Why I Sold My Shares of Disney
I used to be a big fan of Disney stock. I thought because they had a tremendous moat and little-to-no competition that they would be a market outperformer. The “monopoly on happiness” as people like to say. But when the facts change you have to allow your opinions to change with it, and the pandemic has changed a lot about Disney’s business.
In this post, I’ll go through Disney’s four business segments (Media, Parks and Products, Studio, and Direct-To-Consumer) and analyze how they will be impacted by the virus. Then, to conclude, I’ll tie in the company’s valuation and balance sheet to explain why I don’t believe the risk is worth the reward for Disney shares.
Let’s get to it.
In the fourth quarter of 2019, Disney’s media networks brought in $7.36 billion in revenue and had an operating income of $1.63 billion. That is a 22% operating margin. Sales and OI were up over 20% because of the Fox acquisition (mainly FX and Nat Geo channels), but were down organically, mainly because of ESPN.
If you follow Disney, you know that ESPN is their biggest network. But for the last seven years it has struggled big time, losing 14 million cable subscribers. ESPN is the biggest carrier of live sports. Live sports, as we all know, are gone for the time being, and likely won’t be back to normal for a year or so.
This is going to crush ESPN (and therefore Disney’s Media segment) for at least a few quarters and probably longer. Demand/ratings for their channels are decimated, which means revenue will follow suit. And don’t forget that with the economy in shambles, ad rates will plummet from a lack of supply, even further hurting ESPN and really all of Disney’s linear TV business.
Media revenues will be down substantially in 2020, with negative operating margins, and likely won’t reach 2019 levels for 2-3 years. This is not a business I want to be invested in at the current price.
Parks and Experiences
High fixed costs and an unbeatable experience is a recipe for high operating profits. High fixed costs on no experience is a recipe for high operating losses. Disney’s Parks and Experiences segment is now in the latter.
In the fourth quarter of 2019 Parks and Experiences (which also includes cruises and physical merchandise, if you were wondering) revenue increased 8% to $7.4 billion. Operating income increased 9% to $2.3 billion. That is a 31% operating margin, and it shows why historically theme parks have been Disney’s strongest segment.
However, we must note that in order to achieve these high margins, Disney has to invest billions in capex every year. In the last quarter, that number was over $1 billion.
Theme parks and cruises, along with sporting events, will be the last things to fully recover from the pandemic. It may take years for operating margins to fully recover. Even if variable costs are down, the high fixed costs of rollercoasters and cruise ships will still incur, bringing in ginormous losses for Disney. This is not a business I want to be invested in.
Movie theaters are closed and will be for a while. This will crush an already dying industry. Granted, Disney’s movie studios have thrived in this market, with 2019 being the biggest year ever for any individual studio. This translated to $3.8 billion and $948 million in revenue and operating income for the segment in the fourth quarter.
It will never reach that level again. A lot of this revenue will shift to the DTC segment (Hulu/Disney+), but some of it will be lost forever. You might ask, why can’t they just charge $20 to stream the new Avengers movie at home? This seems like a reasonable argument, and one I thought would work, but once you read this LightShed piece you’ll realize it is a pipe dream, even for someone the size of Disney.
Studio Entertainment is a smaller segment than Parks or Media, but is still important for the overall customer flywheel. Eventually, all this will have to move over to the DTC segment (as will media). But can that be achieved while growing revenue/profits for the entire Disney company? I have my doubts.
DTC is Disney’s big growth engine. With the launch of Disney+ in 2019 and the Dis+/Hulu/ESPN+ bundle, segment revenues took off like a rocket. Q4 2019 sales were $4 billion, up from $0.9 billion a year before (some inorganic growth from Fox acquisition, we should note), with a $693 million operating loss. The operating loss is expected, as subscribers have not caught up with the heavy investments they are making in the business.
That quarterly revenue number should at least double by the end of 2020. Disney+ already has 50 million subs, Hulu has 30 million, and ESPN+ likely has less than 10 million. If, by the midpoint of 2020, Disney has 100 million digital subs that pay an average of $8 a month (ARPU is just a guess, but you have to take into account high-paying Live TV subs), that is $2.4 billion in quarterly revenue from their three big streaming services. This would not include HotStar India or any of Disney’s international media businesses.
Can these eventually replace the media and studio businesses? Yes, but not in 2020. Revenue from this segment, if we think optimistically, should offset media/studio losses in a few years, with profits to come a few years after that. That was fine pre-COVID-19. Now, it leaves huge problems.
Stock is Not Reflecting Reality
Disney trades at an enterprise value of $224 billion. They have $41 billion in net debt and 3 out of 4 business segments getting crushed by the economic downturn/no live sports. The Fox acquisition now looks like a big mistake ($70 billion for HotStar, Nat Geo, FX, and The Simpsons?). What’s more, the company is still paying out its dividend and plans to give out some of its executive compensation (at least for the time being) while furloughing/firing thousands of workers.
I think Disney is going to be in some trouble in the short-term. There’s no way this company should be valued at 25-times estimated 2022 earnings with their balance sheet and growth trajectory.
Long-term, do I think Disney will be a fine investment? Maybe. I do know some smart investors who like the stock, and see no reason why in 50 years these stalwart brands can’t still provide value. But I don’t see how, over the next five years, Disney is a market-beating investment.
And that is why I sold all my shares in the company.
Disclosure: The author is not a financial advisor, and may have an interest in the companies talked about.