Is Disney "Unduly Beat Up"?


By David Shook You know you're in rough shape when even Winnie-the-Pooh has it in for you. That's the situation Walt Disney (DIS) is in. As if declining earnings, fleeing shareholders, and falling ratings for Disney's ABC network weren't enough, the company Michael Eisner built into a media juggernaut acknowledged in a recent securities filing that it faces financial risk from a lawsuit brought by the family that owns the rights to Winnie-the-Pooh.

The Stephen Slesinger family claims Disney has cheated it out of $200 million in royalties since 1983 for Pooh-related merchandise and attractions at Disney resorts. Pooh stands to deliver Mickey Mouse one sizeable kick in the shins.

"FEELING THE HEAT." The lawsuit over the loveable bear isn't a long-term risk to Disney, which believes it will prevail in the case. Disney had pro forma earnings of $879 million in fiscal 2001, on $25 billion in sales, so losing the suit would hardly result in a huge blow to earnings. But the situation does shine a spotlight on Disney's wider troubles.

In recent weeks, frustration has run particularly high among investors. The share price, which fell as low as $17 last September, had inched up to $25 by mid-May. But with rumors that the board might be calling for Eisner to step down, and little growth in profits or share price expected near-term, many shareholders have thrown in the towel -- sending the stock to $19.50 on June 20, down 35% from its 52-week high of $30 in late June, 2001. "The company is feeling the heat," says Richard Moroney, editor of Dow Theory Forecasts.

For investors willing to look at Disney with a fresh eye, however, the intense pressure on management and cheaper stock price could be a buying opportunity. The truth is, Disney's problems aren't all that hard to fix.

POISED TO BENEFIT. Much of its earnings decline is due to weakness at ABC, which is in the midst of a turnaround and sports a promising fall lineup. Disney's theme parks have cut costs, and the cable channels, including ESPN, are posting respectable advertising sales gains in a rough market for cable programming. All in all, the company is poised to benefit from the consumer-led economic rebound now under way.

On June 13, Salomon Smith Barney analyst Jill Krutick went against the grain and dared to call Disney a good buy at current levels. She believes the stock may be poised to jump past $30 a share if the economic recovery kicks into gear. "We think Disney looks unduly beat up," agrees Curtiss Scott, co-portfolio manager for the Touchstone Enhanced 30 mutual fund, who has lately been adding to his Disney position.

While Disney has said results for the third quarter ending June 30 will be down from a year ago, it sees reasonably strong profits for the fiscal year ending Sept. 30. Disney told Wall Street to expect net income of about $1.3 billion, or 63 cents per share, on sales of $25 billion for the year.

EASY AS A-B-C. Prudential Securities analyst Katherine Styponias says operating income will fall about 20%, to $3.2 billion, from $4 billion last year, but then should rise by about 21% in 2003. Adds Scott: "Over the long term, I think the company can deliver 9% to 10% net income growth on an annual basis."

The key to winning back Wall Street's favor will be reviving ABC, the largest part of Disney's Media Networks division, accounting for 38% of sales. Last season, ABC ranked fourth among networks in the valuable 18- to 49-year-old audience. It relied too heavily on the overexposed Who Wants to Be a Millionaire and had only one show, Monday Night Football, among programs rated in the top 20, according to Nielsen Media Research.

In the second quarter, Disney's broadcasting operating profits evaporated. From a $167 million profit a year earlier, the division lost $11 million. "ABC really has been the principle overhang for Disney," says Tom Wolzein, analyst for Sanford Bernstein & Co.

COMMERCIAL BREAK. Major changes are under way at the network, however. Early this year, Eisner promoted programming veteran Susan Lyne to ABC Entertainment president, the fourth person to hold the job in five years. This time, analysts think Eisner found the right person. She ditched Millionaire and is investing in more of the smart, original programming that won her acclaim as ABC's chief of movies and miniseries, her previous post. Among the shows under her watch, ABC scored big with Life with Judy Garland: Me and My Shadow and Tuesdays with Morrie.

So far, advertisers seem to like the fall lineup. On June 12, ABC reported a $1 billion advertising buy from Omnicom, which handles ads for Pepsi and Visa, among others. While rivals NBC and CBS had much higher ad-rate increases over the past year, due to their already proven prime-time lineups, ABC did chalk up 4% to 6% price hikes for the coming fall schedule -- respectable, considering much of the programming will be new material.

"Rebuilding ABC is a process that won't happen overnight or in one season. But we're confident that we've laid the groundwork for a turnaround," Lyne said during a Deutsche Bank conference on June 5. "If ABC shows improvement this fall, the stock should see a fairly nice advance," says Bank of America analyst Tim Wallace.

"FEELING VERY GOOD." Wall Street also wants to see growth at Disney's famed theme parks. Sales in the most recent quarter fell 8%, to $1.5 billion, while operating income declined 15%, to $280 million. But earnings at the parks and resorts tend to rise and fall with the economic cycle, and this business now appeara to be on the way out of a significant trough in earnings that began a few months before September 11.

"At this point, we're feeling very good about a rebound in attendance for the theme parks," says Disney CFO Tom Staggs (see BW Online, 6/24/02, "Disney's CFO Measures the Mouse"). "We're already seeing signs of that in the third quarter" ending June 30. While still expecting this quarter's park-and-resort sales to be down 6% to 9% vs. last year, "demand seems to be picking up nicely for later in the summer," he says.

The rest of Disney's divisions are holding their own. Its cable networks unit posted $320 million in operating income in the latest quarter, vs. $336 million in the same period last year, mostly because of success at ESPN and the Disney Channel during the advertising recession. However, due to the financial woes at Adelphia Cable, which buys the rights to the sports network, ESPN is expected to sustain cuts in licensing revenues.

FAIRLY CHEAP? Disney's movie studios, like all of Hollywood, have erratic earnings, which analysts don't try to forecast. Its consumer-product division, which includes all merchandising efforts, is struggling, but it makes up just 10% of sales. Disney expects its summer animated film release, Lilo & Stitch, will generate strong box office and merchandising sales this year.

Tally it all up, and a case can be made that Disney is fairly cheap right now, relative to some competitors. It trades at a price-earnings multiple of 22 times calendar-year 2003 earnings, far less than Viacom's (VIA) comparable 32, but higher than AOL Time Warner (AOL), with a 2003 p-e of 15 following a 70% decline in the stock's value over the last year.

Thanks to the cash-generating theme-park business, Disney has higher free cash flow than its competitors. In the most recent quarter, it had free cash flow per share of $1.98, compared with 86 cents for Viacom and $1.01 for AOL.

LEFT HOOK. Moreover, Disney still has a strong brand name, a global franchise, and, yes, strong management. Shareholders may be prodding Eisner for better performance, but most still seem to think he could find his second wind and lead the company to new growth.

The Winnie-the-Pooh lawsuit, which could cost $200 million or more, may be deliver a left hook, but Mickey Mouse isn't down for the count. Investors who get in now might be there to enjoy the rewards when Disney comes back in fighting shape. Shook is a reporter for BusinessWeek Online in New York


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