On October 30th The Walt Disney Company (NYSE:DIS) announced a $4.1 billion acquisition of Lucasfilm Ltd., the George Lucas-owned studio which owns the Star Wars franchise and other assets (for example, the trademark for the term “droid”). This is the latest piece of Disney’s strategy to acquire content (and characters) that can then be monetized through its many formats including television, movies, and theme parks.
The out-of-left-field nature of the announcement is reminiscent of the company’s purchase of Marvel for roughly the same price in 2009 (though most valuations were obviously lower at that time); The Walt Disney Company primarily hopes to leverage that company’s stable of characters through a parade of action movies but has other opportunities as well. Disney’s press release indicated that it plans to produce new movies set in the Lucasfilm canon- we’d note that Disney has recently been terrible at producing profitable science fiction movies- and mentions the two companies’ history of integrating Lucasfilm content into Disney parks, a feature that might be expected to expand going forward.
The Walt Disney Company had been having a good year, with the stock rising 31% (easily beating the broader market indices) and bringing the market capitalization close to $100 billion. In the company’s third fiscal quarter, which ended in June, revenue was up 4% from the same period in 2011 and with expenses held down Disney’s earnings were up 22%. The higher numbers were led by a 9% increase in revenue from the Parks and Resorts division, as well as a much stronger operating margin in Film Entertainment. Consumer Products and Media Networks also experienced growth. In the first nine months of the fiscal year, Disney saw slightly higher revenue than the same period a year earlier and a 19% increase in net income, showing that the results for the third fiscal quarter were not out of the ordinary.
At the market close on October 26th, (the markets have not been open since then as of this writing), Disney traded at 17 times trailing earnings and 14 times forward earnings estimates. These are reasonable multiples for a company with a strong entertainment brand and the potential to expand it to the global middle class. Lucasfilm platforms, for example, could be very appealing in international markets.
Billionaire Stephen Mandel’s Lone Pine Capital doubled its stake in Disney during the second quarter of 2012, and at the end of June the Tiger Cub’s fund owned almost 12 million shares (see more stock picks from Lone Pine Capital). Southeastern Asset Management, managed by Mason Hawkins, sold shares during the quarter but still reported a position of almost 25 million shares in its 13F filing; this gave Southeastern over $1 billion invested in Disney at that time. Find more stocks that Southeastern had $1 billion invested in.
Disney’s closest peers as a company- as much of its business comes from its television assets- are Comcast Corporation (NASDAQ:CMCSA), which owns NBC Universal; News Corp (NASDAQ:NWSA), which manages the Fox television brand; Time Warner Inc. (NYSE:TWX); and CBS Corporation (NYSE:CBS). Comcast trades at 17 times earnings, on both a trailing and a forward basis. It saw good revenue growth in the third quarter compared to the third quarter of 2011, which helped bring its earnings up at an even greater rate. At that pricing, it also looks like a good stock to consider. News Corp, which is expected to split in two, has Wall Street analysts expecting strong earnings over the next several years. As a result, its forward P/E multiple is 12 and its five-year PEG ratio is 0.9. Those valuation metrics are attractive, but they reflect a large improvement expected to result from the breakup and any investment in the company should follow careful analysis of News Corp’s plans.
Time Warner and CBS carry trailing P/E multiples in the mid-teens, but optimistic sell-side estimates imply that these two peers are good values at 12 and 11 times their respective forward earnings. Time Warner’s earnings were down by about a third in the second quarter of 2012 compared to the same period in 2011, however, and at a similar trailing earnings multiple to the better-performing Disney we would avoid the stock. CBS is more stable in terms of its recent financials, and its television assets are very strong with continued good ratings in the U.S. We recently looked at CBS in relation to a $40 price target from Morgan Stanley and while we weren’t quite that optimistic we did conclude that the stock may be a bit undervalued at $33 per share. Read our recent analysis of CBS.
From a strategic point of view, more content is always better for Disney. Without more financial information, we can’t rule out the possibility that the company overpaid (and M&A deals do tend to reduce shareholder value) but we doubt that Disney would have made this move if it was disappointed by the results of the Marvel acquisition. For now we are cautiously optimistic and Disney could be a buying opportunity if there is a strong negative reaction to the news.
