Friday, June 29, 2007

Disney Part II: A Look at Current vs. Historical Valuations

Few would argue that Disney is an interesting combination of assets, from theme parks, and the 43 square miles of Florida land they sit upon, to ABC, ESPN, a mini-retail empire, somewhat recently acquired Pixar Animation Studios, and an incredible film catalogue, to name a few. However, just because a company owns valuable assets does not mean that is is worthy of purchase; there's another side of the equation that investors- yours truly included- frequently forget, that being the company's current market valuation, and whether that over or underestimates the true value.

Think of it this way: There's a beautiful home on the market, it has everything you've ever wanted, truly your dream home. It is worth $500,000, but the owners have set the price at $1,000,000. The fact that it is beautiful, that it is your dream home, that it is a very nice asset is not changed by the asking price. But you would not purchase it because the price is just too high relative to the value. We as investors often make the mistake of separating the value of an asset or company, with the current price, and sometimes we pay too much. But I digress.

Disney's Historical Valuation
One way to attempt value a company is to look at how it has been valued historically versus current valuations. A couple of colleagues and I did some work and published articles on this subject several years back. We'd developed a model designed to calculate a company's downside risk, or lowest potential value, based on where the company traded relative to a variety of historical ratios. Applying a similar methodology, admittedly not as complex, we've looked at Disney's historical price valuation ratios including Price/Earnings, Price to Book Value, Price to Cashflow, Price to EBITDA, and Price to Sales, going back to 1980, using Bloomberg data.

For each of these ratios, we'll show the high/low range, average at year end for the 27 year period, and calculate the value of Disney using that average. Scientific? Accurate? Not necessarily, but a simple way to put valuations in historical context.

Words of Warning
Fundamental valustions are not perfect, and the data used in this piece should serve as a small part of company evaluation. As a wise, well-known financial writer once told me: "Using historical fundamentals alone is like driving your car by looking in the rear-mirror."

Price Earnings
Hi-Low range: 153(1985)-10(1981)
Average closing P/E: 26.2
Average high P/E: 40.8
Average low P/E: 18.8
Current P/E: 19
Current trailing 12 month EPS: $1.80
Current value based on average:
Closing P/E: $47.16
High P/E: $73.44
Low P/E: $33.84

Price to Book Value
Hi-Low range: 7.5(1987)-1.1(1984)
Average closing P/B: 2.78
Average high P/B: 3.97
Average low P/B: 2.30
Current P/B: 2.13
Current Book Value: $17.04
Current value based on average:
Closing P/B: $44.55
High P/B: $63.63
Low P/B: $36.87

Price to Sales
Hi-Low range: 5.1(1987)-1.1(2002)
Average closing P/S: 2.09
Average high P/S: 2.98
Average low P/S: 1.75
Current P/S: 2
Current value based on average:
Closing P/S: $35.68
High P/S: $50.87
Low P/S: $29.87

Price to Cashflow
Hi-Low range: 18.2(2001)-4.5(1984)
Average closing P/CF: 9.7
Average high P/CF: 13.7
Average low P/CF: 7.9
Current P/CF: 10.6
Current trailing CF/share: $3.22
Current value based on average:
Closing P/CF: $31.24
High P/CF: $44.12
Low P/CF: $25.44

Price to EBITDA
Hi-Low range: 153(1985)-10(1981)
Average closing P/EBITDA: 7.8
Average high P/EBITDA: 11.1
Average low P/EBITDA: 6.3
Current P/EBITDA: 9
Current trailing 12 month EBITDA/share: $3.79
Current value based on average:
Closing P/EBITDA: $29.56
High P/EBITDA: $42.11
Low P/EBITDA: $23.88

Interpreting the Data

There are several ways to interpret the data, here is one: If we then take an average of closing valuations for each of the five ratios, weighting them equally, we arrive at a price of $37.64, roughly 10% greater than Disney's current price of $34.14. Does that mean Disney is currently undervalued? Not necessarily. There are many schools of thought on the validity of fundamental data. While we are strong believers in fundamentals, we also live in a world where certain markets, large cap markets especially, are relatively efficient. Disney is followed by many analysts, and owned by many institutions, so there's probably not a great deal of useful undiscovered information available on Disney. Still, conducting an analysis such as this can serve as one piece of the puzzle.

In conclusion, we are intrigued by the Disney story, and at the very least, believe that it is not fully valued at current levels

As always, do your own homework before investing in any security.

*The author does not have a position in Disney. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only

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