An Increasingly Small World For Disney

By Stephen D. Simpson, CFA | May 13, 2010 AAA

Sometimes, conventional wisdom is not so wise. Take the case of media giant Disney (NYSE:DIS) - the conventional wisdom is that the popularity and ubiquity of its brands (and its eternal appeal to kids) insulates it from economic conditions. That so-called wisdom bypasses the reality that it takes money to go to theme parks, advertising on networks trails off in recessions and movie production requires large upfront investments for uncertain returns.

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Diversification Shows its Advantages
That said, Disney's diversified asset base has helped the company weather the downturn in relatively good order, and this quarter was another example. Revenue rose about 6% overall as strength in the cable and film business offset pretty iffy results in broadcast TV and theme parks. Margins likewise have stayed strong, even as the company lays out significant money for programming rights for ESPN. One note of caution on the margins, though. Successful movies like Alice in Wonderland can certainly boost profitability, but seemingly every studio has a dry spell from time to time and they are inherently impossible to predict (few studio execs would green-light a movie they know is doomed to fail).

It's a Costlier World After All
Disney management has some rather special challenges to navigate. On one hand, Disney is a juggernaut in terms of brands and characters, and those stretch across national borders. While it is not impossible that a firm in China or Japan could launch a compelling brand or character, matching Disney's portfolio would take decades, and there is no guarantee that a rival could leverage a brand the way Disney does (Speed Racer and Dragonball are both popular imports, and both were disasters as major studio movies).

On the other hand, Disney has to increasingly make large moves and take bigger risks to show any real growth. The company paid up for Marvel, has shelled out a lot of money for soccer rights (not a sure thing for American audiences), and faces a cost of competing in TV with Comcast (Nasdaq:CMCSA), General Electric (NYSE:GE), CBS (NYSE:CBS), and News Corporation (NYSE:NWS) that just keeps going up every year. With Comcast building its regional sports offerings and looking to expand the Versus network, Disney could feel a little heat on its flagship ESPN franchise, while the ratings for ABC have left it fourth out of four for much of this TV season.

In a similar vein, the company's calculated risk to start rolling back on discounts for its theme parks is interesting - the economy is not yet back to normal, and the fact that park reservations are down 10% for the fiscal third quarter could be a problem. Will this move gives a boost to theme park rivals like Universal and Cedar Fair (NYSE:FUN)?

The Bottom Line
Analyzing Disney as an investment option is not an easy task. There certainly is no other company quite like Disney in terms of brands and customer goodwill. On the other hand, the returns on capital have never been great, so what good are those intangibles really, if they do not translate to high ROICs. Since Disney is really not that cheap, I would rather look at an idea like France's Vivendi (Nasdaq:VIVDY) - another media company, but one that seems quite cheap relative to its quality and prospects. (The glitz and glam of Hollywood could help put some more glitz in your pocket. To learn more, see Analyzing Show Biz Stocks.)

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