Bob Iger is back directing Disney (DIS) and Wall Street is still scratching its head over this plot twist.
Iger returned for a second act as the CEO of the entertainment giant last month after he departed in 2020. Now investors are trying to figure out whether stock is a deal -- or one to dump for a tax-loss. Let's sort through the story so far to see what we can make of this turn in Disney's story.
On the one hand, the skepticism and tepid stock increase right now allows investors an opportunity to buy shares for the longer term. On the other, the abrupt firing of Bob Chapek, after almost three years, has allowed critics to air a litany of complaints about Disney, making problems seem practically intractable. Is this just the old gimmick of bringing back a favored actor to revive a declining show?
I'd say no. Critics' underestimation of Iger's ability to address Disney's challenges over the next two years will actually open the door to strong stock gains in coming years.
But, wait, the story of Disney takes another turn. A second activist investor emerges:
Not only has Iger returned, but activist fund Trian, managed by Nelson Peltz, was reported to have amassed an $800 million stake, purchased after Disney's recent poor earnings. Trian has proven adept at finding companies under-earning with shares underperforming due to fixable problems (Trian's investment in General Electric (GE) notwithstanding).
I'd say that Trian joins Third Point as activists trying to point Disney in the right direction -- along with Iger.
Disney's value is underestimated due to significant losses incurred in streaming -- about $1.5 billion last quarter -- which could be peaking. The market is likely over-discounting problems at Disney. Wall Street gets most confused when valuing a company with one division with large losses. Not only does it obscure the profitability of the good divisions, it also discounts the whole as a result. Meta Platforms (META) is undergoing a similar problem, with losses in their Metaverse division dragging the entire organization to a deep discount. Importantly, these are fixable problems.
Granted, Disney overpaid for Fox's assets -- paid half in cash, half in stock -- to round out its streaming offering. At least Disney now has "Avatar," likely to revive some box office magic for a few weeks in December, along with a plan for five total movies in the series. Indeed, the large acquisition has encumbered their balance sheet, with $50 billion in debt, up from $15 billion before the deal. Disney also diluted its outstanding shares by 20% to buy Fox. Technically, Disney's depressed stock lowers the cost of the deal since the stock is down by over 20% since the deal close.
If you look at the past, Iger has proven adept at running Disney. It's doubtful he would return without a reasonably clean vision of fixable problems for the numerous decisions that have led Disney in the wrong direction under Chapek. His emphasis on creativity and cash flow in a town hall with employees earlier this week is a good start. UBS believes Iger has a mandate for a change in strategic direction, including a renewed focus on growth and pursuit of strategic alternatives for Disney's linear segment.
Bear markets tend to bring rationalization to business excesses, which Disney desperately needs. The focus on cash flows over growth-at-any-cost will serve investors well in time. Disney's revenues are up by 30% since 2019, while cash flows are down 80%, from $10 billion to $2 billion. Cash flows are set to rebound, however. Guggenheim believes that Disney+ is well-positioned to have industry-leading streaming profit margins based on its dedicated customer base and deep content library.
The most predicted recession in history is on the horizon in 2023, likely impacting travel and Disney's parks. Still, streaming is a remarkably affordable entertainment outlet. Plus, ad-supported streaming in the works could be a practical option for viewers and advertisers alike.
Disney is down 38% this year after being an analyst favorite, with an average target of $190 at the beginning of 2022. Even after the decline, Disney's earnings before interest, taxes, depreciation, and amortization and price-to-earnings ratio are still high, giving the appearance of a high valuation. But this reflects large losses booked in streaming that will start to improve.
Disney's comeback will take time, but it won't be a surprise. This time of year, however, it's easy to throw in the towel on a losing stock to book a tax-loss. But, in fact, this could lead to an excellent long-term entry for the stock. Importantly, investors should feel more comfortable owning a now well-managed Disney under Iger with a stock with a solid risk vs. reward.
