Disney (DIS) reported FY2016 results with sales and earnings modestly below expectations. While the results were slightly underwhelming, investors were more focused on the outlook for 2017 and beyond. Although DIS faces difficult comparisons next year, due largely to year ago strength in Frozen consumer products and Star Wars: Episode VII box office receipts, we believe the long-term growth outlook is still very promising. Using 2017 EPS estimates, DIS is trading at a slight discount to the S&P 500 instead of the premium multiple investors typically award the stock. Given the de-risked estimates and discounted multiple, we believe the shares can move back toward $110 with limited downside from current levels.

Arguably the largest concern for DIS investors recently has been the implications for affiliate fee and advertising revenues tied to the recent decline in ESPN subscribers. On the earnings call, CEO Bob Iger commented that DIS has “taken a more bullish position on the future of ESPN’s sub base.” Two important factors are likely involved in this improved outlook. First, DIS now has deals in place with Sony, Dish Network, Hulu, and AT&T/DirecTV for broadcast and cable networks like ESPN to be included in new skinny bundles. The new distribution deals should help stem subscriber losses if consumers leave traditional cable bundles for the new offerings, and could even add new subscribers who never had cable in the first place. Second, DIS recently purchased a 33% stake in Major League Baseball’s BAMTech, with the option to acquire majority ownership in the coming years. This investment is likely tied to ESPN’s plans to launch a direct-to-consumer OTT network in the near future, further increasing the potential subscriber base. Separately, BAMTech already delivers digital content for several other companies, and could eventually help DIS to create dedicated OTT networks for its other brands including Disney, ABC, Pixar, Marvel, and Star Wars.

While investors worry about ESPN subscribers and revenues, DIS also expects cable programming expenses to increase 8% in 2017, largely driven by the step-up in NBA deal. ESPN now has NBA rights locked up through the 2024-25 season, and has long-term deals in place with the NFL, NCAA Football, NCAA Basketball, and MLB. We believe high-quality sports rights are a worthwhile investment that provides valuable ad inventory at a time when advertisers are struggling to find large audiences watching live TV. Rising costs and the threat of falling sales understandably worry investors. However, we believe that the exclusive sports rights and increasing distribution options will allow ESPN to continue to grow long-term.

The parks and resorts segment is benefitting from a better than expected opening at Shanghai Disneyland. The new park is already pulling visitors from across China, with 50% of attendance coming from outside of Shanghai. Even better, the park is expected to operate at close to break-even profitability by the end of 2017, much faster than originally planned. Due to the early success, DIS is already expanding Shanghai Disneyland to include “Toy Story Land”. The resorts in Orlando and California are each getting their own “Star Wars Land” expansions. DIS believes they have pricing power at their parks due to demand-oriented flexible pricing and new ticket packages.

Finally, and most importantly, DIS continues to leverage their world-class brands and franchises starting with the Studio division. Success at the box office leads to years of success in consumer products and parks. For example, Frozen merchandise is still selling so well 3 years after the film’s release that it creates difficult growth comparisons into 2017! Key upcoming films in the next two years include 4 titles from Marvel, 3 animated pictures from Pixar and Disney, and 2 Star Wars films including Episode VIII. The upcoming film slate and powerful business model is more than enough reason for us to believe that growth will continue across the entire Disney business for years to come.

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 not currently held as a 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.