Disney

Trading at $16.46 on Feb. 10, 2003

Yep, everyone hates the mouse these days.

And, if you're looking at the financial statements, you can certainly see why. This behemoth, this entertainment juggernaut went from providing shareholders with $3 billion or so in free cash flow per year through Sept. 2001 to a little more than $1.2 billion in fiscal 2002. It has a swooning TV network in ABC, lower gate receipts at its parks (particularly the brand-new California Adventure), owns cruise ships that make people sick, and suffered a dismal movie failure this past year in Treasure Planet. Above all else, it has an executive in Michael Eisner whom no one seems to like or even trust. Just how hated is Disney(NYSE: DIS)?

Hang 'em high! The mouse is dead!

"Long live the mouse," I say. First of all, Treasure Planet was a good movie. I liked it. And the Disney-owned Anaheim Angels won the World Series. Further, Jean-Sebastien Giguere, goalie for the Disney-owned Mighty Ducks of Anaheim, is a standout on my fantasy hockey team. See? Everything better. Buy Disney.

Oh, OK, I'll give you a little more. At present, the company, with a $33 billion market capitalization, is trading at a price to free cash flow of approximately 27 from the trailing-12-month results. That's pretty pricey. But here's the question: "Do we think that the last 12 months in any way represent Disney's future earnings power?" I dare say no.

Few companies were hurt worse by the Sept. 11 attacks than Disney. Its resorts -- which include Disney World, Disneyland, Epcot, Tokyo Disney, and Eurodisney -- saw an 8% decline in revenues between 2001 and 2002. Its media networks are down 4%. Doesn't sound that bad, does it? Ah, well, both businesses have very high fixed-cost elements to them. Each additional customer or dollar beyond that breakeven point is extremely high dollar, so profits from these segments just from losing those small percentages of revenues come in 26% and 49% lower, respectively.

Disney cannot operate in an environment that doesn't exist. And right now, the operating backdrop for tourism, in the midst of an international threat of war and terrorism, is not great. Nor is the advertising climate, described by many in the industry as a 100-year storm. Disney's asset values in these areas are nothing short of astounding. Despite its missteps and a significant rebuilding job ahead of it at ABC, if it just claws back to its average free cash flow generation from the previous four years, it would be at a current multiple of 10.

ESPN reaches 87 million households in the U.S. alone, another 119 million worldwide, and owns five other sub-brands. Cable networks can go without just about anything, but ESPN is one of the few "must-have" channels. Thank heavens, my local cable network doesn't have ESPN Classic, or I would have long since been divorced: "Let me get this straight. You're watching a Detroit-Colorado game from 1997? You know how it ends!!!!"

Yep, ESPN is one of the world's great businesses, period. It has built into its contracts with cable operators some substantial price increases over the next few years, so it promises even more. ABC is more of an issue, as it is currently losing more than $600 million per year. Again, the advertising environment is lousy, but the network has been on the losing side of programming versus its main rivals for some time. A quick look at its lineup tells you exactly what the ratings already do: It's hurting. Perhaps it can build around Eight Rules for Dating My Teenage Daughter, a hit from this past year. We'll see. But ABC is in no danger of collapsing, and these things are cyclical. Even marginal improvements in viewership substantially enhance revenues.

And that's the story with Disney. People look at its gaudy multiples and say, "Wow! That's expensive!" Then they look at the price tag of Michael Eisner's employment contract and say, "Wow! That's expensive!" But only one of the two is really the case.

Disney's multiples are expensive only if you believe that the current economic, political, and advertising atmosphere will persist. Though they may be ongoing, they are not permanent, and Disney has plenty of financial power to weather the storm. These things would have been a much larger concern when the stock was double where it is today -- but as it is right now, people just hate the mouse.

Not me, man. I think the mouse is just playing possum.

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