Thanks to the 2Q19 earnings report, for a brief stretch, focus on Disney (DIS) turned back to the fundamentals of their current operating businesses.  It turns out the news is pretty good.  Theme parks are performing very well with growth prospects soon to be supported by new attractions in Orlando and Southern California.  The film business had a tough quarter but only because of last year’s massive success for Black Panther and the later fiscal year timing of soon to be all-time box office champ Avengers: Endgame soon to be followed by The Lion King, Frozen 2, and the conclusion of the main Star Wars saga.  ESPN still faces long-term challenges as subscribers fall due to cord cutting while sports rights escalate creating a profit squeeze.  However, recent renegotiation of carriage agreements with traditional and digital distributors has provided a reprieve – good news even if we see it as temporary.  This fundamental strength is good timing for DIS as 2019 also marks the expensive transition of the company toward a digital direct-to-consumer future.

In April, DIS provided a detailed and extremely well-received presentation about its digital services to be anchored by the November launch of Disney+.  Disney+ will be the home for the company’s Marvel, Star Wars, Pixar, Disney, and National Geographic content.  DIS will also continue to develop it’s now fully controlled Hulu services and already launched ESPN+, creating a suite of digital direct-to-consumer products.  The cost of this strategic transformation against current earnings is high – foregone revenue from licensing content to Netflix and others, technology and marketing costs, increased investment in new TV shows and movies, dilution from paying a steep price to acquire the entertainment assets of 21st Century Fox.

For now, even when earnings are reported, the narrative surrounding DIS shares is all about the future.  So far investors are valuing DIS in two parts.  First, a traditional P-E multiple is applied to core earnings of around $8.00 per share.  Using a below long-term average of 15X gets to $120.  Second, investors are valuing the direct-to-consumer business, especially Disney+ and Hulu on a per subscriber basis.  Management offered huge 60-90 million sub guidance five years out for Disney+.  Hulu can be valued based on recent transactions between DIS and Hulu co-owners Comcast and AT&T.  Analysts appear to see $20-$50 in value for these assets combined.  Put it all together and a stock price in the $140-$160 range is the consensus view.

Northlake agrees with this but with the caveat that once Disney+ rolls out actual subscriber uptake and actual cost to execute will dictate the sustainability of these target prices and, more importantly, the next big move for DIS.  Over the next six months, DIS investors probably have little to worry about.

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