2. The Walt Disney Company (NYSE: DIS)
Value: $869,664,000
Percent of Dan Loeb’s 13F Portfolio: 6.7%
Number of Hedge Fund Holders: 144
Disney ranks 2nd on the list of billionaire Dan Loeb’s top 10 stock picks. KeyBanc recently reiterated its Overweight rating for the entertainment company, citing strengths in its streaming business. Disney Plus recently crossed 100 million subscriber count. KeyBanc also hopes that the latest easing of restrictions in California could allow the company to open Disneyland in April. The firm has a $225 price target.
The company is also getting the attention of the smart money, as 144 hedge funds tracked by Insider Monkey reported owning stakes in the company at the end of the fourth quarter, up from 112 funds a quarter earlier. Disney ranks 11th in our list of the 30 Most Popular Stocks Among Hedge Funds: 2020 Q4 Rankings.
Semper Augustus Investments Group, in their Q4 2020 investor letter, said that they’ve initiated positions in The Walt Disney Company (NYSE: DIS) at high single-digit expected earnings yields.
Here is what Semper Augustus Investments Group has to say about The Walt Disney Company in their Q4 2020 investor letter:
“With few exceptions, portfolio activity added tremendous earning power. Sales were generally undertaken at high prices where price gains had outstripped fundamentals and thus as earnings yields diminished. Buys added wholesale earnings power. When numerous holdings plunged in price in March and later, we both added to and initiated positions at high single-digit expected earnings yields.
Portfolio activity in Disney provides an example of the opportunity the year brought. Disney was originally purchased in 2018 prior to the closing of their merger with Twenty-First Century Fox (21st Century Fox). Disney’s shares were weak during the prior four years, largely due to the well-known fact that cord cutting was harming Disney’s valuable ESPN franchise. Hard to believe in my household but some people evidently don’t enjoy watching televised sports, and as the highest priced platform in the traditional cable or satellite bundle, a loss of subscribers comes with a loss of revenue. Further, the merger-arbitrage community had bid up the price of Fox and down the price of Disney shares. At $100 per share, Disney traded for roughly 15 times its then earning power.
Disney’s decision to pull content from Netflix shined the light on the investment case at Semper. Netflix was initially viewed by Disney as just another pipe for distribution of TV and film content to its audience. Pulling content back in house and then distributing directly to customers via a new Disney+ app as well as Hulu, ESPN+ and a number of global platforms coming with the Fox deal turned us on to the enormous value of the franchise. Growth would come with much higher margins. My mistake at the time was not buying enough Disney. The merger consummated in March 2019 and we watched our little 1% position race ahead by half by the end of that year. I’ve done this many times, buying an outstanding company at an attractive price with too little money and watching my small position approach fair value. The mistake when made is not enough of an initial burn to qualify as a “touching of the hot stove” lesson, but I’d like to think I’ve done it enough to know better. Some rationale can be attributed to an appreciation of opportunity cost not being an exact science. In fairness there were other attractive venues for capital when buying Disney, but only 1% in a position of that business at that price was inexcusable.
A lesson for all investors when making an initial acquisition is to look in the mirror and ask, “Am I buying enough if for some reason I don’t get to add to it?”Redemption came with the pandemic, an unusual phrase in these tough times. In the case of Disney, the mouse was taken behind the woodshed and more than roughed up. Closed entirely were the theme parks, the cruise line, the broadcast and movie studios. Live sports were cancelled or moved to later dates. The company acted rationally, even brilliantly by suspending the semi-annual dividend, increasing its liquidity position by drawing on lines of credit and adding term debt to an already encumbered balance sheet (thanks to having only recently financed the Fox deal). In the case of Semper, a determination that the plague would be finite and stress testing the balance sheet and degree of cash flow impairment allowed for survival. Survival? Would you have imagined?
Confident that Disney would survive the pandemic with the balance sheet intact, the original sin of underspending led to salvation by adding materially to the position following the plummeting of the stock. By March, Disney’s shares traded back to $100 and even below our original purchase price. At our “new” purchase price, Disney fetched an expected 10% post-pandemic earnings yield and was valued at less than 2/3 of fair value. Of course, the calculation of earnings yield required an estimate of earning power in a more normal environment because Disney was surely going to lose money in 2020. Valuations using temporarily depressed earnings produce what appears a high price. At two-thirds of value, expected return becomes the earnings yield plus a 50% gain to fair value, plus any additional organic growth between here and there. When the world caught on to the success Disney was having attracting customers to its new app, even though much of Disney’s operations still run below capacity (Disneyland in California remains closed due to government dictate for example), investors looked beyond the immediate horizon and bid up the shares. By yearend, Disney rose to $181.18, somewhat north of our appraisal, allowing us to trim a now large, more fully valued position. Opportunity knocks.
Portfolio activity in Disney illustrates the folly of several beliefs. Under the efficient market hypothesis, whereby the market is all knowing, and no amount of research can add independent value, one might ask whether during a twelve-month period of time an established, mature company like Disney should see its shares fall by 45% and then rise by 129%. Even in a crisis like the one we all dealt with during 2020, is there room for rational analysis determining that Disney was Disney at the end of 2019, and at some point, post pandemic, will again be Disney, and oh by the way, with better content distribution than before and a cascade of pent-up demand?”
