The Cloud Hanging Over Disney Has a Silver Lining

The Mouse is barely walking, let alone roaring. And according to conventional wisdom, the only roar you're likely to hear is from bears devouring Disney (DIS) stock.

Disney certainly hasn't been "the happiest place on earth" for investors. In fact, over the past year, Disney shareholders have felt more like Wile E. Coyote.

And that's exactly why Disney deserves a second look.

The bearish side of the story is well-known. The sagging media business was already putting pressure on Disney. The company's big-screen arm didn't get the boost it thought it would from its Pearl Harbor flick, and advertising revenue from its media empire was slipping with the economy.

Then, on Sept. 11, the world changed. An economy that was teetering on the brink fell quickly over, and the consumer -- the only bright spot on the landscape -- quickly lost confidence. And, more important for Disney, leisure travel came to an abrupt halt.

The overnight decline in leisure travel hurts Disney's amusement parks and lodging facilities. Commercial-free coverage of the terrorist attacks further eroded media revenue, and the movie on which Disney studios pinned their fall hopes -- Big Trouble starring Tim Allen -- remains shelved indefinitely as the plot involves a bomb and an airplane.

What else could go wrong? Last Thursday, the Bass family was forced to sell 135 million shares of Disney to meet a margin call and for other liquidity reasons. Disney purchased 50 million of those shares, and Goldman Sachs picked up the other 85 million at roughly $15 per share and resold them into the market. Partly in order to fund the repurchase, Disney borrowed $1 billion last week, leaving the company with $16 billion in debt, the most the company has ever carried. As a result, Standard & Poor's has placed the company's debt on credit watch with negative implications.

It's hard to imagine things at Disney getting worse.

The Basses' sale provides good investor intelligence, though. When a big chunk of supply hits the market in the worst possible circumstances -- in this case, a margin call -- and an opportunistic company and broker step in to meet the supply, that price usually signals a bottom for the stock. Hence, absent another extracurricular event that impacts leisure stocks, Disney's downside should be limited to about $15.50 per share. In fact, the stock closed that trading day near $17 and seems to be comfortable holding that level.

As Disney's fiscal year ends this month, current 2001 earnings estimates of 78 cents a share may be a bit high. However, if Disney earns 73 cents, the stock trades at about 22 times this year's earnings. Even with little or no growth next year, the stock trades at the low end of its historic valuation. Since 1994, Disney's average price-to-earnings multiple is about 31 times current year earnings, and the range's low end was 22 times during the 1994 slowdown.

While the slowing economy could further erode Disney's performance, a 2002 turnaround could push the stock higher. According to Credit Suisse First Boston analyst Laura Martin, entertainment stocks like Disney tend to underperform the S&P 500 by two to three times during periods of economic slowdown, but they outperform the benchmark by three to four times as the economy reaccelerates.

In addition, a lot could go right for Disney from here. As investors and analysts expect the worst, I like the contrary nature of the play. I also like the fact that the heat is on Eisner & Co. to perform. The pressure may provide an opportunity for Disney to refocus its energy on its core entertainment businesses. If that happens as the economy recovers, shareholders should be rewarded.

If that doesn't happen, you still have some of the best brands on earth combined with an average business at an average price. You could do worse.

As Robert Hagstrom, the manager of (FOCTX)Legg Mason Focus Trust and longtime Warren Buffett follower, said last week when asked about Disney, "At some price, even a mediocre business is worth having."

While it's a tough road for investors, this mouse probably won't become a rat.

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