Disney’s (NYSE:DIS) stock gained over 30% in 2012, thanks to the continued strong results at ESPN, an improved performance from the Disney Channel, a recovery in parks and resorts and a successful blockbuster produced by its film entertainment unit. Even though overall revenue growth was not stellar, there was a notable improvement in profitability as margins grew across all business segments. Disney has high operating leverage as the bulk of its costs are fixed. Therefore, any improvement in revenues directly impacts the margins. This was especially visible in its parks & resorts business, which benefited from improvement in attendance as well as per capita spend.
As we enter 2013, we expect Disney to build further on the success it witnessed in 2012. The momentum it gained is likely to continue, given the strength of its brand across its businesses. There is virtually no strong competitor for ESPN and Disney’s parks and resorts. In addition to this, the company’s film studio owns a bunch of highly successful franchises, owing to some recent acquisitions. This bodes well for Disney’s future movie releases.
ESPN And Disney Channel Drove Cable Networks
Disney saw growth in both revenues as well as margins for its media networks business. This business is dominated by ESPN, the Disney Channel and ABC Broadcasting. While broadcasting remained more or less flat, cable networks saw good growth in revenues and operating income. This was driven by an improved advertising market and contractual increases in fees per subscriber.
We estimate that ESPN will bring close to $11 billion in revenues for Disney in 2012. These include revenues from primary ESPN channel as well as its other sister channels such as ESPN2, ESPNU, ESPNEWS, ESPN Classic and ESPN Deportes. A large chunk of these revenues, approximately $10.3 billion, will come from ESPN and ESPN2 alone. If we dig deeper, we find that close to $9.1 billion will come from just ESPN, with ESPN2 contributing approximately $1.2 billion in 2012. The channel has close to 100 million subscribers in the U.S., which speaks of the huge demand as well as bundling strategies that pay-TV service providers adopt.
Additionally, ESPN charges more than $5 per month per subscriber, by far the highest carriage fee in the pay-TV industry, with the exception of a few premium cable networks such as HBO. In addition to over $6 billion generated through subscription fees, ESPN generates close to $3 billion in ad revenues. ESPN enjoys an average daily viewership of over 1 million and charges high ad prices from its advertisers. We estimate this pricing to be around $16-$17 per 1,000 impressions. This accounts to a huge amount, but its advertisers are big companies with high spending capacity that target male audiences (typical audience for sports channels).
Besides ESPN, the Disney Channel is another flagship channel for Disney. In 2012, it surpassed Viacom’s (NASDAQ:VIA) Nickelodeon to become the top-rated channel on cable. As expected, the performance paid off, and Disney stated that the channel was the prime driver of cable networks revenue growth in Q3 fiscal 2012, due to a contractual increase in subscription fees. Nevertheless when seen in context of the whole company and compared to ESPN, the Disney Channel is still a small value contributor.
Ratings Pressure Existed
While the increase in subscription revenue due to higher pricing has aided Disney’s media networks, the advertising revenue has remained more or less flat, as the higher ad pricing was mitigated by ratings declines. This decline was not just seen in Disney’s ABC broadcasting network but also its flagship channel ESPN. Some of this can be attributed to broadcast of Olympics, and this leads us to believe that the decline in ESPN’s viewership is not a long term trend, but rather a short term anomaly.
We expect ESPN to be able to maintain its programming lead over other sports networks in the future. However, ABC broadcasting’s revenues were flat for the whole fiscal year 2012, implying a sustained decline in viewership. Disney needs to offset this decline with higher licensing and retransmission deals. CBS (NYSE:CBS) seems to be doing a pretty good job at this.
Parks & Resorts Did Well
We estimate that Disney’s parks & resorts business contributes close to 15% to its stock value, despite accounting for 30% of its revenues and 25% of its EBITDA (earnings before interest, taxes, depreciation and amortization). This is due to higher capital expenditures that soak up potential free cash flow. The resorts business also has high fixed costs and is heavily influenced by the general state of the economy and consumer confidence. There was improvement in these metrics and Disney’s theme parks saw higher attendance as well as higher per capita guess spend. Close to 71 million people visited Disney’s U.S. theme parks as per our estimates and spent on average $114 per person. In addition to the improving economy, the success of Disney’s new cruise also helped.
Movie Business Recovered From John Carter’s Failure
The failure of the Sci-Fi movie, John Carter, early in 2012, created a concern around launch of big budget movies. The movie resulted in loss of close to $200 million for Disney. However, that did not discourage the company from launching another big budget movie, Avengers, that went on to become a blockbuster hit. Even though we did not see revenue growth in Disney’s movie business in 2012, there was improvement in profits because costs were limited to fewer movies. Avengers single-handedly drove a significant proportion of these profits. We estimate that movie business constitutes close to 10% of the Disney’s value.
Avengers has developed into an important franchise for Disney, and the company’s several other businesses such as cable networks, broadcasting, consumer products etc. are working to leverage this franchise to boost their own sales. The true value of such franchises is not limited to box office or DVD sales.
Disney is planning to leverage Marvel’s characters, its animation unit’s efforts and its recent acquisition of Lucasfilm, to bring more potentially successful movies over the course of next few years. The sequel of Avengers and some other movies based on characters such as Iron Man, Thor and Captain America, are lined up for the next couple of years. This suggests that Disney could continue to perform well in the movie business.
Efforts In Mobile & Social Games
Disney made several efforts to increase its presence in mobile and social gaming. Following the success of some of its initial mobile games that topped the charts among paid Apple (NASDAQ:AAPL) apps, the company launched more new games that leverage its popular characters. These include Monsters Inc. Run, Finding Nemo Reef and Where’s My Holiday.
A typical gaming app sells for $0.99 per download on Apple’s app store. If we assume that Disney’s games are downloaded about 50 million times a year, which is quite optimistic, Disney would earn close to $35 million in annual revenues, after accounting for Apple’s cut. Given that its consumer products and video gaming businesses together earn more than $4 billion annually, the incremental benefit is limited on a relative basis. In fact, the profits from the gaming division are negative, implying that Disney is actually losing money in this business.
However, Disney still pushed for games in order to better engage its consumers. This provides cross marketing opportunities for Disney’s other businesses and keeps the brand image stable in its customers’ minds. For example, Disney could easily promote its movies, consumer products and theme parks via games. Apart from mobile gaming, the company also launched some social games on Facebook, based on its popular characters and franchise.
Our price estimate for Disney stands at $54.60, implying a premium of about 10% to the market price.