NEW YORK (CNN/Money) -
Comcast's initial offer for Disney, the equivalent of $26.47 a share, is a lowball bid. What comes next, no one knows. But one thing does seem clear: Media stocks are undervalued and have begun a major recovery.
The major media conglomerates reflect the health of the overall economy in general and the advertising market in particular. And after a slump lasting more than three years, ad spending is projected to increase this year and next.
As a result, analysts have been turning more bullish on the major media companies, such as Disney, Viacom and Time Warner (owner of this Web site).
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Each of these companies has its own problems, but they share two things in common -- they are in upswings that should continue as long as ad spending is improving, and their share prices are still at least 35 percent below their 2000 highs.
There is a case for buying roughly equal dollar amounts of each of these three stocks as a long-term play on a cyclical recovery in the media business.
Since Disney is now in play, it deserves a closer look. Here's how I size up the situation.
The first rule of takeover situations is that small investors should resist buying a stock that has run up on a hostile bid. The risks of the deal busting are always high and insiders will always have better information than you will on how the deal is progressing.
There is an exception, however. You can reasonably buy a stock that's in play if it's cheap on its fundamentals and you believe that the bid has begun a chain reaction that will lead to a fairer valuation of the company's assets.
That's exactly what I think is going to happen with Disney. Comcast's initial bid pushed Disney's price up from $24.08 to $27.60 -- a gain of less than 15 percent.
And I see several factors that could give the stock significant upside.
The first is that Disney is earning way below its historical capability. Net profit margins are half what they were at their peak in the early 1990s. Return on equity is one third what it was at the peak.
In addition, the company has a first-rate balance sheet. In fact, the value of its theme parks -- perhaps in excess of $15 billion -- is sufficient to pay off all of Disney's debt.
What's needed is a catalyst, something that will force Disney to focus on improving its profitability. In fact, that catalyst exists -- enormous pressure is building on Disney CEO Michael Eisner.
The chief mouskateer has been the target of a campaign by former Board member Roy Disney calling for Eisner's resignation. Activist shareholders are also calling for Disney to respond to Comcast's bid in a way that gets Disney's share price up.
In my view, that's what's likely to happen.
It's true that there's a risk Disney's stock might slip back a few dollars if no deal develops. But in this environment -- and at Disney's current share price -- the downside doesn't look very big.
On the upside, however, Disney has significantly greater value than its current share price recognizes. And Eisner has a strong incentive to get the stock up. If he doesn't, he could be replaced by someone else who will.
Most important, though, the fundamentals of the entire industry have begun an upswing. And that argues for including at least one of the big media stocks in any well balanced portfolio.
Michael Sivy is an editor-at-large for MONEY magazine. Sign up for free e-mail delivery every Tuesday and Thursday of Sivy on Stocks.
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