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DISNEY: IS ESPN THAT BIG OF A DEAL?Recently Disney stock has been battered down by about 20% since the start of 2016. To put that into perspective, that’s a 45 billion dollar loss in market cap for investors. That’s a lot, but I’d like to remind the reader that these things happen in the marketplace, all the time.For example, Apple Inc. (AAPL) recently hit the low of 90 bucks a share, that was from a high of 123 dollars a share. There, the loss concerning market cap was even bigger: Around 160 billion dollars disappeared from investors pockets.However, in less than three months, it has regained almost all of that back. At its lows, people said Apple was done; the IPhone was a dying fad; and that it had lost all innovation. Furthermore, its competitors were increasingly beating Apple and Samsung was becoming the new leader in the smartphone market. That was the story the market, and the majority of its participants told themselves at the time to justify such a huge price drop.Nonetheless, Mr. Market fooled most people most of the time once again, and those that sold at 90 after having bought at 120 received a hard lesson in trying to time the market. You can't do it, and nobody can. And in another ironic market twist, now Apple has sold out IPhone 7 plus pre-orders.Everybody wants Apple at 120, and nobody wanted to touch it at 90. Welcome to the stock market.Of course, Disney and Apple are entirely different companies. I mentioned the example above to remind the reader that the market does this all the time, it’s not uncommon for people to lose a lot of money (on paper) on AAA investments.Recently Warren Buffet “lost” 1.4 billion on Wells Fargo, that’s on paper, though. You think he's lost any sleep over it? I don’t think so.So, it’s the investor’s job to take a close look at the story the market is spinning to justify such a significant price drop in Disney stock.Mr. Market’s side of the story on Disney:Cord cutting, TV is a dying fad, and the internet is the next hot place for content.ESPN is losing subscribers, 10 million since 2013.Growth is slowing down.The stock is overvalued given all its uncertainties and risks.And so, now everyone thinks 90 is the new standard for Disney, and furthermore, 70's are quite a real possibility now right? Well, let’s dive into the facts.Cord cutting: Cord cutting is very real, people can get content on the internet, on demand and cheaper. Also, they can access it on their phone, TV, radio, wherever they want it, they have it; this is a trend that's only picking up, without signs of slowing down.However, you can't count out Disney so fast. At the end of the day, accessibility to content is critical, but what's most relevant is the content itself. Content is king. And Disney is the king of content. I don't have to list the all the intellectual property and rights that Disney has; other fellow contributors have done already a fantastic job at this. It's sufficed to say that Disney's content is quite simply amazing, extensive and ever so increasing.So at the end of the day, the real question is, can Disney monetize its content given these new trends? I believe so, and it's not particularly difficult if you think about it. Disney has a lot of it that can bundle, repackage, sell at a discount, stream, lease, etc. There are a million different possibilities for them to do so, and they have top class professionals working on this very issue 24/7.So yes, my bet is on Disney being able to pull it off.ESPN ESPN has been signaled as the culprit for almost everything wrong with Disney stock as of recently. And there’s a lot of truth to it, but first, let’s put ESPN in perspective.So, Media Networks segment accounts for 48% of Disney's revenues so far in 2016. Out of that 48%, about half of it comes from ESPN. 50% of your primary revenue generator is a big deal, no matter how you slice it and this is something shareholders have to be concerned. Source: 10K SEC filings from Disney plus author’s calculations.In other words, if 50% of 50% of revenues changes by 10%, with an impact of 2.50%; this is how material is ESPN to Disney’s profits. To the untrained eye, it might not seem like much, but that’s a lot of money when you’re talking about billions of dollars.But, even though ESPN has seen a string of bad years regarding subscriber bleeding, last quarter it still grew its net income. Disney explained in its recent 10-Q filing that growth was "due to affiliate and advertising revenue growth, partially offset by higher programming costs. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers and an unfavorable impact from foreign currency translation.”The key factors regarding ESPN:Yes, they’re still bleeding subscribers.But, they still see growth in income, mainly due to contractual rate increases. So, no negative impact yet on Disney’s results.Regarding the subscriber bleeding issue, CEO Bob Iger has commented that “the majority of losses aren’t coming from cord cutters, but rather cord shavers." Apparently, skinny bundles by most pay-tv providers don’t include ESPN, since it increases its cost substantially.However, Sling TV and Playstation Vue have helped ESPN gain some subscribers, although not yet enough to stop the bleeding. The CEO also pointed out that “all have expressed an avid interest in having ESPN and our other channels included in their initial offerings” and “we are very, very encouraged by the discussions/negotiations that we are having."This scenario fits in with the survey conducted by BTIG at the beginning of the year asking respondents if they would remove ESPN and ESPN2 to save $8 per month on their cable bill, 56% of respondents said they would cut the networks.Source: ESPN logo.As I remarked earlier in the article, the issue isn’t content, people want ESPN, they just want a better price or package. I believe Disney will be able to solve this problem, stop the subscriber bleeding, or reframe their business model so that it continues to deliver growth to its Media Networks segment. They have done so in the past multiple times already, and this time should be no different.Yes, at this point things are yet uncertain, it is the very definition of a risk. It’s a risk for investors because it has caused a significant discount on an otherwise AAA stock, but if this situation worsens much more, it can cause an even bigger drop in share price.Growth.When writing the article, I looked for every reason I could find that pointed to a remarkable slowdown in growth. As mentioned earlier, even a scenario where there's an ESPN disaster, and it shows another 10% decline in subscribers, its impact would be mitigated thanks to Disney being very diversified given the circumstances.Still, there’s indeed a slowdown in growth. But we have to put that into perspective, Disney’s growth has been stellar the past years, keeping up with it as it has done is a very impressive achievement from management. When a 150 billion dollar enterprise manages to keep growing at something above 3-4%, you can tell it’s the product of good management.Think about it; there are countries in the world with GDPs smaller than Disney's market cap that can't grow at that pace.Source: 10K SEC filings from Disney plus author’s calculations.Bottom line, it’s still growing at a very healthy pace for a company of its size.Overvalued?Overvalue is a little trickier to define, but in the interest of time I just want to mention some relevant financial and valuation metrics:P/E Ratio: 16.50 and earnings yield of 6% (annual)Dividend Yield: 1.5% (annual)So far in 2016 Disney has used 6 billion dollars to repurchase shares in floatIt’s reasonable to expect it to generate somewhere around 7.75 billion dollars in FCF for FY2016, which at its current Mkt. Cap yields a little over 5%.Regarding its balance sheet, I’d like to point out the following:Disney seems to have been adding debt to its balance sheet, although nothing is alarming so far. Also, it refinanced portions of its long-term debt, a savvy financial move in the current low-interest rate environment.It’s been piling cash at a rate of 24% per year. Currently, it is sitting on 5.23 billion dollars, which could easily use to acquire more competitors or invest in its business at a ROA of 10%. Disney has kept investing in its parks/resorts, films, and television; together they stand at 33 billion, up from 29 billion since 2014. This investment is expected to keep increasing and eventually become a major contributor to growth.Overall, a very healthy balance sheet from a financial standpoint.VALUATIONNo matter how good an asset might be (and Disney is one fantastic asset indeed), it can’t be worth an infinite price. In that line, I present the reader the following valuation of Disney:The father of value investing, Ben Graham, mentioned that a reasonable margin of safety for the earnings yield of an asset was that of 50%. He used the benchmark of comparable rated corporate bonds for his calculations. However, in today's market AAA yields are still extremely low (hence corporations should borrow/refinance now), so I used three benchmarks: The 10-year Treasury bond, mortgages (which are very much junk bonds), and what the 10-year Treasury bond used to yield in the year 2000. Also, I averaged those three resulting margins of safety for a more encompassing metric.According to the numbers, I presented above; Disney is a great buy at this time. However, I have to say that with the following caveat: Interest rates may rise. CONCLUSIONThe reader can clearly see that if rates were around 6% like they were in the year 2000 (rates reached 15% in the 80s), then Disney's PE would have to substantially drop for its earnings yield to continue having a 50% margin over the benchmark.In a 6% interest rate environment, Disney would have a 50% margin of safety at an 11.11 PE ratio. This value, in turn, would represent a market cap of 102 billion, and a price per share of 62 dollars a share; this would mean a 30% price cut from where it is right now. However, for the time being, the FED only has a target of reaching 2% at some point in the future. Rumors of NIRP instead of ZIRP are plenty (although FED officials claim they wouldn’t go to negative rates). So the reader shouldn’t worry about rates going as high as 6% for the time being, in fact even reaching 2% next year seems a far-fetched right now.Incidentally, in this brave new world of low-interest rates, Apple Inc. would be an even better buy, since its PE stands currently at just 13.42. And, of course, it’s Apple. So yes, right now the numbers suggest Disney is an adamant buy; this is despite ESPN woes, despite slowing growth, despite cord-cutting, despite a high-priced stock market. As long as the FED keeps rates this low there's no reason to not buy. Buy. Buy.As traders would say: “Just BTFD.”I would suggest for longer term investors to invest monthly on Disney, price averaging investors in stocks with relative valuations like this has proven very profitable historically; this is important: Don't go all in right now, rather spread your investment over 12 months.As always, if there’s any comments/questions regarding the contents of the article, I’ll be happy to answer them in the comment section. I sincerely hope the article’s information is of use for you.Good luck everyone. ................
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