'Tooned in for the Takings

By Ben McClure | March 15, 2006 AAA

Disney is making a come-back. The company's share price is still lingering below $30, but the media and entertainment group's prospects haven't looked so good in quite some time. On the edge of new growth, The Walt Disney Company (DIS) could spell long-term opportunity for investors.

Disney has delivered impressive earnings recovery over the past year. The Disney World theme park set a record for attendance last quarter, and the newly-completed Hong Kong theme park is shaping up.

Disney's ABC television -- thanks to top rated hits such as Desperate Housewives and Grey's Anatomy -- is in the midst of a ratings turnaround, and that's translating into improved financial results at the network. The sports network, ESPN, also continues to contribute to bottom-line growth. By all accounts, recently appointed Bob Iger appears to be transitioning smoothly into the CEO slot.

Disney is best known for its animated films. But the company hasn't produced a major hit in years. Frankly, Disney's stories and technology are dated, and with increasing competition from Pixar (PIXR) and DreamWorks Animation (DWA) the company is struggling to produce films that ring with today's moviegoers.

Disney's purchase of Pixar could change all that. Pixar is the king of today's animated film world. It hasn't missed yet, with titles including Toy Story, Bugs Life, Monster's Inc, Finding Nemo and the Incredibles. Disney, meanwhile, has the experience and assets -- from film distribution to theme parks and merchandising -- to squeeze the most value out of Pixar's popular animated characters. The pairing of Disney and Pixar will go a long way to re-establishing Disney as the natural leader in animated movies.

Over time, growth will also come from moves to connect Disney's vast and valuable storehouse of entertainment with new technology platforms. Disney has opened its cupboard to supply more downloadable content to Apple (AAPL) iPods -- from ABC TV shows to ESPN sports to Disney kids programming -- and expect the company to deepen its relationship with Apple further.

Disney has also inked a deal with Verizon Communications (VZ) to deliver programs over its mobile phones. A Disney-branded wireless service, like the ESPN service it launched in February, is in the works. Then there is a $49 million joint venture with tech giants Cisco Systems (CSCO) and Intel (INTC) to re-launch MovieBeam, a wireless movie delivery business.

By my reckoning, Disney shares are undervalued. Fresh leadership, momentum at its TV networks, strong gains at its theme parks, together with the Pixar deal and other strategic moves into the new-media era have yet to be built into the share price.

Steady increases in free cash flow have gone largely unnoticed. Last quarter, Disney produced $579 million in free cash; in the same period last year it consumed $191 million. That free cash flow, plus cash from the sell-off of ABC Radio and $1 billion in cash on Pixar's balance sheet give Disney the freedom to boost its dividend and buy back more shares this year.

Of course, there are risks. Disney still has to fold Pixar into its business mix and hope that studio doesn't lose its knack for producing blockbusters. Moves to spread its content to new digital and mobile platforms are still experimental and have yet to pay-off. Its upcoming Pirates of the Caribbean sequel and Cars releases may not draw the cinema crowds expected. As always, Disney is vulnerable to a downturn in advertising spending or the economy as a whole.

Nonetheless, with Disney shifting gears, the stock's fundamentals could improve considerably. There are good reasons to think the shares will break past the $30 mark, and much higher over time.

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