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April 12, 2024

Disney (DIS): A “Go F Yourself” Battleplan

There is no love lost between Elon Musk and Bob Iger.

Back in November of last year, Elon found himself on stage at the New York Times DealBook Summit, an environment he presumably considered enemy territory. Wearing what appeared to be combat boots and a vintage naval flight crew jacket over an untucked black t-shirt, he came dressed for battle.

Journalist Andrew Ross Sorkin, a stark contrast in his royal blue, well-tailored suit, started quizzing Elon about some recent controversial tweets. Several corporate advertisers were now boycotting X.

Elon either lost his cool or deliberately did something that extraordinarily wealthy people sometimes like to indulge in. In any event, he clarified the concept of “f*** you money” for the benefit of anyone there who didn’t know what the expression meant.

“If someone is going to try to blackmail me with advertising… blackmail me with money? Go f*** yourself…  GO. F***. YOURSELF. Is that clear? I hope it is. Hey, Bob, if you’re in the audience.”

He was of course singling out Disney CEO Bob Iger, who was among the participants in the boycott.

Elon’s resentment towards Bob would not subside in the weeks that followed. Elon tweeted in early December: “He should be fired immediately. Walt Disney is turning in his grave over what Bob has done to his company.”

Maybe Elon feels satisfied that he has made his point, since his tweet has garnered 615,000 views. But maybe he isn’t.

Of course, if Elon owned Disney, or even just became a prominent shareholder, he actually might have the opportunity to fire Bob himself.

Revenge fantasy? Or real possibility?

As we all have been following, activist investor Nelson Peltz tried, and failed, to get on the Disney board. It was a valiant effort. Nelson got a lot of votes (over 30%) and the support of some major shareholders, like CalPERS.

Whether Iger is willing to admit it or not, Peltz has changed the narrative around Disney. Iger’s job is now to fix all the problems that Peltz and his investment firm Trian Partners very diligently laid out.

For those who missed it, we discussed the implications of Peltz’s defeat below.

This year’s shareholder meeting has come and gone, but Disney isn’t going anywhere, nor are its issues. And Peltz has also indicated he is not going anywhere if Disney management does not right the ship.

We’ve got a new set of promises, and I hope they keep them. And if they do, I’ll be a guest on your show probably talking about a different company. But if they don’t, you’ll see me again, Jim. - Nelson Peltz to Jim Cramer, 4/4/2024

Shareholders are giving Iger an opportunity to improve the situation. But Trian and other activists remain in the stock. And with the stock still down 40% or so from the 2021 peak, basically all shareholders are disappointed.

Iger is not out of the woods. Next year’s shareholder meeting is just twelve months away.

Could Elon buy Disney? Should he?

With a market cap greater than $200 billion, the biggest obstacle to an Elon Musk takeover or Leveraged Buyout (LBO) is the price tag. Disney’s current valuation is approximately five times what Elon paid for Twitter.

Assembling a buyout group of that magnitude would be extremely difficult, even if the financial math supports it (we think it could and discuss further below).

There is another possibility though. It may not put Elon in the position of controlling shareholder. But it could allow him to effect the changes he wants to see and to unlock the shareholder value that is trapped within this sprawling and underperforming entertainment conglomerate. And, perhaps most importantly, it could allow him to get Bob Iger fired.

What if Elon orchestrated a grassroots effort to bring politically motivated investors into the stock?

We saw the potential of this with Trump Media & Technology Group (DJT). As we write, DJT has a market capitalization close to $5 billion. While DJT has taken a life of its own as a meme stock, the shares are clearly propped up by supporters of the former President.

With revenue last year in the neighborhood of $10 million, DJT’s valuation is hard to justify with financial metrics. It is a vehicle for speculation and for Trump’s base to express moral support.

Political and shareholder activism unite

Investors have shunned Disney precisely because they feel it has been managed in a way that destroys shareholder value and/or offends their personal moral sensibilities. But if there were a feeling that Disney could be transformed through their investment in it, they may start to feel differently.

We could envision the following scenario. Elon Musk (or a similarly inclined private investor or activist fund manager) builds a stake in Disney, alongside Trian and the other activists already in the name. He openly pushes to replace Iger and pursue a significant restructuring of the company, including perhaps a change of control transaction. He declares his intention to realign Disney with its customer base and restore the connection to traditional family values and sensibilities.

If someone were willing to lead such a campaign as an anchor investor, this could invite a wave of retail investment in Disney that could change the shareholder base dramatically.

Peltz already had more than 30% of the shareholders supporting him. At 50%, the dynamic changes. Disney’s board is not classified, which means all members must be re-elected annually. While the board may have the opportunity to amend its bylaws in a way that gives itself more protection, Disney bears various obligations to shareholders as a Delaware corporation.

Generally speaking, being incorporated in Delaware is the best case scenario from the standpoint of shareholder rights. For example, the Disney board would have a fiduciary obligation to consider any bona fide change of control transactions that may be presented.

Tourism assets backstop value

Trian Partners published a detailed 133 page white paper explaining its diagnosis of Disney’s problems and their proposed solutions. We refer to many of the highlights here.

The first thing to understand about Disney is how the company is actually making money now. This is a key pillar of Trian’s investment case.

Source: Trian Partners

As the chart above indicates , Disney is facing declining profitability or losses across every major division except its “Experiences” segment. (EBIT, or Earnings Before Interest and Taxes, is a measure of operating profits.)

The Experiences segment is mainly theme parks but also cruises and merchandise. Notably, Disney World in Orlando is said to contribute about half the profits of the segment (or one-third of the whole company).

Experiences are 70% of operating profits

The Experiences business has actually performed quite well. Consumers, especially post-Covid, crave curated real-life entertainment and travel opportunities. They may not like the woke movies, but they still clearly like the theme parks, cruise ships and t-shirts.

They are also willing to shell out a lot of money for these opportunities. As Trian points out, theme park spending per visitor has grown at 9% per year over the last 5 years (largely price hikes).

Profitability from the Experiences segment is now 70% of all segment operating profits, even though it only represents about a third of total company sales. Operating profit margins are significantly higher than the other segments.

As Trian emphasizes, Experiences operating profits have actually grown 43% over the past 5 years. While not without some challenges ahead, Experiences is propping up the company and offsetting the truly abysmal performance of the other areas.

Disney reports its financial performance based on three operating segments (financial data relates to 2023 results).

• Entertainment (45% of revenue, 11% of operating profits): Television networks (ABC, Disney Channel, FX, National Geographic); Direct-to-Consumer (Disney+ and Hulu streaming services); Content (film, TV and live entertainment).

• Sports (19% of revenue, 19% of operating profits): ESPN and Star (Indian sports channels).

• Experiences (36% of revenue, 70% of operating profits): Theme Parks and Resorts, Cruises, Consumer Products (merchandise and retail).

Trian is not alone in highlighting the Experiences business as the crown jewel of the conglomerate. Another activist investment firm, ValueAct Capital, revealed in November 2023 that it too had established a position in Disney in the low $80s per share. At the time, ValueAct made known its view that the Experiences business alone justified the entire valuation of the company.

(As a side note, as Trian points out, ValueAct agreed not to challenge Disney for board representation, in exchange for certain consulting privileges. Trian has its doubts about this arrangement.)

Source: Trian Partners

If the Experiences segment in isolation is worth $80 per share, taking into account corporate overhead expenses and net debt, this implicitly values the segment at a bit under $200 billion, or approximately 20 times 2023 operating profit of $9.5 billion. We concur with ValueAct that this is a reasonable estimate for the value of the segment, given its asset value and growth trajectory.

Sum of the parts

At the current share price of approximately $115 to $120, if one assumes the above valuation for the Experiences segment, the current price attributes approximately $70 billion to the remaining businesses. In 2023, these businesses generated approximately $3 billion of operating profit. However, this $3 billion is net of Trian’s estimate of $2.6 billion of operating losses related to streaming.

Let’s now exclude the streaming losses, on the theory they can be reversed or worst case scenario the business can be wound down.

The other businesses are then implicitly being valued at about 12.5x operating income ($70 billion divided by $5.6 billion). This is a fairly low multiple given the potential for margin improvement, asset sales and other strategic alternatives.

Additionally, despite their current loss-making status, Disney’s streaming operations do have value, potentially a lot of value, if they can be fixed or sold.

Trian presents a striking contrast between Disney’s loss-making streaming operations and the highly profitable streaming business of Netflix (NFLX). There are many reasons to believe Disney’s streaming business will not be able to achieve what Netflix has accomplished overnight, if ever. But the massive performance gap between the two companies suggests at least some potential for convergence.

Source: Trian Partners

From a shareholder value perspective, the performance gap between the streaming operations of Netflix and Disney is staggering. Netflix has a market cap now of over $260 billion, well above Disney’s, because it has been able to generate profits from its $34 billion of streaming revenues.

In terms of streaming revenue, Disney is actually not that far behind ($22 billion run-rate, according to Trian). But because it is currently loss-making, the streaming business is attributed minimal if any value and possibly negative value.

If Disney could somehow get streaming right—a giant if—the business could theoretically be worth hundreds of billions of dollars.

Heads You Win, Tails You Win?

Investors considering a purchase of Disney should understand a wide range of outcomes is possible here and think about these probabilistically. At the moment, Bob Iger has won the day. He has likely bought himself at least a year to restore momentum to the business and disprove his critics.

Whatever one’s personal opinion of Iger, if one were to buy Disney shares around current levels, and he is able to deliver the improvements he is promising, this would be a happy outcome (at least financially).

It is also quite possible that Iger fails to deliver, and Disney continues to struggle. This could lead to downside in the share price. But as we observed in the fall of 2023, when a company is vulnerable to activist pressure, poor performance can itself become a catalyst.

A long-term investor in Disney might even hope to see share price weakness in that it could set the stage for even more value to be unlocked down the road through a change of management, a radical restructuring of the business, or perhaps a change of control.

While it is widely anticipated that Disney will continue to face pressure from Peltz and similar activists who are focused on margin improvements and finding a solution to the streaming losses, the scenario we have outlined above, involving a politically motivated retail investment wave, is probably off most investors’ radar.

To be fair, Disney is a very large company, but already 30% of the shareholder base was prepared to support a dissident slate. With the right strategic/activist investor (like an Elon Musk) buying a reasonably sized stake in the company and becoming a ringleader for dramatic change, it is conceivable that Disney could become an activist campaign like none other.

In this scenario, investors would have the promise of value creation but will be motivated to acquire shares because they want to reverse unwelcome changes in the corporate culture and the content offerings. They could win politically and financially.

Attractive risk-reward

Disney is facing considerable challenges, but the Experiences segment likely provides a floor of value. There is legitimate upside potential if the underperforming business units can be effectively addressed. For investors prepared to tolerate a wide range of outcomes and a potentially volatile path forward, we see the merit of establishing a position at current levels.

The investment could become significantly more interesting if Disney shares start to slide back toward the fall 2023 levels ($80 to $90 per share) and approach that floor value for the Experiences segment we discussed. The worse the Disney share price price performs, the higher the likelihood of further activist involvement.

If an activist enters the picture and galvanizes the public with the prospect of a culture war victory, this would be unprecedented and could create a new template for individual investors who want to take back American companies that seem to have lost their way.

Hey, Bob

Elon’s anger towards Bob Iger may be personal, but it probably also stems from what Bob Iger represents. We suspect Elon sees Bob as an elitist establishment figure who promotes woke ideology, cancels opposing voices and gets paid lavishly despite failing in every way.

A lot of other people may see him that way as well. Elon has a viable opportunity here to tap into those anti-establishment feelings—and perhaps make a lot of money in the process.

Disney (DIS): Company Snapshot

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