Disney: Bears vs. Bulls
Shares of the media giant are at their lowest point in six years. Is it time to buy, or do they have farther to go?
NEW YORK (Fortune) -- Walt Disney Co. is hurting as consumer spending remains tight. The world's biggest media conglomerate reported profit declines last month in its major business segments as advertising declined at its ABC network, fewer tourists visited Disney World, and 2008's "Wall-E" remained its last box office hit.
Shares now trade around 2003 levels (declining 42% in the past year vs. 40% for the S&P 500) and its price to earnings ratio of 9 is its lowest on record.
Is Disney set for a rebound, or will shares drop further as the economy remains weak? We asked two top analysts if now is the time to buy or sell.
"I categorize Disney's problems into three types: the first is economic concerns like theme park attendance; the second is secular, at the film studio and broadcasting division, particularly ABC; the third is creative concern that this year there are less hit movies.
"In addition, Disney's (DIS, Fortune 500) stock trades at a significant premium to its peers - depending which metric you use, it's at 30 to 50%. That's likely to revert closer to the group. My target price is $17 a share.
"Businesses exposed to the economy include the theme parks division, the broadcasting division, and the cable networks because ESPN advertising is hurt by the automotive downturn.
"For the first time in the last three years, margins were compressed in the cable business, which includes the Disney Channel and ESPN. For fiscal 2008 the cable network business' operating margins was 40.8%. (In 2008, ESPN brought in more than 40% of operating income.)
"ESPN pays for its sports content in the form of the licensing fees that it pays to the leagues, and those are long-term multi-year TV rights deals with the likes of the NFL and the NBA. Those payments are contractual, so it's difficult for ESPN to cut costs. And to the extent that those sports rights fees are increasing over time, there's a risk for ESPN's margins. This is a point that might be relevant for a lot of Disney investors: Because ESPN over-indexes to automotive advertising, we think revenues are down more than 10%.
"The creative cycle is also moving against them now. At ABC, you need hits to replace 'Lost,' 'Desperate Housewives,' and 'Grey's Anatomy.' Last holiday season, you had successes last year such as 'Wall-E' at the box office. This year my concern is that there are fewer Disney hit movies.
``I do think CEO Bob Iger and the rest of management are making the right moves to acknowledge the secular issues facing the media industry - things like piracy and Internet-video distribution. Many of the issues that Disney faces are cyclical, and our rating is 'underweight.'''
"Disney is a stock that will trade in the $30s when the economy hits bottom and we start to emerge from this recession. It is a premier company, and has always traded at a premium to the S&P 500 (SPX) until now. It's also trading at a record low price to earnings ratio.
"Disney is more diversified than ever. Its revenue streams are less cyclical, its brands are stronger globally, and it just so happens like the recession of 2001-02, every business is going the wrong way.
"Almost two thirds of the company's operating profits will come from their cable networks, where you have secular winds in your sails, and the business is set to outpace the economy and grow margins. ESPN's automotive advertising exposure is actually pretty similar to other cable networks. For example, Discovery said theirs is around 12%.
"It's the same story with consumer products: over next year or two they'll pick back up, especially if content cycle improves with next round of Pixar films being 'Toy Story 3' and 'Cars 2.' 'Pirates of the Caribbean 4' is coming too. All three are extremely profitable franchises on the consumer products side.
"The fact that its broadcast division, which includes ABC, has significant losses to cable doesn't really have much of a financial impact anymore given its small contribution - only about 4% of profits.
"In the end they could convert it to a cable network, merge it with another broadcast network, or cut primetime hours from 22 to 10. It might turn out to be a nice asset that is dramatically under-earning or undervalued. But it's not going to surprise people this year.
"Disney has the lowest cost-to-capital ratio among major media companies and doesn't have any holes that it needs to spend enormous sums on to fill. It has been investing aggressively for long term growth - like buildings cruise ships and spending $300 million a year on its digital media platform.
"Over the last two and a half decades, there have only been a few times Disney trades in the teens, and each time it's been a terrific time to accumulate Disney stock." 
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