marvel can't do it alone.

    Of course market price can also exceed fair value if short term expectations are high :-)

    Best Regards

    Philip

  • Report this Comment On March 24, 2010, at 1:36 PM, TMFAdmiral wrote:

    Hi Everyone,

    I originally posted this at 6.18pm last night but we had to remove it as it was accidently attributed to 'jimofarabia' whoever he is instead of me TMFAdmiral!

    Excellent article Tim - very well balanced and I have to agree that Marvel would have been better out of the clutches of Mickey Mouse as shareholders had a better chance of benefiting from Marvel as a standalone.

    Marvel was a great company & good investment but one can't transfer the "growth hype" to Disney because Disney is just way too large for Marvel to do a whole lot to increase Disney's growth rates. I see way too many arguments touting Marvel as catalyst for a major jump in Disney's value - sure it could make some difference but there are other pieces of the Disney puzzle that have a far larger effect.

    In 2009 Disney's revenues were $36 billion and net income was $3.8 billion (adjusted for one-time items). Assuming Marvel was bought at fair value adding the last 12 months figures I have (to September 09) up's these figures to $36.7 billion and $4 billion. So Marvel hardly makes a dent in the revenue but does improve the profit margin by 0.35% but then again Disney paid for much more than that. If Marvel's revenues doubled it would increase Disney's revenues by just 1.9%. If net income doubled then Disney's net income improves by 5.4%. Even in the Disney empire I doubt that can happen in much less than 3 years (that's roughly 25% growth per year compounded).

    It's instructive to look at what has happened to Disney's Studio Entertainment division since they acquired Pixar for $11 billion in cash & stock. Back then this division had revenues of $7.5 billion and even after acquiring Pixar revenues actually declined in 2007 and 2008 - not that Pixar wasn't doing well for Disney but other properties declined to offset the Pixar benefit. For 2009 this division crashed to $6.1 billion in revenues. So my question here would be is Marvel, like Pixar, replacement revenue for other properties that are in decline? Of course Consumer Products division will also be boosted by Marvel and that was boosted by Pixar and actually has held up pretty well but with $1.1 billion in revenues is much smaller.

    Theme Parks annual revenues are still in the $10.7 billion range and Media Networks at $16.2 billion

    Also Media Networks are 68% of the operating profit contribution (ie before corporate overhead)

    So if you have a high valuation for Disney it has to come from a better growth projection in Media Networks

    Marvel is a great property & the jury is out on whether Disney paid fair value, paid too much or got a steal. My main point is that even if they got a steal it will not move the needle on the valuation by more than a few dollars - certainly not $10 or more as I've seen mentioned. For that to happen you have to believe that the rest of Disney will grow revenue a lot faster than the 3.3% per year it has done over the last 5 years (including Pixar).

    Best Regards

    Philip

    Advisor, Motley Fool Inside Value

  • Report this Comment On March 24, 2010, at 2:10 PM, TMFMileHigh wrote:

    Hello SwampBull,

    Thanks for writing and for your question. Thanks also to Philip for weighing in.

    >>I have read that Disney's deal does not result in an immediate ownership of licensing rights to Spider-Man, who is still pretty much Sony's action-figure-in-chief until otherwise (really don't know the full terms here).

    Marvel and Sony created a joint venture as part of the movie franchising deal that allowed the comic book co. to escape bankruptcy. When Marvel was an independent co., earnings from this JV were reported to Marvel as if it was a separate business, because contractually, it was and still is.

    It was a beauty of a deal for Sony. All it had to do was pay Marvel a regular fee to re-up movie rights to the entire universe of Spider-Man characters. So long as a movie was made in the period covered -- 3-5 years, I think -- Sony wouldn't lose the movie rights. What's more, any merchandise revenue generated from a Sony Spider-Man production would be shared between the two, via the Spider-Man JV.

    Starting to see what Marvel created its own studio? The terms of this JV virtually guaranteed Sony outsized profits any blockbuster. Marvel, not so much.

    The problem for Disney here is the word "universe." Sony has the movie rights to *any* character that traditionally appears in Spider-Man comics, including Mary Jane Watson if it so desires. Disney can either buy its way out of this deal -- unlikely, Sony loves it too much -- or simply deal with it, choosing instead to focus on characters to which it owns the movie rights.

    Iger is a smart guy; he'll choose the latter.

    Now, before you get too disappointed, remember that there's great misunderstanding about how Marvel structured its studio. Philip's right that Marvel is a bit player in the Disney stage act, but steps taken by management last year virtually guarantee that IM2 is going to generate a *lot* more earnings that IM1 did. Here's more on the changes:

    http://www.fool.com/investing/general/2008/10/02/buffett-sho...

    So while you have every right to be disappointed that Spidey isn't yet a full member of The Mickey Mouse Club, don't buy the hype that Marvel doesn't have much to offer Disney because of these restrictive agreements, or that an emerging peer like Hasbro has a fundamentally better model than Marvel's. It's bunk.

    Hasbro is a great business, sure, but David Maisel and the team at Marvel negotiated one of the great studio deals *ever*, which Disney now owns. I'm willing to hold my shares and collect the incremental revenue and earnings gains that should follow as a result.

    Does this help? I hope so.

    FWIW and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On March 30, 2010, at 10:27 PM, SwampBull wrote:

    Thank you Tim for the acute insights!

    I am curious why you state that Iger is too smart to buy Spider-Man out from under Sony - either you are suggesting that Sony would demand too high a price, or that Spider-Man is too played out after the 2 sequels for it to be worthwhile. If I ran Disney, my thought process would read more along the lines of "if Sony ever gets tired of Spidey, I'll make an offer"...

    Regardless, thank you again for the detailed and thorough answer to my question.

  • Report this Comment On March 30, 2010, at 10:49 PM, SwampBull wrote:

    Well it looks like my response was tossed to the ether, so here goes my second try at it:

    First, thanks for the thorough and insightful answer you have provided. I am unsure whether Iger will leave Spider-Man be or if he will try to scoop him up someday, but in any case it seems that Disney has gained a little market share in the licensing/branded products categories with the acquisition. That being said, I fully agree with Philip's analysis, and those who say Disney's stock may as well have the ticker "ESPN" when it comes to sources of revenue.

    The real question for Disney in general will be: can Iger keep the magic strong at Disney and its place as a premier entertainment source in the changing tides of media distribution - in the YouTube age of media.

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