Disney (DIS) reported slightly better than expected earnings for the quarter ending June 2015.  The results continue a string of results above expectations driven primarily by the incredible success of the company’s content strategy including hit films from Marvel, Pixar, and Disney Animation.  This success is projected to continue later this year with another Pixar release and a relaunch of the Star Wars franchise.

Despite the good results, DIS shares fell about 10% as the company lowered its forecast for its cable networks segment from high single digit to mid-single growth in operating profit.  The culprit was a dip in subscribers at ESPN.  ESPN’s primary revenue source is monthly fees it receives from cable and satellite companies that pay based on a per subscriber affiliate fee.  The advent of over the top streaming services like Netflix and Hulu and the different TV consumption habits of millennials has led to a slow decline in the number of cable and satellite subscribers in the United States.  ESPN was thought to be immune from this trend given its highly viewed sports content.  Lower sub counts for ESPN could set up a dangerous scenario for DIS given that the network is locked into long-term, expensive sports rights contracts with annual escalators.

The decline in DIS shares was exacerbated by the incredible performance of the shares leading into the report.  The shares sat at an all-time high after doubling in two years.

Thanks to the news from DIS and a higher than expected loss of total multichannel TV subscribers in the June quarter (cable, satellite, and telco), there is widespread fear that cord cutting and cord shaving/skinny bundles (smaller channel packages) has reached a tipping point that will stymie growth in TV networks business.  Sharp declines in nightly TV ratings that began in the summer of 2014 and have continued are also a worrying trend.

Northlake shares Wall Street’s concern but feels last week’s stock price reaction in DIS and other media stocks is an overreaction in the short-term.  Cord cutting has been ongoing for several years and will likely continue but do so at a pace that should still allow TV network to enjoy modest growth in financial results.  DIS is better insulated from these fears due to its content engine and the unique way in which successful content creates profits at the company’s theme park, cable networks, and consumer product segments.

We do expect a period of sluggish performance for DIS and other media stocks as a new Wall Street consensus forms around the company and other media companies.  We think DIS is worth holding given its financial strength and upcoming catalysts in businesses beyond cable networks (Star Wars, Shanghai Disney opening).  Northlake has been deemphasizing media stocks for some time with prior sales of Discovery Communications and new purchases purposefully diversifying the individual stock portfolio into more industry sectors (Activison Blizzard, La Quinta Holdings, ClubCorp).

DIS shares still have potential to rise 10-20% over the next 6-12 months and we plan to maintain Northlake client positions.  The doubling of the shares since they were first purchased for Northlake client accounts has led to large position concentrations so it would not be unusual to see certain client holdings in DIS trimmed slightly should cash reserves need supplementing for any reason.

DIS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  DIS is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.