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August 02, 2007

Disney Earnings Growth Continues Unabated

Disney (DIS) reported another strong quarter. EPS of 58 cents exceeded the 55 cent consensus estimate with revenues in line with expectations at $9.05 billion. The upside came from margins with Broadcasting being unusually strong with operating income up 127%. Cable Networks also had higher margins than analysts were expecting. The only shortfall was operating income at Studio Entertainment but this segment has notoriously volatile and difficult to predict financial performance.

Commentary about the fourth quarter and general big picture thoughts about 2008 and beyond was all positive. Between the upside surprise and the confidence expressed by management I think the concerns over DIS's future growth will moderate somewhat. This should allow the shares to resume their leadership among megacap entertainment conglomerates. All you really need to do is juxtapose the earnings reports and conference calls of Disney and Time Warner from yesterday to see why Disney shares remain attractive.

Disney also announced the acquisition of Club Penguin, a social networking site focused on the kids demographic. DIS will make an upfront payment of $350 million with an additional $350 million due if certain incentives are met. The deal should be accretive in year one and accretion will rise if the incentives are met. Club Penguin could have about $50 million in revenue and I would guess pre-tax margins are near 40%. I like the deal for DIS. Promoting Club Penguin across Disney properties should accelerate growth and in the long run the ability to use Club Penguin across the company's other assets seems plausible.

Looking more carefully at the segment level, it was another quarter of solid growth. Revenues were up 7% and operating income again rose double digits, gaining 14%. EPS for the first nine months of the fiscal year have grown by 24%....

Broadcasting had a great quarter with revenues up 9% and operating income up 127%. Programming costs were much lower due to success of ABC's schedule while international and domestic syndication of recent hits on the network drove revenue.

Cable Networks had 5% revenue growth and 9% operating income growth. ESPN and the domestic Disney owned networks led the way. Next quarter will see a big boost in revenue from ESPN deferrals but will also assume much of the NASCAR rights fees. I am not sure how this will balance out relative to expectations but I would guess that analysts knew about the rights fees already and the extra revenue will be incremental.

The volatile Studio Entertainment segment saw revenues decline rise 6% and operating income fall a worse than expected 20%. The entire issue was about a tough comparison in highly profitable DVD sales. Next quarter faces a tough comparison on theatrical box office since Pirates 2 was entirely in the third quarter a year ago and is one of the top grossing movies of all time.

Theme Parks continue to plug along with domestic attendance trends flattish but better than expected against tough comparison. Per capita spending at the parks and hotels is running up strongly helping to drive margins. Management had met its 20% margin goal but commentary on the call suggests they think they can get back towards toward record margins of 23% in the next few years.

Consumer Products remains an underappreciated segment. Revenues rose 23% and operating income was up 12%. Investments in video games and merchandising held back margins but given all the great content DIS has produced in the last few years this investment will pay off down the road. Consumer Products has the potential to surprise to the upside and help sustain growth next year as DIS faces tough comparisons elsewhere.

Posted by Steve Birenberg at August 2, 2007 09:37 AM in DIS