Walt Disney: A Sustainable Business Model

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Jan 13, 2014

Walt Disney Co. (DIS, Financial) has been charming children’s hearts for decades, with its world-famous characters. And although today’s youngest generation still enjoys the classics, tastes have changed. Yet this company has been highly successful in adapting its movies and entertainment strategy to modern day standards. Today, the firm has established itself as a globally recognized brand, with a diversified income strategy and a wide economic moat. But will this entertainment factory remain a win-win investment in the future?

Diversity to Reduce Risk

One of Walt Disney Co.’s key strengths is its diverse portfolio of renowned brands, the likes of which include ESPN, ABC, Walt Disney, Marvel Entertainment, Touchstone Pictures and Lucasfilms. In addition to this, the firm own a 42% stake in A&E, The History Channel and Lifetime Networks. These television networks and movie studios have laid the groundwork for the company’s live-action and animated film production, but have also helped achieve a strong and steadily growing revenue stream. And with over half of all profits deriving from the entertainment networks, these brands are considered the company’s backbone.

In this scenario, one of the key players is 24-hour domestic sports cable channel ESPN, along with ESPN2 and its sister channels. The popular sports channel reels in 75% of cable network sales at Walt Disney Co., due to its large viewer base of 100 million U.S. households. Also, ESPN benefits from a dual income stream, defined by advertising dollars and affiliate fees, leaving it at a competitive advantage over other broadcast networks that rely solely on ads.

Nevertheless, ESPN isn’t all that Walt Disney Co. has to offer. In 2013 the company entered into content distribution agreements for its television series and movies. The deals with Comcast Corporation (CMCSA, Financial), Netflix Inc. (NFLX, Financial)Â and Charter Communications Inc. (CHTR, Financial) are meant to help strengthen the firm’s multi-channel subscription model by increasing the platforms for content delivery. Additionally, this strategy will balance future revenue losses in the DVD segment, as a consequence of the cheaper viewing alternatives.

Theme Parks and Overseas Expansion

Walt Disney Co. undoubtedly has a talent for monetizing its characters and franchises across multiple platforms, but its theme parks are the crown jewel. These are an especially attractive and unique segment in the company’s assets, mainly because they are almost impossible to replicate. The Parks and Resorts division accounts for 25% of operating profits and after the 2009 crisis, revenues have been recovering at a fast pace. During the last quarter of 2013, revenue in this segment experienced an 8.5% increase, while operating income marked a 15% rise. In fact, the company is focused on further deploying its capital towards the expansion of the Parks and Resorts business, thereby creating new growth opportunities.

Looking forward, Walt Disney Co. is aiming to expand its operations overseas, in the emerging nations China, Russia and India. The Shanghai Disney Resort, for example, will contain a Shanghai Disneyland, two themed hotels and a retail, dining and entertainment venue, and is set to be China’s largest theme park by 2015. Despite possible unfavourable foreign currency translations, this firm should be able to sustain its growth given its multiple revenue sources. Furthermore, the entertainment giant has been highly successful at managing its cash flow, returning large sums of its free cash to shareholders via dividends and share repurchases. The 71.3 million repurchased shares in fiscal 2013, worth close to $4.1 billion, are expected to increase in 2014 and will range between $6 and $8 billion in returns.

Despite the risks of the economy deteriorating and primetime ratings fall, which could affect advertising dollars and revenue generating capabilities, I remain highly bullish about Walt Disney Co.’s future. The dual business model of theme parks and television networks, have contributed to a steady 40% revenue growth over the past decade, leading to a sum total of $45 billion in 2013. With a 20.50% operating margin and trading at a price premium of merely 14% compared to the industry’s average, I believe this company has a bright future. Investment guru Ray Dalio (Trades, Portfolio) also put his trust in Walt Disney, as he recently acquired nearly 200,000 company shares. Â Â Â Â Â Â


Disclosure: Patricio Kehoe holds no position in any stocks mentioned.