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May 08, 2006

Disney March 2006 Quarterly Earnings Preview

Disney (DIS) reports its 2Q06 after the close on Tuesday. Consensus calls for 31 cents against 32 cents a year ago. DIS has forecast a backend loaded year leading to a fourth straight year of 10% growth. The shares have acted well all year so there is little concern about the flat year-over-year growth forecast for the latest quarter. Timing of theatrical and DVD releases, revenue deferrals at ESPN, and a shift in the Easter holiday are each contributing to the "slow 1H/grow 2H " progression in this year's results. Estimates have inched up recently for 2Q with some analysts appearing to expect a repeat of the better than expected 1Q results.

On Friday, DIS shares closed over $29 for the first time since March 2005. Investors have rewarded DIS for stringing together several years of double digit growth. Investors are also happy with Bob Iger's leadership and the content-centric strategic direction he is taking the company. The Pixar acquisition just closed, complementing the divestiture of radio as a sign that for DIS the future is content over distribution. I share Cramer's view and sense a slight shift on the street in favor of content as the proliferation of touch points with consumers via the internet, iTunes, and advanced services like VOD and DVRs are being viewed as incremental. The big entertainment companies have always benefited from technology transitions (VHS to DVD being a great recent example) and while risks are unusually high as the current business models are under severe stress, DIS at least appears to have a coherent strategy....

2Q should witness strength in Broadcasting and weakness at Studio Entertainment. Broadcasting is benefiting form the continued turnaround at ABC which benefits the network and the TV stations. The studio has another tough comparison that will lead to a down quarter despite decent box office and DVD results in the quarter. Last year saw the release of The Incredibles DVD, so a big decline in studio profits is in order. This should reverse beginning this quarter with the June release of Cars followed by the July release of the sequel to Pirates of the Caribbean. I've seen two separate polls that recently ranked Pirates as the runaway choice for most anticipated summer film. FY07 results will get the biggest financial benefit from these two releases.

Cable Networks is dominated by ESPN which faces another quarter of revenue deferrals due to the timing of sports programming. Management has confidently stated that ESPN will grow double digits through 2010.

Theme Parks should have another solid quarter and the outlook is improving with the recent weakness in the dollar. Continued improvement in margins on moderate top line growth is the story at the theme parks.

Three other items that might come up on the call include ESPN Mobile, the ESPN contracts with Comcast (CMCSA/K) and Time Warner (TWX), and aborted McDonald's (MCD) partnership. Losses for the ESPN Mobile project are expected to be considerable this year. I fear that loss estimates could rise as I believe the company has upped its handset subsidy. I have also noticed a shift in the advertising message, which might indicate initial response was poor. On the contract renewals, ESPN will look for a 10-20% increase in the first or second year of the new deals with lower single digit gains in the out years. Deals like this have been struck with other operators but CMCSA and TWX are tough negotiators and this could be a difficult fight. On Monday, news broke that DIS was ending its promotional arrangement with MCD after Cars and Pirates. DIS shares traded down on this news. I saw one comment that said this deal was worth $100 million to DIS but I have no idea if that is accurate. Apparently, DIS wants to reduce its exposure to the children's obesity issue.

I continue to like DIS with a target in the low $30s. I think the big summer box office, 2H06 EPS, and growing confidence in the growth outlook in 2007 and beyond will be the next catalysts.

Posted by Steve Birenberg at May 8, 2006 01:46 PM in DIS