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November 17, 2005

Previewing Disney's September Quarter Earnings

Disney (DIS) reports after the close tonight. Current consensus estimates call for EPS and revenue of 18 cents and $7.9 billion, respectively. EPS are down a penny from a year ago and revenue is up 5.5%. Operating income growth is projected at just a 2.2% gain. These headline figures mask a better underlying story as DIS has already announced a $275-300 million write-off at its studio related primarily to Miramax films due to the departure of the Weinstein Brothers. DIS had several big budget flops of its own in the quarter so presumably these are included in the write-off. If not, that could be the source of a negative surprise. I am not that concerned about the movie studio as investors will put the tough quarter behind them due to the success of Chicken Little and likely success of upcoming films The Lion, the Witch, and the Wardrobe based on the Narnia series and the sequel to Pirates of the Carribean which returns its entire cast. The original Pirates grossed over $300 million at the domestic box office and brought in another $260 million in the home video window. That makes up for a bunch of Brothers Grimm....

Another key to the quarter will be results at home video, which has slowed sharply and to which DIS has disproportionately high exposure at 18-20% of revenues. DIS also has done a lot of family-oriented direct-to-video releases, an area that has been noticeably weak of late. Also worth watching is results at the Touchstone TV studio. This has been a laggard area but is at the start of a series of likely syndication hits, starting small this quarter but growing over time as current hits Desperate Housewives, Lost, and Grey's Anatomy reach the 100 episode level. In the just concluded fiscal year, Touchstone operated near-breakeven, an improvement of $90 million year-over-year. Another swing of $100 million or more to the positive could occur over the next year or two.

Looking at the fourth quarter on a segment basis, the big gains are expected at the Broadcast and Cable Networks. Besides a turn in syndication, Broadcast will benefit from the ratings success at ABC. For the quarter, a shift from a loss of $75 million to a gain of $80 million is expected for all of Broadcast. Cable Networks are expected to grow around 25% as timing of revenue recognition at ESPN will be favorable this quarter reversing the 1H05 drag. Theme Parks estimates have recently come down a bit but the expectation is still for a double digit gain driven by margin expansion and an easy comparable to Florida's hurricane ravaged 2004.

I also hope the conference call provides some insights into the sale of the company's radio stations. The recently announced sale of Susquehanna's radio stations was completed at a good price that implies over $2 billion in value to DIS. DIS seems likely to dedicate any cash received on the transaction to further share repurchases, which I think will be well received by analysts.

The reason I see the quarterly as appositive catalyst is that it will shift investor focus to FY06 which should be another good year for DIS. Given all the negative sentiment toward growth at traditional media companies, I'll bet a lot of investors would be surprised to learn that 2006 will mark the fourth consecutive year of double digit operating growth at DIS. FY06 will be driven by the continuing turnaround at ABC and Touchstone and further expansion in theme park margins. ESPN should show double digit growth off rising affiliate fees and advertising revenue. Interestingly, and in my opinion, a source of upside for FY06, current analyst estimates do not look for a big rebound at the movie studio. This despite the strong lineup already mentioned, a good run for the Jodie Foster film Flightplan, and hopefully non-recurring $250-$300 million write-off.

Current consensus EPS estimates for DIS in FY06 ending September are $1.47. I think those estimates cold prove low (estimates range up to $1.59) but even at consensus, I do not find the P-E of 17 times to be unduly challenging given another year of double digit operating growth. I also think it is worth noting that DIS has minimal exposure to traditional media distribution assets with TV and radio stations contributing only 5% of revenue and no exposure to newspapers or cable plant. I think this benefit outweighs the added risk of the company's exposure to cyclical trends through its Theme Parks.

Posted by Steve Birenberg at November 17, 2005 10:40 AM in DIS