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August 13, 2005

Disney Earnings Fail To Provide Desired Catalyst For Shares

Disney (DIS) shares fell 3% on Wednesday in reaction to the company's 3Q05 earnings report. The quarter was decent but I found the 3Q results disappointing as I was expecting an unequivocally strong report to act as a catalyst for the shares. However, I did not find the results to a major miss and was a bit surprised with the harsh reaction by the market. Coming off the quarter, I am holding all client positions and still think the shares belong in the low $30s. However, comps toughen in the second half of calendar 2006, so the window is narrowing a bit for that objective to be achieved. My key takeaway from the quarter is that things better liven up in the next two quarters or owning the shares will have been a waste of time....

....Rather than recap the quarterly financial figures, I thought I'd just add a few impressions from the report and the analyst commentary that followed:

• The Street was surprised by weakness in the Studio which was mostly attributed to the lackluster DVD sales. However, DIS DVD results were worse than the other studios this quarter which indicates that for now at least the problem is lack of hit movies as much as the slowing DVD market. This has been on ongoing at DIS as outside of Pixar films the company has had few hits the last several years. The FY06 film slate looks promising with a Pirates of the Caribbean sequel and new films off established properties such as Chicken Little and the Chronicles of Narnia. As of now, the street expects a 10% growth in the Studio operating income in FY06 against a 20% decline in FY05. This is likely the biggest risk to current estimates although DIS will be playing catch up in the relatively hot TV DVD market this fall when Desperate Housewives and Lost hit stores.

• The company is committed to expanding its presence in mobile content and admitted that there could be material start-up losses. This represents another risk to future estimates.

• The turnaround at ABC is starting to have a financial impact and I think estimates in FY06 could be low in the Broadcast division. One analyst noted that ABC held back inventory from its hit shows in the upfront which means that if pricing and ratings hold, a good amount of premium priced inventory will be available for the new TV season.

• Share buybacks accelerated and were ahead of analyst estimates. DIS has a very good balance sheet and will be underleveraged by my taste in the next few years. If Radio is divested for cash this will lead to further deleveraging. A key question for the future is what the company does with its financial strength. Given the split at Viacom and the big buyback at Time Warner, this is one of the only area where DIS currently falls short of its peers.

Finally, Ray Katz at Bear Stearns noted in his quarterly summary that he though there were already subtle changes at DIS as leadership transitions from Eisner to Iger. He noted a willingness to consider wide ranging alternatives for the structure of a radio divestiture, a possible softer negotiating position with Pixar, and a willingness to challenge traditional business methods such as theatrical windows. I think Ray be on to something although the immediate financial impact may be negative. However, in a changing and challenging environment for traditional media a more flexible DIS would be a good thing.

Posted by Steve Birenberg at August 13, 2005 02:31 PM in DIS