Why It’s Time to Take Profits in Disney

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Walt Disney (NYSE:DIS) is a household name. It is a blue chip stock as well. However, in the past few months it has traded more like a large growth name, and this has given investors excellent opportunities to make solid gains. However, the pressure is mounting on the company. In this article, I will lay out why I believe it is time to sell some of your position (not all.)

First, let’s talk about the good things. The movie business has been fantastic. Most Disney films perform extremely well. The most recent animated phenomenon Frozen was an exceptionally strong performing film grossing several hundred million in revenue for Disney. It was also one of the most popular Thanksgiving weekends, ever. Its deals with satellite companies are also strong.  Disney along with DISH network  recently announced an agreement that will allow Dish to create an Internet-based streaming service that Dish customers can use to access Disney-owned programming on its tablets, computers, smartphones, televisions, gaming consoles, and other devices.

The agreement also put an end to the legal battle that had been ensuing between the companies over Dish’s DVR service, which allows customers to skip over commercials. To protect advertisers, Disney wanted three days of ‘unskippable’ advertising. It was a win-win for both companies. Now, Disney is in talks to make a similar agreement with DirecTV. For more on this, please see the recent Wall Street Cheat Sheet article.

However, while this is a good deal for all involved, I don’t see how the revenue generated from this venture justify Disney’s stock propelling to new all time highs. Each day it has climbed and climbed since the announcement. The most recent quarterly results were decent, but the company simply does not have the growth to justify a multiple expansion — and that is what is happening. Disney is now beginning to trade at a premium relative to standard indices and other blue chip names. Normally this would be fine, but even under Bob Iger, a great CEO, the growth just is not there. In fact, the company is struggling on several fronts.

The theme park business is a huge weight. While it draws millions of customers, the upkeep, labor, utilities, etc. really weigh on net margins. Many say Disney’s decision to raise prices at its theme park recently (which normally is done in the summer) as strength. To me, a long-term holder of Disney stock, this move is a sign of weakness. I won’t say desperation, as that’s too harsh, but I did not like this decision. It tells me the company is trying to make up for losses from other areas by passing along the pain to its consumers. This is not a strength. The rise of ticket prices alienates families that simply cannot afford to visit. To me, Disney was about being open to all (at a cost), but the theme parks are becoming prohibitively expensive. The parks were always a volume business; not a high ticket high margin item. This is a major red flag sell signal in my estimation.

What about the video game segment? Disney interactive was once a proud segment delivering hits. Lately, it has been a complete money pit. The failure of Disney to leverage this huge opportunity and massive market is a sign of fundamental weakness. This is evidenced by Disney making an attempt to “overhaul” its struggling interactive division in a desperate (yes this time I will use that term) maneuver to reorganize, which will reduce the number of video games it develops and alter its advertising strategy to focus more on the fast-changing mobile market. So, again, it is moving from a volume business into what?

Well, first off, 700 employees are out of a job, which is 23 percent of the interactive division. Its response is to move to the mobile market (evidently, it has not seen Sony’s Playstation 4 sales.) Well, Disney already did that when it purchased Playdom for over $500 million, an acquisition that has been a persistent money loser. Last year, Disney Interactive lost $87 million as revenue rose 26 percent from 2012; the division has lost a total in recent years of more than $1 billion.

I am not comfortable letting my position in this company grow (as the stock grows in price, so too does your total portfolio percentage allocation.) Thankfully, it will continue to develop games and content for its “Infinity” platform, a combination video game and toy line; it has sold more than 3 million copies of the platform globally since its August release. Its other approach is to shut down two smaller sites and focus on ad revenue. While I am glad steps are being taken, longer-term, I think it’s a negative.

So, we have a household name in Disney with its stock becoming very expensive on a multiple basis without growth to back it up. In just 6 months, the stock has risen over 30 percent. Although the film business is successful, the theme park business is mediocre and the video game unit has lost us over a billion dollars. As a long-term shareholder, I am recommending selling one-third to one half of your position. Personally, I will be booking profits on 40 percent of my position and waiting for the stock to deservedly pullback.

Disclosure: Christopher F. Davis is long Disney.