Disney (DIS) reported solid 1Q19 earnings with Theme Parks doing very well, Studio Entertainment struggling as expected against a tough comparison, and Media Networks showing improvement against strong secular headwinds related to cord cutting and on demand viewing.  EPS surprised to the upside although management cautioned that much of the upside was timing related such that full year expectations should largely be maintained.

The reality is that none of this really matters.  DIS’s future outlook is about to change dramatically as it closes on its acquisitions of assets from 21^st Century Fox and embarks of the launch of its Disney+ direct to consumer (DTC) product.  Current EPS projections for DIS call for $7+ in 2019 and further growth in 2020.  However, these estimates are mostly based on DIS before the DTC transition.

Late last year, DIS issued three years of restated financial statements based on the company’s new reporting structure that is aligned with the DTC transition.  Segment data was provided that is helpful to assess the future outlook.  The big challenge DIS faces is that historically a material part of its business model for Media Networks and Studio Entertainment has been based on creating content, TV shows and movies, and licensing the properties to third parties.  Looking ahead, DIS will forego the licensing revenue and use the content in its own DTC services.  The properties are enormously valuable and include Marvel, Pixar, Star Wars, Disney, and ABC Network TV shows.  Furthermore, beyond passing on the very high profit margin licensing revenue,  For Disney to fill out a competitive DTC offering at Disney+ and its soon to be majority owned Hulu, likely requires a large increase in its own programming expense.  DIS+ and Hulu do not need as much as content as Netflix to be successful but they do need a much broader array of programming than DIS and new Fox assets have historically produced.

DIS is hosting an analyst meeting in April to more fully address its plans for its DTC businesses.  We have spent a lot of time reviewing Wall Street analysis of the possible EPS outcomes for DIS under its new strategy.  There is no doubt that over 2019 to 2021 time frame that earnings will be heavily pressured, perhaps bottoming close to $6.00.  From there, the growth profile is highly contingent on how many subscribers Disney and Hulu can attract.

Northlake is taking a wait and see attitude DIS.  The company owns many premium brands and has an amazing track record of success.  This suggests the shares should sustain an average to average P-E ratio on trough earnings.  Call it 15-18 times or $90-108.  We suspect that investors will initially give some credit to subscribers to be attained over the next few years and assume successful launch of Disney+.  This could push the multiple up to 20 times or higher and get the stock to $120 at least.  DIS shares presently trade near $100 or right in the middle of our range.  Northlake thinks the odds of DIS completing a successful transition are good, so we are comfortable holding the shares even as we expect little movement in the near-term.

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