Disney (DIS) reported excellent December quarter earnings driven the massive success of Star Wars.  Star Wars not only drove the studio but also boosted consumer product sales.  Theme parks also had a very strong quarter.  Despite a big beat to consensus EPS estimates, investors focused on slightly disappointing growth in affiliate fess earned by DIS’s cable networks.  This is primarily ESPN where there is great concern that cord cutting or cord shaving is causing ESPN to lose subscribers.  Given that ESPN is locked into very high cost sports contracts out to 2020-2022, margins could get squeezed badly.  This issue was first raised in August when Disney announced that ESPN had lost about 3 million subscribers.  Today, it remains the controlling issue for the DIS shares and this seems unlikely to change in the near future.

Northlake believes these concerns are real but that investors have overreacted.  DIS is well protected in the near-term by its contracts with cable and satellite companies (MVPDs) that have required minimum carriage.  Additionally, DIS management appears to be showing some flexibility to work with MVPDs and Over The Top providers to design smaller channel packages that include ESPN.  Management also feels confident in their ability to extract higher per subscriber fees in future negotiations.

Away from ESPN, everything is going well for Disney.  The company is in the midst of fantastic content cycle using its Star Wars, Marvel, and Pixar franchises.  Additionally, the opening of the new theme park in Shanghai in June will allow the company to get beyond the upfront opening costs and heavy capital spending.  Theme Parks, the film studio, and consumer products should allow DIS to grow earnings even as cable networks face a couple of slow growth years starting in 2017 when the much higher costs for the new NBA contract kick in.

DIS is the sort of quality company that investors find attractive when the market is in turmoil.  We expect the strong content cycle to continue to power better than expected results in 2016.  Concerns about ESPN will not be put to bed right away but with the stock at 15X 2016 earnings, we think the shares offer value and could trade back to $100-110 in a stable market environment.  We are willing to give DSI the benefit of the doubt for now and plan to continue to hold the stock for Northlake clients.

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.