Source: Wikimedia
When a stock rises from around $45 to near $70 in a year, investors can get lost in the euphoria. With Walt Disney (DIS +1.72%) recovering its lost luster, the house the Mouse built is getting a lot of attention. That said, two things hold the company back from even better results in the future.
Leveraging the value of these brands
Just because Disney needs to address some issues doesn't mean the company is falling apart, far from it. In the most recent quarter, Disney beat two of its fiercest competitors in both studio and park performance.
If investors are wondering if the economy is improving, they need look no further than theme park performance at both Disney and Comcast's (CMCSA 0.87%) Universal Studios. Theme park spending falls far outside of a "necessity" for most and the fact that both companies reported strong sales growth is an encouraging sign.
Disney's parks and resorts division makes up more than 30% of its revenue , which is important because the division's revenue increased by 8%. Universal Studios also witnessed strong revenue growth of just under 8 %. With these strong performances, investors in Time Warner (TWX +0.00%) should probably start asking when a domestic Warner Bros. theme park will see the light of day?
While the company's theme park performance was impressive, studio performance could be even more important to Disney's future. In the last three months, the company's studios outperformed those of its peers. Time Warner's studio revenue dropped 7 %, and Comcast's studio revenue increased by less than 4%. By comparison, Disney's revenue was up by 7%.
In the current quarter, Disney benefited from Monsters University which compares with Brave last year. While quarter-to-quarter there will be variations, the strength of The Avengers franchise and the upcoming refresh of the Star Wars franchise should provide platforms for the company's studio division to propel profits for the next several years. In addition, as these new movies are released, they should help Disney push new toys and games into the marketplace.
Not as simple as ABC
The first issue facing Walt Disney is the company's media network division's performance. For all the strength of Disney's parks and studio operations, the company's media networks division is a mixed bag of challenges. It's clear that the company's ESPN properties are some of the most valuable on television. No matter who you are or whom you talk to, everyone knows the name ESPN equals sports.
However, where ESPN performs admirably, the ABC network offers a far less compelling lineup of shows. With the combination of these networks, the company's media networks division grew revenue by just 1%. Given that this division makes up almost 43% of revenue and 58% of operating income, lower performance in this division is a huge issue.
It would be one thing if the other networks were reporting slow growth as well, but this isn't happening. Comcast's NBC channels reported revenue up roughly 4% when you adjust for the lack of the Olympics this year versus last year. Time Warner's TBS and TNT stations plus HBO reported revenue up almost 5.5%. It seems clear that Disney needs to do something to turn around growth at this division.
Good acquisitions that could have meant more to shareholders
The second issue facing Disney is management's strategy of paying for acquisitions with stock. Normally when a company repurchases $4 billion in stock, shareholders are rewarded with a significant decrease in the company's share count. In the last year, Disney spent this amount on buybacks, yet the company's diluted share count declined by just 0.4%.
By comparison, Comcast retired 1.7% of its shares in the last year, and Time Warner did even better by retiring 3.6% of diluted shares. If shareholders are wondering why Disney's share count didn't decline as quickly, they need to look at the way the company has been paying for its acquisitions.
In the last few years, Disney bought Lucasfilm for about $4 billion using both cash and stock. When Disney bought Marvel, the company again spent about $4 billion in both cash and stock.
It's not that these acquisitions didn't make sense, it's just that their financing could have been done differently. Disney's balance sheet is much less leveraged than its peers. The company's debt-to-equity ratio is 0.26. By comparison, Comcast's debt-to-equity ratio is 0.88 and Time Warner's ratio is 0.64.
If Disney selected debt financing instead of stock in either one of the aforementioned deals, the company's share count would be lower. While it's true that the company would have more leverage and a higher interest expense, Disney's shareholders would have less share dilution. In the last four quarters, Disney generated over $5 billion in free cash flow and spent just $300 million on interest, so clearly more debt wouldn't cripple the company.
In the end, Disney has been a great value in the last year. However, considering the share dilution from acquisitions and the slow growth of the division that includes ABC, the company could be doing better. When you combine the significant increase in the company's stock price with these challenges, investors should be cautious about expecting similar increases in the stock price going forward.
