Disney: It’s A War Over The Board

Summary:

• Disney is facing a board fight, but CEO Bob Iger has a strong track record.
• Activists often prioritize short-term profits over long-term goals, which may not be beneficial for long-term shareholders.
• Finding knowledgeable board members for a large and diverse company like Disney is challenging, and there’s currently a lack of suitable candidates by the activists.
• The board needs to back Bob Iger instead of “questioning his every move” without industry experience.
• The activists use conclusion phrases like “poorly managed” that beg the question “compared to what?”

Disney (NYSE:DIS) is now engaging in a board fight similar to what some of us remember from the late 1980s. The difference this time is that the CEO in place, Bob Iger, is a far stronger personality with a darn good record (by all accounts) of running the company. What’s unlikely to get resolved is successor issues. But what needs to be dealt with now is a unified board that knows the business. None of the proposed nominees fit the bill of “knowing the business” I learned the hard way in my corporate experience that very few can “walk in the door” and turn a business around. Instead, it often takes a long time to learn each part of the business (and this company has a lot of parts). That probably fits Bob Iger to a “T” But he needs the backing of the board to get the job done. Right now, he has that. Investors need to make sure it stays that way.

No sooner had Bob Iger, CEO, returned to running the company than all kinds of personalities came “out of the woodwork” with proposals and people to fix Disney. Those of us who remember the 1980s can remember when Saul Steinberg made a similar move only to be beaten by the Bass Brothers who were a part of the group that hired Michael Eisner (among other things) that led to a renaissance of the company. Things were even more acrimonious back then. But Michael Eisner went on to have an unmatched career at Disney.

Bob Iger has “hit the road” to advertise what he has done in really the less than two years since he came back to the job. The one thing that the activist seem bent on distorting is the Disney changes to meet new market conditions across all of the company businesses. Note that the company could not change anything during the shutdown because “no one was working” so change could not occur. But the company is rapidly making up for that.

Still, until it’s done, the company is an easy activist target for “they are not doing” and “they are behind.” But large companies take a while to get going. Bob Iger is likely the public beneficiary of at least some tasks begun before the shareholders could tell anything was underway. Warner Bros. Discovery (WBD) management mentioned many times that what shareholders see now often began three or more years ago. That has to be true here as well.

The latest presentation was at the Morgan Stanley Technology, Media & Telecom Conference March 5, 2024. On the hand, someone needs to rebut a lot of misinformation as I show some examples of this below. On the other hand, I would rather he run the company as he is second to none in the industry.

Note that in the conference, Disney is rapidly changing to meet new market conditions. The announcement, for example, of the Indian operation combination was discussed. Of course there was a whole lot more.

Activists Track Record

Oftentimes, activists have a very short horizon. They’re definitely not a friend of long-term shareholders. But they often cater to traders who make up a sizable voting bloc in that they can produce a short-term profit at the expense (oftentimes) of long-term goals and objectives (sometimes competitive position suffers long-term as well).

That makes this claim about Mr. Peltz particularly important. Getting to know all of the Disney businesses is probably going to take a lot of time. It may well prove to be a full-time job in and of itself. Either Mr. Peltz does it by himself full time (which he probably cannot do with his existing commitments) or he’s part of a group that has knowledgeable people that can take control of the Disney business. Most of us remember that this happened the last time around when Michael Eisner came onboard along with several others that clearly resulted in a thriving business as well as a successor in Bob Iger.

Right now, there does not appear to be those people in the activist position and the opposition is split. An activist board has to be a knowledgeable board (not a “trust me” board). When you’re talking a large business such as Disney, the candidates become few and far in-between real fast. If it was hard to do the last time around, then it’s even more challenging this time around because the business now is even larger and more diverse.

Streaming

There appears to be a lot of misconceptions about the streaming business. Mr. Peltz is attempting to tap into those misconceptions and Disney is trying to refute those ideas.

As I noted in the last article, this business is showing considerable profit improvement as is shown in the Disney answer below:

One of the things to note about the refuted claims is that they use key words like “poorly managed.” That’s a “conclusion” term that begs the question “compared to what?” Without the comparison, it’s hard to understand the point being made because the statement as shown above is “wide open” and could refer to anything. Shareholders need specifics which the answer gives and hence effectively reframes the statement.

Michael Porter’s book “Competitive Strategies” covers the fact that many large companies wait for a new idea to become at least a $1 billion opportunity. Otherwise, entrance into that new business does not “move the needle” and is not a justified use of management time.

Then oftentimes when management does enter the business it goes for market share first and then does exactly what is shown above to achieve profits. Therefore, this is a legitimate way to run the business. Now whether or not it’s the best can be argued until long after we are gone. But “poorly managed” seems to be an unfit conclusion not justified by basic business management theory as what happened is valid.

It should be noted that there are a number of other ways to enter a business. Each of those ways may or may not work out better. The real question is “did management chose a viable strategy” followed by “did management course correct as needed?” Any management that blindly pursues one strategy while ignoring any feedback is probably going to fail regardless of the strategy chosen. Course correction as the business proceeds is mandatory.

Netflix Comparison On Free Cash Flow

The other idea is that the dispute seems to center on profits. But profits are easy to report if the assumptions are aggressive and yet allowed by GAAP. A very easy reference on this is Netflix (NFLX) which is often cited for its profits and hence “giant lead” while omitting the negative free cash flow that existed for a very long time.

Profits do not do a lot of good if the company does not receive a comparable amount of cash to back those “great” profits up. If anything, the profits reported during this time period would be on the aggressive side.

Note that the company now is finally reporting some free cash flow the last few years. But even then, a very rough indicator of conservative accounting is that cash flow is equal to profits plus depreciation. That’s only very recently becoming the case here.

Even then Netflix has been using its free cash flow to make acquisitions to bolster its model. That calls into question whether it really has any free cash flow because it needs acquisitions to survive. A calculation is one thing. Whether it’s actually spendable money is something else.

Compared To Disney Cash Flow

Disney has disappointed its investors due to the very long ramp-up time required after the coronavirus shutdown. But it’s not like the company had a guidebook on how to do this because there were precedents. Management probably did the best it could one day at a time for a non-repeating event.

Now, cash flow is off to a fantastic start in the current fiscal year when compared to the fiscal year before. That’s likely due to a lack of ramp-up expenses combined with a lack of revenue from existing business because you’re starting from zero in a shut-down situation.

A giant positive comparison like the one shown above almost always assures a good fiscal year unless there’s an unexpected major event (like a pandemic) that would cause a momentous shift in expectations “overnight” In fact, that sizable free cash flow comparison probably preludes one of the best fiscal years in some time for the company as well as a return to normal business conditions. Run properly, Disney was always a big cash flow generator. That “run properly” appears to be returning to the forefront with that comparison.

Company Position

Despite the current stock price, the board claims that they’re aware of the issues and are working on those issues. As Warner Bros. Discovery (WBD) has stated several times (and I put it several times in my articles on them too), it takes years for a company the size of Disney to get an idea into motion enough that shareholders can tell the difference.

If the proxy vote comes out such that the board changes materially, then there’s every chance things would be in turmoil for several more years until those ideas became apparent. Big companies do not “turn on a dime” That’s also covered one way or another by Michael Porter in his book.

In the meantime:

Clearly the company is going to make serious progress based upon the objectives shown above. Also, clearly the markets in which the company does business shifted considerably during the pandemic shutdown. The effects of the pandemic are not the fault of management.

What should be considered is that management is clearly dealing with the hand it was dealt. The other major idea is that management is course correcting as it goes along. That’s the polar opposite of a management that will fail.

Summary

Usually when a stock price goes “down the drain” these kinds of activists come out of the woodwork claiming that they can immediately get the company back on track.

As shown above, the stock hit rock bottom during the pandemic and then it recovered to some decent prices on the theory that the recovery was “just around the corner” The problem was that corner was way longer than the market had patience for. Therefore, the stock went right back down a second time.

But it’s hard to criticize management for taking so long when the coronavirus issues caused additional theme park shutdowns and movies take years to get to the theaters. Any rational and deliberate thought process would indicate that this was not going to be an instant bounce-back no matter what Mr. Market thought.

Therefore, the idea that someone can come in and make the stock price go up takes a whole lot of faith that really is not backed up by either academic research or even the usual experience. For every person that can do this there are at least 10 pretending to have the same ability (while disappointing shareholders). Those are not good odds.

In the meantime, you have Bob Iger, CEO, who is legendary throughout the industry for how well he ran the company in his first stint. It would honestly be hard to have a better candidate with the current board backing him. The idea that someone new could just sit on the board with better (material) ideas than Bob Iger and his team defies logic. Already Bob Iger has shown tangible progress in one year. So, there is no indication he has lost his touch.

Now there’s a succession issue that needs to be dealt with. In the future, I want to hear all about this because it is going to be challenging to find another Michael Eisner or Bob Iger to succeed the current CEO. Since the company is far larger, the progress on that front needs to show up soon.

But for me that’s not enough to put any new people on the board. Instead, it would appear to be that this board is doing just fine as it is and so is the CEO. The board already changed CEO’s when Bob Iger came back. I would not count on being lucky a second time.

To me, this is still a strong buy as I believe that Disney will win the proxy battle now underway. But I would also encourage investors to consider buying Disney stock and voting for the board because I suspect that the stock price will be hitting new highs as the recovery continues and the company can finally take advantage of the last acquisition that was stymied by the pandemic. I also think that streaming has a bright future with Bob Iger at the helm (and it will not be by using aggressive accounting either).

Clearly the current management aims to grow the business at the pace of the “good old days” before the pandemic. That may not make the dividend a priority. But total returns were fantastic for many years. I look forward to those days again because there is good recovery potential before we get to that growth.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of DIS either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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