Important disclosures appear on the last page of this report. The Henry Fund Henry B. Tippie College of Business Cooper LaRue [[email protected]] The Walt Disney Company (DIS) Oct. 4, 2020 Communications Services- Media & Entertainment Stock Rating Buy Investment Thesis Target Price $150-160 The Walt Disney Company is a household brand in video content and park entertainment worldwide. We believe this market positioning will improve as Disney expands its global footprint by creating content targeted at international markets and further translating existing content. We also believe Disney is well positioned to become a top contender in streaming services with their recent launch of Disney+, coupled with their 67% ownership in Hulu after acquiring 21 st Century Fox last year. We recommend a buy rating with a price target of $150-$160, implying a 27% upside. Drivers of Thesis • We are forecasting a 7% 4-year CAGR in international media and studio markets as Disney has started focusing on content specifically for international populations, mainly in the Asian Pacific region. • With the acquisition of 21 st Century Fox last year, Disney now has one of the strongest libraries of content that will allow them to compete with Netflix leveraging Disney+, ESPN+ and Hulu. • As emerging markets further develop, we expect demand for more Disney theme parks just like we have seen in Shanghai, leading to continuous 5% growth in their parks & entertainment division for the next 5 years. Risks to Thesis • Disney’s ability to create adult focused content has not been proven, and they will need to create content for this demographic to keep consumers re subscribing to Hulu and Disney+. • The prolonged effects of COVID-19 could force Disney to take on more debt to cover fixed costs on their parks as well as create lasting effects on consumers confidence in spending money on vacations. Henry Fund DCF $168 Henry Fund DDM $115 Relative Multiple $139 Price Data Current Price $122 52wk Range $79-153 Consensus 1yr Target $136 Key Statistics (*5Y Avg.) Market Cap (B) $232 Shares Outstanding (M) 1,807 Institutional Ownership 66% Beta 1.14 Dividend Yield 0% Est. 5yr Growth 4.4% Price/Earnings* 17.60 EV/ EBITDA* 12.30 Price/Sales* 3.38 Price/Book* 3.40 Profitability (*5Y Avg.) Operating Margin* 23.5% Profit Margin* 17.1% Return on Assets* 10% Return on Equity* 20.9% Earnings Estimates Year 2018 2019 2020E 2021E 2022E 2023E EPS HF Est. $8.40 $8.40 $6.27 $6.27 ($1.17) ($1.10) $1.96 $.95 $4.32 $3.28 $5.05 $5.33 Growth 47% (25%) (118%) 186% 246% 63% 12 Month Performance Company Description The Walt Disney Company is an international entertainment company whose brand recognition and cultural impact is second to none. Company segments include cable networks, production studios, theme parks, resorts, cruise lines, merchandise and streaming services. Revenues are 72% concentrated in North America but recent theme park expansion in China and Japan are diversifying Disney’s graphical presence. 19.6 15.0 18.1 34.6 9.9 10.4 0 10 20 30 40 P/E Net Margin % EV/EBITDA 2019 Metrics DIS Competitors -50% -30% -10% 10% 30% S O N D J F M A M J J A DIS S&P 500 Source: Yahoo Finance
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The Walt Disney Company (DIS) Oct. 4, 2020The Walt Disney Company is an international entertainment company whose brand recognition and cultural impact is second to none. Company segments
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Important disclosures appear on the last page of this report.
Communications Services- Media & Entertainment Stock Rating Buy
Investment Thesis Target Price $150-160 The Walt Disney Company is a household brand in video content and park entertainment worldwide. We believe this market positioning will improve as Disney expands its global footprint by creating content targeted at international markets and further translating existing content. We also believe Disney is well positioned to become a top contender in streaming services with their recent launch of Disney+, coupled with their 67% ownership in Hulu after acquiring 21st Century Fox last year. We recommend a buy rating with a price target of $150-$160, implying a 27% upside. Drivers of Thesis
• We are forecasting a 7% 4-year CAGR in international media and studio markets as Disney has started focusing on content specifically for international populations, mainly in the Asian Pacific region.
• With the acquisition of 21st Century Fox last year, Disney now has one of the strongest libraries of content that will allow them to compete with Netflix leveraging Disney+, ESPN+ and Hulu.
• As emerging markets further develop, we expect demand for more Disney theme parks just like we have seen in Shanghai, leading to continuous 5% growth in their parks & entertainment division for the next 5 years.
Risks to Thesis
• Disney’s ability to create adult focused content has not been proven, and they will need to create content for this demographic to keep consumers re subscribing to Hulu and Disney+.
• The prolonged effects of COVID-19 could force Disney to take on more debt to cover fixed costs on their parks as well as create lasting effects on consumers confidence in spending money on vacations.
Henry Fund DCF $168 Henry Fund DDM $115 Relative Multiple $139 Price Data Current Price $122 52wk Range $79-153 Consensus 1yr Target $136 Key Statistics (*5Y Avg.) Market Cap (B) $232 Shares Outstanding (M) 1,807 Institutional Ownership 66% Beta 1.14 Dividend Yield 0% Est. 5yr Growth 4.4% Price/Earnings* 17.60 EV/ EBITDA* 12.30 Price/Sales* 3.38 Price/Book* 3.40 Profitability (*5Y Avg.) Operating Margin* 23.5% Profit Margin* 17.1% Return on Assets* 10% Return on Equity* 20.9%
Earnings Estimates Year 2018 2019 2020E 2021E 2022E 2023E
EPS HF Est.
$8.40 $8.40
$6.27 $6.27
($1.17) ($1.10)
$1.96 $.95
$4.32 $3.28
$5.05 $5.33
Growth 47% (25%) (118%) 186% 246% 63%
12 Month Performance Company Description
The Walt Disney Company is an international entertainment company whose brand recognition and cultural impact is second to none. Company segments include cable networks, production studios, theme parks, resorts, cruise lines, merchandise and streaming services. Revenues are 72% concentrated in North America but recent theme park expansion in China and Japan are diversifying Disney’s graphical presence.
19.6
15.018.1
34.6
9.9 10.4
0
10
20
30
40
P/E Net Margin % EV/EBITDA
2019 Metrics
DIS Competitors
-50%
-30%
-10%
10%
30%
S O N D J F M A M J J A
DIS S&P 500
Source: Yahoo Finance
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COMPANY DESCRIPTION
Founded in 1927, The Walt Disney Company has remained a staple in Media and entertainment worldwide. Their characters and stories are household names and have had cultural impacts on all of us. Disney’s operations include Media Networks, Parks & Experiences, Studio Entertainment and Direct-to-Consumer. Disney’s media networks and parks are currently 72% of revenue and have always been core to their business. Disney also consistently produces some of the best performing movies every year from their studio entertainment division which accounts for 16% of revenue. The smallest, but quickest growing, segment is their direct-to-consumer business which now includes revenue from Disney+, ESPN+ and their 67% ownership of Hulu. Below is a revenue decomposition and further detail about the revenue segments of Disney.
Media Networks
The Media Networks segment includes cable and broadcast television networks, television production and distribution operations, domestic television stations, radio networks and stations. Notable network brands include Disney, ESPN, Freeform, FX, National Geographic and 50% equity ownership in A&E T.V. Disney also owns ABC broadcasting networks, Twentieth Century Fox and Fox 21 Television Studios.
Revenue from this segment is derived from advertising and leasing content to other distributors such as Netflix and Amazon Prime Video or other programing networks.
We forecast relatively low growth in this segment with domestic markets at 3% growth for the foreseeable future, but international expansion growing at 7.5% CAGR for the next 4 years and declining to 2% growth in 2028. While domestic media network markets are saturated, Disney has grown internationally through added foreign content and further translation into more than 30+ languages, driving viewership in emerging markets.
Parks & Experiences
Parks and Experiences have always been core to Disney’s brand. This includes iconic vacation spots like Disneyland, Disney World, Disney cruise lines, Disneyland Paris, Hong Kong Disneyland, Toyko Disneyland and most recently opened in 2016, Shanghi Disneyland. In total, Disney owns 13 theme parks worldwide.
Revenue from these parks comes mostly from ticket revenue and additional in park experiences. Due to COVID, most parks were closed for a large portion of 2020. Most of their parks are now open, but attendance is low due to significant capacity restrictions and people worried to travel. Disney saw 85% drop in park revenue in their fiscal Q3 (April-June 2020) but is starting to see that slowly rebound as some parks reopen and it seems like customers are getting more comfortable being out in public. In the U.S., Disneyworld in Florida is open with restrictions, but Disneyland in California is not, and likely won’t until mid-2021.
We believe low park attendance will continue for the remainder of 2020 and all of 2021. We forecast just 2% and 4% growth for domestic and international revenues respectively in 2021 after this 40% decline in fiscal year 2020. We forecast that revenues will rebound to pre COVID levels by mid-2022 with moderate 4% CAGR growth the 4 years thereafter before slowing to just 1% growth in the continuing value year in 2029.
Studio Entertainment
Disney owns some of the most beloved video producing brands in the world such as Walt Disney Pictures, Pixar, Marvel, Blue Sky Studios, Twentieth Century Fox and Lucasfilm. This segment also includes Disney’s live theatrical shows.
Revenue comes from theater ticket sales, licensing content to networks and consumer purchases of physical or digital
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copies of the content. In fiscal 2020, we expect Disney to see an 15% decline in studio entertainment revenue due to loss of theater ticket sales and some production delays.1 Going forward we forecast moderate 5% annual growth for 2021 with full revenue recovery by 2023 and stable 3% growth thereafter. Disney consistently releases top producing movies and we believe that will continue, but only lead to low growth as this level of video production is expected from Disney every year.
Direct-to-Consumer
Disney’s Direct-to-Consumer segment is currently only 13% of revenue but holds the most potential to grow. This segment includes new revenue streams such as Disney+, ESPN+ and Hulu. Disney+ and ESPN+ were released in November 2019 and Disney now owns 67% of HULU after their acquisition of 21st Century Fox in March 2019. This streaming service distribution strategy has always been a threat to Disney until now, where they control their own platform rather than licensing content to Netflix. This segment also includes revenue from video game production, which is a relatively small portion of revenue.
Driven by the release of Disney+, this segment saw a 204% increase in revenue in 2019 and is on pace for a 55% increase in 2020.1 Disney+ currently has 60 million subscribers and we expect them to add 25 million over the next 2 years. At $7 PMPM that would add $2.1 billion in revenue. We believe this will be the key to Disney’s growth and margin expansion going forward with 15%-20% CAGR revenue growth over the next 3 years, and declining growth thereafter once they are established in the market.
Below is a graph comparing our revenue growth rates for each of the described revenue segments.
Margins
Historically Disney has been able to operate at roughly a 17% net margin but that then went negative in 2020 and we forecast to be just 3% in 2021. Cost of sales has historically been 55% of revenue and we expect this to increase over time as they invest more into streaming and international markets. We forecast Disney’s cost of revenue to increase to 64% in 2020-2021, as Disney will still have many fixed costs associated with parks they must pay while attendance declines.
SG&A expense is their second largest expense at roughly 16% of revenue historically but that increased to 21% in 2020 again due to fixed costs withing SG&A. We forecast this to drop to 18% in 2021, 17% in 2020 and then hold constant in 2023 at 16% which is in line with historical.
Overall, we are expecting net margin to partially recover after 2023 up to 13% but this is still well below their historical average of 17%. This is due to increased costs in creating content and added interest payments on debt. Over time, this will slowly increase as Disney pays down the principal on debt and stabilizes their investment in streaming services.
Brand
Disney is truly a one-of-a-kind business with nearly a 75-year history of cultural impact. While Disney does have competitors in each of its segments, no other company has all four revenue streams (Networks, Parks, Studio and DTC) for consumers to associate with each other and work as one to create brand strength. Disney is consistently in the top five most admired companies in the world and came in at fourth behind Apple, Amazon and Microsoft in 2020 according to Forbes yearly survey.2 We believe that Disney is better positioned to monetize its brand through streaming services in the future while park and studio segments simultaneously continue to outperform. This brand creates a mote around Disney that we think will only strengthen as their global footprint expands.
ESG Analysis
Disney has taken firm action to reduce carbon emissions, use sustainable energy, create an inclusive work environment and create positive social change on the world. From 2012-2019 Disney reduced their carbon emission by 47% worldwide. They have also built a 270-
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acre solar farm that provides the power needed for half of the theme parks in Disneyworld.3
They have also taken aggressive initiatives to reduce waste in their parks, but this would likely still be considered a negative by most, due to the massive amounts of waste produced from Disney parks. It is also not clear how Disney suppliers treat workers in emerging markets where their merchandise is produced.
Overall, we would rank Disney as doing average in terms of ESG, but this opinion is extremely subjective as there is no universal way to compare ESG ratings across companies.
RECENT DEVELOPMENTS
Disney is not a company that has had any drastic changes in revenue segments for the past 75 years but that is beginning to change. Since formation Disney has focused on two things, movies and theme parks. Now with the rise of streaming services, Disney realized they needed to compete in the space or else their content would be hindered by its outdated distribution channels and their licensing contracts would essentially be set by Netflix as they would have all the pricing power.
This realization lead to the acquisition of 21st Century Fox and the release of Disney+ in 2019. The launch of Disney+ in November 2019 was good timing as unanticipated COVID was right around the corner and has likely helped Disney gain subscribers who have been quarantined at home.
COVID-19 Impact
The severity and duration of COVID-19 worldwide will have a direct impact on every segment of Disney’s business. Parks and experiences make up 37% of revenue which were all closed at some point this year and some are still closed. Disney’s studio entertainment is also hurt by lack of customers in movie theaters to drive box office revenue. Disney reported in their fiscal Q3 which ends June 27th that they lost $4.72 billion due to the pandemic. This contributed to Disney posting their first quarterly loss in two decades.17
Another negative is that COVID-19 has caused a softening in advertising markets where Disney makes revenue on their broadcasting networks. If this continues, and a slow economic recovery is seen, we would be concerned about
Disney’s ability to find strong advertisers across their T.V. networks.
The one segment where COVID-19 is likely helping Disney is with their direct-to-consumer streaming services. With Disney+ just being released in November 2019 and COVID-19 heavily impacting the U.S. not far after it is hard to correlate any specific increases in subscriptions to COVID-19, but we believe it has been a helpful driver.
Finally, Disney wrote down $5B in goodwill and intangible assets due to the effect COVID-19 has had on the book value of their 21st Century Fox assets recently acquired. They believed that the remaining FCFs of these assets were not in line with the recognized book value any longer.6
28,000 Layoffs
On September 29th Disney announced they were laying off 28,000 employees assigned to their Disneyland theme park in California after state legislators indicated that the park must stay closed for the foreseeable future. These 28,000 employees had been furloughed since April. They were receiving little to no pay, but still had all health and other employee benefits costing Disney millions each week.
Disney made sure to note that the layoffs were directly correlated to legislators strict social distancing laws. Disney World in Florida has been open since July with restrictions and this has allowed them to avoid any widespread layoffs in Florida. They also have parks open in Japan, France and China. We believe that these layoffs are necessary to reduce cost and acted more as a statement to the California government that Disney won’t keep paying furloughed employees indefinitely if the state won’t allow them to open. It then transfers those now unemployed persons benefits to the state and federal level. It also puts pressure on the state as Disney says roughly 80,000 local jobs are dependent on the park’s visitors, many of which outside Disney’s employment.17
Disney +
In November 2019 Disney released Disney+ so they can own the distribution of their content. While previously Disney was at the heels of Netflix to distribute their content, now Disney is in a position to take all of their content off Netflix once the contracts expire and compete against them. Now that Disney also owns 67% of Hulu,
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Disney+ and Hulu can offer a bundle which includes both for a discounted price.
Below is a chart comparing the prices of each service along with the number of subscribers each currently has.
Acquisition of 20th Century Fox
On March 20, 2019, the acquisition of 21st Century Fox was finalized. Rumors of this acquisition first came about in late 2017 and after 18 months the deal was done with Disney for $69.5 billion.7 Here is what they got:
1. 21st Century Fox 2. 20th Century Fox 3. Fox Searchlight 4. Fox 2000 5. Blue Sky Animations 6. Fox Sports Stations 7. National Geographic Holdings 8. 30% of Hulu (Disney already owned 37%)
This acquisition, as are all acquisitions in the space was for one thing, content. Disney knew they were going to fall behind in line to Netflix if they did not have majority ownership of their own streaming service and they felt like the content just from Disney was not enough.
It is important to note that Disney also acquired Marvel in 2009 but it did not get full access to past and future content rights. Some outstanding Marvel characters such as Deadpool, Fantastic Four and X-Men were still owned by Fox which Disney now has.8
Now with a library of Disney, 21st Century Fox, Pixar, Star Wars, ESPN, National Geographic and Marvel, we believe Disney+/Hulu is positioned to obtain a subscriber base comparable to Netflix.
Disney financed this acquisition through a mixture of cash stock. They paid $35.7 billion in cash, $21 billion of which came from a debt offering, and then paid $33.8 billion in Disney shares at $110 per share.1
Recent Earnings Announcement
Disney’s last earnings call was on August 5, 2020. Shares rose 8.6% after stronger than expected revenue and EPS for the quarter. The closure of parks and theaters caused steep declines in those segments but direct-to-consumer through Disney+ and Hulu came in strong as expected. The surprise came from their Broadcasting segment whose revenue came in at $2.53B when the street was predicting $2.2B.
Disney had a big beat on EPS coming in at $0.08 vs the forecasted ($0.61). Disney noted that they estimate lost operating income of $3.5 billion in Q3 due to COVID-19. This was expected and did not provide any specific revenue guidance going forward.
INDUSTRY TRENDS
Disney has always done a great job at adjusting content according to consumer preferences, but the company’s distribution strategy has had very little change in 20 years. Until the rise of streaming services, Disney has always distributed content through traditional mediums of Cable, DVDs and theaters but that is quickly changing. Another trend is the consistent desire consumers have for theme parks and live entertainment where Disney dominates the market.
Streaming Services
Streaming services have completely changed the way video content is distributed to create a more streamlined and convenient user experience. After Netflix began dominating the market in 2007, other players such as HBO Max, Amazon Prime Video, Hulu and most recently Disney+ have also come to fight for the market. Rapid adoption in the U.S. has led to these companies investing billions in content rights and the creation of original content.
In 2015, just over half of U.S. households had at least one subscription service compared with 2019 at 74%.9 This rapid penetration has led to companies doubling down on their content to secure market position. Luckily for those
Monthly
Standard
Monthly
Premium
Subscribers
(M)
Netflix $8.99 $15.99 182
Amazon Video $8.99 $12.99 26
HBO Max 43
Hulu $5.99 $11.99 30
Diseny+ 55
Hulu & Diseny + 85
CBS All Access $5.99 $9.99 4
$14.99
$6.99
$12.99
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services like Amazon Prime Video and Disney+ that are newer, this market is not a one service wins all. Roughly 70% of all people who use streaming services have more than one subscription.10
We believe this is good for Disney+ as their content is relatively niche with mostly kid’s content. Disney+ may not be a household’s primary video service for adults but any household with kids will likely opt in. Then households can also add Hulu for more teenage and older content.
Parks & Experiences
Theme parks have always been one of peoples first choices for vacations as parks have become larger, more extravagant and more immersive. Disney is overwhelmingly the largest player in this space owning 13 of the top 25 theme parks worldwide. Coming in second is Universal Studios with 4/25 top ranked parks in the world by annual attendance.11 Disney also holds the top 4 positions with Disney Magic Kingdom, Disneyland, Toyko Disneyland and Toyko DisneySea.
Growth has been steady at 3%-5% per year across the worlds top 25 parks and we expect this type of growth to continue once COVID-19 passes. We do not believe that theme park growth will be what materially drives the stock price as most analysts also assume this rate of steady growth over time but this segment is a staple to the Disney brand and is relatively profitable at 39% operating margin in 2019.1
COMPETITORS
While Disney is truly in a league of its own as a whole company, it still has competitors that compete against every segment of their business separately. Most of the content producers focus on just content and distribution, while Disney also has their parks and entertainment divisions. Most other content producers have not invested into parks with the exception of Comcast with Universal Studios. We believe Disney’s key competitors are Comcast NBC, Charter Communications, Viacom CBS, AT&T (Time Warner) and Netflix.
Comcast NBC (CMCSA)
Comcast is Disney’s closest competitor as they have very similar lines of revenue and relatively the same footprint. Comcast’s revenue segments include Cable Networks,
Broadcast Television, Filmed Entertainment, Theme Parks and Sky segments. Notable brands include Xfinity, NBC, Universal Pictures and parks, DreamWorks Animation and Sky Sports.
Of these segments, 58% of their revenue comes from their internet service division, 12% from their cable networks, 10% from broadcast networks and 7% from parks.13
We believe that while Comcast will continue to produce desirable content, their distribution methods are outdated. Cable and broadcasting revenues have been slowly declining as streaming services have become preferred by most Americans and while Comcast does have Xfinity Instant TV, it has not gained much traction.
Charter Communications (CHTR)
Charter Communications is primarily an internet service provider and cable network provider who owns the Spectrum brands for internet, cable and T.V. They have historically owned significant means of distribution that companies like Disney and other content producers would have to license to for distribution. Previously Disney and Charter Communications have worked together to distribute content through their cable networks, but this is becoming less important over time and therefore we do not see Charter as a strong competitor.
Viacom CBS (VIAC)
Viacom and CBS were both media companies whose channels and shows have been enjoyed for decades. They operate a number of channels under the CBS brand including sports, news, daytime T.V., late night T.V. and movies. These two companies merged in 2019 so they could be better positioned to compete with Disney, Netflix and Comcast. However, it is not clear if this merger will be able to get them into the same league as their competitors. Viacom CBS is one tenth the size of Disney and Netflix and we do not think their content is strong enough to be a stand-alone service long-term.
Viacom CBS was an early mover on streaming content with CBS All Access which launched in 2014. This contains all their content and live stations. However, the big difference between them and Disney is CBS still licenses their content to other services. CBS content is on Netflix and Hulu whereas Disney is pulling all their content from Netflix to exclusively be on Disney+. This indicates that CBS content
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alone is not a strong enough library to be a stand-alone product and therefore, will continue to be dependent on other means of distribution. We could also see them being acquired by Comcast or Charter Communications in the future.
AT&T/ Time Warner (T)
AT&T acquired Time Warner for $85.4 billion in 2019 after a controversial case by the Department of Justice noting that this acquisition would give AT&T too much pricing power. They claimed it would also incentivize AT&T to provide slower internet service to networks who were competitors of Time Warner. After some delay, it was approved, and the deal was done 3 days later.
Time Warner’s brands include HBO, CNN, Adult Swim, Cartoon Network, TNT, truTV, TBS along with their production studio. HBO has very desirable content such as Game of Thrones and The Wire, but these are one off shows and we do not think the overall content they produce is superior over Disney, or any other producer. HBO has their streaming service offering but has not seen significant growth like Netflix, Hulu and Disney+, we believe due to lack of unique content.
Netflix (NFLX)
Netflix is the clear competitor regarding Disney’s number one growth segment, streaming. Currently 60% of all U.S. households have a Netflix subscription with 193 million subscriptions worldwide.14 Netflix has been able to create unique and desirable content that keeps customers entertained and renewing their subscriptions. We believe that while Netflix and Disney+ will be direct competitors, there is room for both in the market and consumers will have both. We believe households will have Netflix for teenage and older content and Disney+/ ESPN+ for kids/ sports content.
Valuations and Ratios
Each of Disney’s competitors are very different in their operations, distribution and content and we believe Disney is well positioned among them from an operational standpoint as well as a valuation one. Below are some key valuation metrics from 2019 for comparison. We choose to use 2019 data as the most recent Q2 2020 data is so
poor it would be hard to interoperate their relative value given some negative earnings.
Source: Factset
We believe Disney is undervalued compared to their competitors and deserves a much higher valuation given their growth potential with Disney+ and international growth. We believe once Disney+ gains more traction it will be valued more like Netflix, rather than Comcast. Disney is also doing the best job of operating efficiencies as reflected in the 15% net margin which is best in class.
ECONOMIC OUTLOOK
We believe there are two key economic factors that have material affect on Disney’s revenue. Consumer sentiment, and disposable personal income and interest rates.
Consumer Sentiment
Consumer sentiment drives how people either spend their money in the economy, or save it for potential hard times. If consumer sentiment is low it is very unlikely that people will spend their money on vacations, consuming additional content or purchasing a new streaming subscription.
For this report I chose the Michigan Consumer Sentiment Index (MCSI) over the Consumer Confidence Index (CCI) because the MCSI focuses more on ones personal financial well being and we believe is a better indicator of how people would spend money on extras, like vacations or entertainment.
Consumer sentiment was relatively flat from 2015-2020 until the COVID outbreak. The consumer sentiment index dropped from 101 in February to 71.8 in April.16 It then ticked up slightly in June but is now just slightly higher than its April low. We believe that this index will gradually rise to normal levels as soon as COVID-19 is over, and all social distancing restrictions are removed. However, this could be more than a year away.
- MCap (B) P/E Net Margin EV/EBITDA ROE
Disney 232,443 19.6 15.0% 18.1 15.2%
Comcast 206,752 15.9 12.0% 9.1 16.9%
Charter Comm. 128,113 65.1 3.6% 11.2 4.9%
Viacom CBS 18,729 7.8 11.8% 2.7 40.8%
AT&T 206,100 20.6 7.7% 8.1 7.5%
Netflix 207,260 78.3 9.3% 12.9 29.1%
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Below is a chart showing the steep drop after February where it went from 101 to 71 in two months and little recovery since.
Disposable Personal Income
Disposable personal income is the amount of money a person has left over after taxes and all necessary expenses such as living, insurance and healthcare. Disposable income can be spent on things people enjoy and is an indicator of the funds people have available to spend on vacations, going to movies and video entertainment which all benefit Disney.
Although we have seen record unemployment, disposable personal income has remained high around $15,000 for the average U.S. adult and recently spiked up in April due to the $1,200 stimulus check. Before that, only a slight decline of less than 1% was seen in March 2020.15
We do not expect any significant drop in this metric because government intervention is filling in the gaps of lost income for the most part, leading to only minor lifestyle spending changes for most people. This view could change if the effects of COVID are longer than expected or the government cuts back unemployment benefits.
Interest Rates
Interest rates have a major effect on the interest payments Disney will be paying, as roughly one third of their $54 billion in long term debt is on a floating interest rate. Currently the 10-year treasury is at .704% and we do not
forecast this will change much in the next 12-18 months. In the long term we do think rates will go up to the target rate around 3-4% but by then Disney will be able to pay down much of their principal so we do not think any change in interest rates will make a positive or negative impact on Disney’s valuation.
VALUATION
Revenue Assumptions
Disney’s revenues come from four key segments.
Media Netowrks: Disney, ESPN, Freeform, FX, National Geographic and 50% equity ownership in A&E T.V. Disney also owns operates ABC broadcasting networks, Twentieth Century Fox and Fox 21 Television Studios
This segment has historically grown at around 2%-5% annual growth and we are forecasting for that to continue in the U.S., however we are forecasting stronger growth internationally at 7% annually for the next 4 years before slowing to a growth rate of 1% in the continuing value year in 2029. This international growth is from early signs of growing interest in Asian markets and Disney’s efforts to translate their content into more languages.
Parks & Entertainment: Includes Disney’s 13 theme parks worldwide.
Disney’s park revenue was growing at a very healthy 5-8% annually until the COVID pandemic where they instantly lost 75% of theme park revenue in one quarter. We are forecasting that U.S. parks will remain closed for the rest of 2020 and into 2021 with parks reopening mid 2021. We are then forecasting a strong recovery back to pre COVID level revenue by late-2022 and then 5% growth thereafter until the continuing value year in 2029 at 1% growth.
Studio Entertainment: Walt Disney Pictures, Pixar, Marvel, Blue Sky Studios, Twentieth Century Fox and Lucasfilm.
Disney’s studios revenue is relatively volatile based on what movies are released each year but overall, they have seen strong 7-15% yearly growth from these operations. Going forward we are expecting a sharp decline of 17% in 2020 with a gradual recovery in the subsequent years and fully recovering by mid-2023. After the recovery of revenue, we forecast 3% CAGR for the next 3 years and then dropping to 1% growth in the continuing value year in 2029.
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Direct to Consumer: Disney+, HULU, and ESPN+
While this is currently the smallest segment, it is where the most growth will come from that will generate material revenue growth for Disney. We are forecasting 10-20% growth for the next 3 years in this segment and then it declines down to 1% in 2029.
Below are the projected growth rates by segment YOY. Disney’s fiscal year ends September 31st so each of these periods start in October of the previous year. This is why the 2020E decline for Parks & Experiences is less than you would expect. It is because that year includes the quarter from October-December 2019 which was very strong for Disney. The 2020 revenues are estimated because they have not released their Q4 results so 2020E are ¾ actuals and ¼ estimated.
Operating Cost Assumptions
Disney’s key operating assumptions are their cost of product & services and SG&A. We are forecasting increased cost of service and product as Disney will need to make large investments into new content for Disney+ and Hulu. For 2021 we are forecasting a 63% cost of product and sales which then declines to 58.5% by 2029.
Their second largest operating expense is SG&A at 16% of revenue historically. We forecast this to slightly increase to 18% in 2020 due to the fact that they still have a number of expenses they will need to cover even though the parks are not generating revenue so we forecasted it as a higher percentage of revenue to include that expense. After 2021 we forecasted SG&A to remain relatively flat at 16% of revenue.
Debt Maturity
Disney has historically had little debt on its balance sheet but has recently increased its debt by 3x due to the acquisition of 21st Century Fox and raising $18.3 billion in 2020 to make sure they have enough money to get through COVID. In the acquisition of 21 Century Fox they took on $21 billion in debt and then had to make three additional debt offerings in 2020 totaling $18.3 billion to
make sure they could get through COVID. This debt was issued at a blended interest rate of 3.35%. In 2020, Disney has $64 billion dollars in combined short and long-term debt and assets of $194 billion. We are slightly concerned about Disney’s ability to control and pay down their debt. We forecast that Disney will be paying roughly $2.2 billion in interest each year on this $64 billion but forecast them to pay down the principle at 4% a year after 2023. This view may change if COVID is drawn out until past 2022. Then Disney may need to raise additional capital and would be a signal of financial distress.
Luckily for Disney this newly issued debt can take advantage of low rates but without stable cash flow coming in they may need to refinance them in the future.
DCF/EP vs DDM & Relative PE
We put the most emphasis in the DCF/ EP models as it most accurately reflects the true value of Disney. Due to the COVID pandemic Disney decided to completely cut their dividend, but we forecast Disney to reinstate their dividend in 2024 at $1.48 per share which is just 30 cents less than their dividend was previously. With this model we computed a value of $112.26 and put the least amount of weighting into this model.
Our relative PE model computes a value of $138.89 and we put moderate weight into this model as we compared companies that had similar revenue segments to Disney, but no company has all the revenue streams Disney does. While it was once valued very similar to Comcast, Viacom, and Charter Communications, it is starting to move more into the Netflix strategy camp and hopefully get some of the premium associated.
After considering all four valuation models we came to a price target of $150-160, implying a 27% upside.
Our Forecast vs. Consensus
Our forecast is different from other analyst in that we believe Disney will have a slower recovery from COVID then street estimates but better post-COVID revenue and margins.
In 2019, Disney’s revenue was just over $69 billion and in 2020 we are forecasting revenue to decline to $60 billion. This is under the $65 billion analysts are estimating due to our less optimistic Q4 2020 results. We are also forecasting revenue to be $10 billion lower than analysts in 2021 as we
believe the impacts of COVID will continue to keep people away from traveling to parks and going to movies. Therefore our 2020, 2021 and 2022 EPS is lower than estimates but then that changes in 2023.
After 2023 we believe Disney will have strong growth in Direct to Consumer, Studio Entertainment and Parks. In these segments our long-term forecast outpaces the street and as a result have higher EPS from 2023 onward. Disney is currently covered by 25 analysts with 14 buy ratings, 10 hold rating and 0 sell ratings. All combined with an average price target of $136, moderately below our forecasted range of $150-160.
CATALYSTS FOR GROWTH
We see three key reasons why Disney’s stock is positioned to outperform. Our thesis is driven by the growth in revenue from streaming services, growth in international parks markets and growth in international studio markets.
Disney, ESPN, & Hulu
Disney in in a unique position to create a streaming service that that would have content to appeal to every race and age demographic. We believe that in the future Disney will consolidate Disney+, ESPN+ and Hulu to create one service that has it all. TV Shows, Movies, and sports all in one place for households.
Currently Disney’s direct-to-consumer segment generates $14 billion in revenue and we project that to increase to $25 billion by 2025 and then $28 billion by 2029. This would imply that Disney is able to nearly double its 84 million combined subscribers between Disney+ and Hulu in the next 8 years which we believe is a very conservative growth rate.
International Growth
Over the last five years Disney has had significant expansion in international markets with their network, studio and parks segments. Driven primarily by development in China, Japan and India, consumers in these countries are gaining more access to Disney’s digital content and country development has led to more appetite for theme parks.
We expect this growth to continue as Disney is also creating some content specifically for other populations rather than just taking the English version and translating
it. We believe this targeted content will not only create strong growth in their media and studio platform but then also lead to increased desire for Disney theme parks.
RISKS TO THESIS
Increasing Expenses
One factor that could negatively affect Disney is increased expenses in both their park operations and content production. With the launch of Disney+ and majority stake in Hulu, Disney is going to need to create more content to keep subscribers attached and this will add increased expenses. Including more content to appeals to teenagers and adults that they will either post on Disney+ or Hulu.
New Content Targets
For decades Disney has produced top quality content that has mostly been kids focused. With the acquisition of Hulu, they will now be part in creating content for a new demographic they have not traditionally done. Some of the most successful T.V. shows and series Netflix and HBO have been mature content and Disney does not have extensive experience in this realm. Shows like Game of Thrones, Stanger Things, The Witcher, 13 Reasons Why, Sex Education and more are all top preforming shows that would be consider for mature viewership.
Prolonged COVID-19
As mentioned earlier in the debt section. We are forecasting Disney to have almost no growth in their parks and entertainment division for 2021 but a strong rebound in 2022. This added revenue along with that from studio in 2022 is needed to pay down the interest and principle on Disney’s $64 billion in debt. If these forecasted revenues are not seen, Disney may need to issue more debt that would worry us. It could also potentially drop them out of being an A rated issuer and therefore lead to them paying higher rates on newly issued debt.
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REFERENCES
1. Walt Disney 10k 2. Fortune- World’s Most Admired Companies:
10. Statista: U.S. Subscription Services Data: https://www.statista.com/statistics/778912/video-streaming-service-multiple-subscriptions/
11. Themed Entertainment Association (TEA) annual parks report: https://www.aaaa.org/global-attractions-attendance-report/#::text=Theme%20Index%20and%20Museum%20Index%3A%20Global%20Attractions%20Attendance%20Report,-July%2015%2C%202020&text=The%20Themed%20Entertainment%20Association%20(TEA,global%20and%20regional%20industry%20trends.
17. WSJ: Disney Laying off 28,000 Employees: https://www.wsj.com/articles/disneylands-reopening-date-remains-unclear-11601413802?cx_testId=3&cx_testVariant=cx_2&cx_artPos=3#cxrecs_s
DISCLAIMER
Henry Fund reports are created by graduate students in the Applied Securities Management program at the University of Iowa’s Tippie College of Business. These reports provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of our students. Henry Fund analysts are not registered investment advisors, brokers or licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold an investment position in the companies mentioned in this report.
Walt Disney CompanyWeighted Average Cost of Capital (WACC) Estimation
Cost of Equity: ASSUMPTIONS:Risk-Free Rate 0.78% 10 year treasuryBeta 1.14 5-year monthlyEquity Risk Premium 5.15% Henry Fund EstimateCost of Equity 5.76%
Cost of Debt:Effective Tax rate 21.70%Pre Tax cost of debt 5.68% Blended rate of borrowings interest ratesAfter-Tax Cost of Debt 4.45%
Market Value of Common Equity: MV WeightsTotal Shares Outstanding 1,807Current Stock Price $122.00MV of Equity 220,454 76.10%
Market Value of Debt:Current Portion of LTD 10,224 Long-Term Debt 54,197 PV of Operating Leases 4,802 MV of Total Debt 69,223.15 23.90%
Market Value of the Firm 289,677 100.00%
Estimated WACC 5.45%
In Millions
Walt Disney CompanyDiscounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models
Key Inputs: CV Growth of NOPLAT 1.82% CV Year ROIC 24.13% WACC 5.45% Cost of Equity 5.76%
Value of Operating Assets: 364,809 Non-Operating AdjustmentsNormal Cash 1,215 Less: PV of operating leases (4,960) Less: PV ESOP (1,003) Current portion of LT debt (10,839) Long term debt (54,197) MV of non-controlling int. (4,597) Value of Equity 290,427 Shares Outstanding 1,827 Intrinsic Value of Last FYE 158.99$ Implied Price as of Today 168.31$
EP Model:Economic Profit (EP) (1,418) 2,483 6,631 10,282 11,629 12,646 13,190 13,556 13,801 Continuing Value (CV) 380,715 PV of EP (1,345) 2,233 5,655 8,316 8,920 9,199 9,099 8,868 244,754
Total PV of EP 295,700 Invested Capital (last FYE) 70,183 Value of Operating Assets: 365,883 Non-Operating AdjustmentsNormal Cash 1,215 Less: PV of operating leases (4,960) Less: PV ESOP (1,003) Current portion of LT debt (10,839) Long term debt (54,197) MV of non-controlling int. (4,597) Value of Equity 291,501 Shares Outstanding 1,827 Intrinsic Value of Last FYE 159.58$ Implied Price as of Today 168.31$
Walt Disney CompanyDividend Discount Model (DDM) or Fundamental P/E Valuation Model