Walt Disney shares slipped today after analysts at Barclays downgraded them as a result of concerns about ESPN. Historically, the stock has traded at a premium compared to the rest of the entertainment industry, but that could change. There is a handful of likely reasons for the premium, including strong, sustainable demand for ESPN, the franchise studio acquisitions like Pixar and diversified revenue streams which also include the Disney theme parks.
Shares of Disney fell by as much as 5.07% to $94.09 per share during regular trading hours today following the downgrade.
Walt Disney stock to Underweight
In a report dated Jan. 15, Barclays analyst Kannan Venkateshwar said he downgraded Walt Disney from Equal Weight to Underweight and cut his price target from $98 to $89 per share. He’s concerned that demand for ESPN is not elastic and believes that it is the most exposed to the ongoing fragmentation of the media industry. The sports network’s business model is reliant on pay-TV bundles, but the shift toward over-the-top TV streaming services is resulting in the gradual unbundling of TV networks.
As a result, because of the fixed cost structure and variable revenue model, he believes that ESPN will take a bigger hit from subscriber losses compared to Disney’s other entertainment networks. He estimates that ESPN makes up a disproportionate share of the company’s total cash flow, adding that the gap between operating cash flow and EBIT growth over the last couple of years probably already is indicative of the risk from subscriber declines. Further, he thinks possible increases in cost recognition may compound the problem.
What about success at the box office?
Venkateshwar expects Walt Disney’s fourth quarter earnings to show tailwinds from deferred revenues for the newest Star Wars movie. He added that currently the entertainment company’s studio business trades at an implicit premium based on the belief that the franchise acquisitions it has made over the years have de-risked the business model of the studio business.
Indeed, Disney does have some strong film and TV franchises, including Marvel and Lucas Films in addition to Pixar. However, the Barclays analyst added that over the last eight years, revenue from the studio and merchandizing businesses has not grown much, especially when adjusted for the Frozen movie.
Walt Disney shares sold off by more than 12% since the Star Wars movie came out, but that still left the stock at a 5% to 16% premium compared to its peers. Venkateshwar thinks that the best catalysts are now in the past. He also believes that increasing pressure on ESPN, which has historically been the company’s most important cash flow source, the off-balance sheet liabilities of 3.3 times EBITDA, and possible management transition in the next couple of years will keep Walt Disney shares in line with or below those of the company’s peers.