2017 will likely go down in history as a seminal year for the Walt Disney Company (DIS). Last August, the company dropped a bombshell when it stated that it would terminate its distribution agreements with online partners and instead launch its own streaming service. At the same time, Disney announced a deal to take a majority stake in streaming technology company BAMTech for $1.6 billion. That surprise move was quickly followed by another broadside when the company struck a mammoth $66 billion deal to acquire most of 21^st Century Fox’s (FOX) entertainment assets. The buyout would also give Disney majority control of the streaming service Hulu, currently a joint venture between Disney, Fox, Comcast (CMCSA), and Time Warner (TWX).

This opening salvo clearly sets the stage for Disney’s emerging war against the likes of Netflix (NFLX). Although I greatly admire the Netflix model and remain fascinated with the company’s success, I see Disney as the better buy from an ownership perspective. For one, the House of Mouse boasts a stable of legendary content that seems likely to endure for many decades. Netflix has been aggressive on this front as well, but the company is still feeling around for a long term winner. Furthermore, Disney’s stock price is far lower than what the market demands for Netflix, with far less business risk.

Content is King

In our previous Disney article, I explain that I would much rather own a company with a great, brand name product, as opposed to a company that distributes the product. In the case of media, I am more confident about the earnings power of great content than the longevity of distribution or production methods.

No matter if content is consumed on a television, at the cinema, or online, the producer will find a way to reach audiences. Of all the major content owners, Disney has the best portfolio by a long shot. Since the new millennium, the company has gobbled up Pixar, Marvel, and Lucasfilm. Previously it acquired a majority stake in ESPN, followed by the ABC/Cap Cities merger. If the Fox deal comes to pass, Disney will gain control of the 20^th Century Fox movie studio, FX Networks, National Geographic, and Sky. And let us not forget the classic characters from the animation studio's golden years - Snow White, Bambi, and so on.

Many of the characters and franchises that Disney owns have become part of the cultural zeitgeist. “May the Force be with you” is an almost universally recognized greeting. The Captain America character, first invented in 1941, still stars in contemporary films. As Charlie Munger writes in his Poor Charlie’s Almanac, Disney is like an "oil company that can put the oil back in the ground after it is done drilling so it can drill it again."

This year Netflix will spend at least $7 billion on content, and the online upstart has upended the studio system by giving creative talent an unprecedented amount of freedom to develop content as they see fit. As a viewer, I certainly appreciate the risk that Netflix takes on in greenlighting new programming. Its willingness to push the envelope on content is one of the company’s major strengths, leading to a well-deserved reputation for quality shows and films.

However, there is a vast difference between content that is appreciated for a few years and content that can be continued and enjoyed decades later. Netflix will have to continue churning out new ideas for shows and movies in order to keep subscribers interested, which is quite a daunting task. Disney, on the other hand, just has to recycle the same characters and retell the same stories that audiences have adored for generations. I think that qualifies as one of the companies that Warren Buffett says is so easy that it could be managed by a “ham sandwich.”

Business Risk

Disney

Right now Disney shares are changing hands for 18 times earnings per share when one-time gains from the recent tax legislation are excluded. Yet since 2012, the company’s return on equity has exceeded 14 percent. The dividend payout quadrupled in value over the last eight years, while shares outstanding shrank 20 percent. The stock’s present earnings yield (earnings per share divided by share price) now sits at 5.5 percent, as opposed to the S&P 500’s earnings yield of 4 percent. Here we have a way above average company is selling for much less than a mediocre firm, which means that Disney is relatively very attractive compared to 99 percent of everything else on the market.

Aside from massive brand equity, Disney also owns an astonishing $32 billion worth of real estate. As of 2016, Disney owns or controls 31,600 acres of land, with 25,000 acres belonging to Walt Disney World near Orlando, Florida. It is a rare company whose value is backed by both a powerful brand and physical assets.

Netflix

Meanwhile, Netflix shares command an incredible premium to the average company. With a share price of $258 and earnings per share of $1.25, the stock’s earnings yield sits at a trivial 0.005 percent. Even though earnings have quintupled over five years, this is a strong signal that the company could be overvalued.

Due to Netflix’s aggressive content buying spree, the company has not been cash flow positive since 2014. Aside from $2.8 billion in cash on balance sheet, the company owns few real assets. Long term debt amounts to nearly $10 billion.

Conclusion

Fundamentally, Disney looks like the better buy. Not only does the company possess a robust portfolio of proven content, but it also owns a vast amount of property. Among the general public, the “Disney” name stands for family-friendly, quality entertainment – a reputation assiduously cultivated for decades. The moat around the business is quite deep, indeed. What is more, the stock price looks quite reasonable given that this company will very likely still be generating earnings in 50 or 100 years.

Again, I would like to emphasize that I have nothing against Netflix or its business model. Many concerns among analysts about the company’s cash burn are likely overblown, and I truly believe that CEO Reed Hastings is a rare example of pure business genius. That said, I have a hard time seeing how it makes sense to buy Netflix over Disney at this particular moment.

 

 

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