VGI Partners – Walt Disney: A Highly Attractive Entry Price For A Global Leader
Contributor since 2019 / 9944 Followers
Summary:
- Diversified global entertainment group The Walt Disney Company is one of our more recent additions to the portfolio.
- When we built our stake, Disney was trading at more than a 35% discount to fair value.
- Using conservative profitability assumptions, we expect the stock to re-rate back to a 4-5% free cashflow yield in FY26.
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The following segment was excerpted from this fund letter.
Walt Disney Co. (NYSE:DIS)
The Walt Disney Company is a diversified media conglomerate operating media networks, theme parks, film and TV studios and direct-to-consumer streaming services. It is the global leader in theme parks with hotels and cruise lines aimed at families. Key assets within Disney are the instantly recognisable entertainment franchises that have multiple avenues of monetisation such as Mickey Mouse, Star Wars, ABC and Marvel’s Avengers.
Disney’s share price declined due to a number of factors in 2022, presenting us the chance to purchase a long-admired business and its unique collection of valuable intellectual property assets at what we consider to be a very attractive valuation. Summarily, the EPS of Disney has declined from US$7 in 2018 to ~US$2.60 in 2022 but we believe that the earnings power of the assets has not diminished to anywhere near this extent.
Disney is currently undergoing a business transition within the Media and Entertainment Distribution division (DMED) from traditional media property distribution via third parties (i.e. cinemas and broadcast networks) to a Direct-To-Consumer (DTC) model via the Disney+ streaming service. A key element of our thesis is that the earnings power of the company is currently being masked by the marketing and content investments within Disney+ and that this will normalise over the next several years.
To put this in perspective, Disney+ (DTC sub-segment) currently generates operating losses of over US$3.3bn (a negative 14% operating margin) compared to operating margins at its nearest streaming competitor, Netflix, of +15.5%.
A secondary concern around Disney has been the CEO leadership transition from Bob Iger to Bob Chapek that occurred in February 2020. As well documented in the media, the changes that Bob Chapek made to the organisational structure of the business affecting the creative output at Disney did not resonate with senior executives nor investors and he was ultimately removed by the board.
Hollywood loves a sequel – Bob Iger was sensationally reinstated to the CEO role in November of 2022. During his original tenure as CEO, Mr Iger was a well-respected leader, overseeing successful acquisitions of Pixar, Marvel Entertainment and Lucasfilm. We view the board actions as supportive of long-term shareholder value creation as Mr Iger seeks to unify the executive team and navigate the company through the current challenges.
The resilient cashflows of the Disney components have allowed it to invest heavily in the DTC content space and give the management team the necessary flexibility to prove out the earnings power of the business. In this context, it would be remiss of us to not discuss the Parks, Experiences and Products division (PEP) of Disney, which makes up 35% of revenue and 49% of operating profits (ex DTC losses) but has been overlooked recently given the intense focus on the media business.
PEP is a solid business, with the opportunity to invest alongside the core franchises in a ‘flywheel’ of value creation (i.e. Star Wars and Avengers attractions at Parks). After suffering as a result of COVID, the business has bounced back remarkably well, with operating profit now 8% above the FY19 level. Further upside will come from the full re-opening of International Parks – prior to COVID these represented 10% of operating profit of the division. Contrary to conventional wisdom, Return on Invested Capital (ROIC) in this business is estimated at 18% and there is further opportunity to invest material amounts of capital at high rates of return.
When we built our stake, Disney was trading at more than a 35% discount to fair value, and we could underwrite the valuation if the streaming business simply broke even. On our FY26 estimates, Disney is trading on a 7% FCFF (free cashflow) yield, despite profitability still being depressed and continuing to reinvest aggressively as highlighted. Using conservative profitability assumptions, we expect the stock to re-rate back to a 4-5% free cashflow yield in FY26.
Walt Disney (DIS) DTC Operating Profit and FCFF Yield
Source: Company filings, VGI Partners analysis.
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