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Should Disney Buy LeapFrog?

Posted on Tuesday, Feb 22nd 2011

Cord-cutting has remained a serious threat to cable services providers over the past several months, and Time Warner and Disney recently came together to try to combat this threat. The two are bundling ESPN broadband streams with cable, and TV Everywhere customers can now view ESPN, ESPN2, and ESPNU programming online. Through the tie-up, Warner hopes to make TV Everywhere more compelling and thus help to retain customers. Both companies recently released their fourth quarter results, which exceeded market expectations.

Time Warner’s Financials
Times Warner’s (TWX) revenues grew 8% over the year to $7.8 billion for the quarter driven by 21% growth in advertising revenues. The market was expecting earnings of $7.5 billion. By segment, revenues from TV networks grew 14% over the year to $3.35 billion and movie studio revenues grew 10% to $3.6 billion. Publishing revenues fell 4% over the year to $1.1 billion owing to lower advertising and subscription revenues. For the quarter, EPS of $0.67 managed to surpass analyst expectations of $0.62.

The company ended the year with revenues growing 6% to $26.9 billion and EPS 32% to $2.41. For the current year, Time Warner projects EPS to grow in the low teens over the $2.41 earned last year.

Time Warner’s Cloud Focus
Recently, the company announced the acquisition of NaviSite, a leading provider of enterprise-class hosting, application managing, messaging, and cloud services, for $230 million. NaviSite has a base of more than 1,200 customers for its cloud services. Through the acquisition, Time Warner is looking to establish an immediate presence in the managed services market. It will be leveraging NaviSite’s enterprise-class offerings for small and medium-sized businesses.

Time Warner’s Content Everywhere
Time Warner maintained its focus on its TV EverywhereHBO GO, and MAX GO initiatives. TV Everywhere now claims to be available in over 45 million and is expecting to be on target to reach 70 million homes by the middle of the current year.

Time Warner Grows Internationally
The company is also focusing on expanding its geographic reach. For the year, international operations grew to 18% of revenue from 15% a year ago driven by growth in Latin America and Asia. Over the next few years, Time Warner aims to have a international operations contribute 20% of revenues. At HBO too, the number of international subscribers continued to increase, by 10% over the year to 43 million.

The stock is trading at 52-week high levels of $38.18 with a market capitalization of $41.9 billion.

Disney’s Financials
Walt Disney’s (NYSE:DIS) Q1 revenues grew 10% over the year to $10.7 billion. EPS of $0.68 grew 55% over previous year’s $0.44. The market was expecting revenues of $10.5 billion with EPS of $0.56.

This significant growth was driven by strong advertising revenues at ESPN. Disny saw 27% growth in advertising revenues on the sports network. Media Networks revenues grew 11% over the year to $4.65 billion, and revenues from the Parks and Resorts division grew 8% to $2.87 billion. Studio Entertainment revenues remained flat over the period at $1.93 billion despite the strong performance of Toy Story 3, which has been nominated for three Academy Awards. Consumer Products revenues grew 24% to $0.92 billion and Interactive Media revenues grew 58% to $0.35 billion.

Disney’s Resort Expansion
Disney continues to invest heavily in expanding its resorts both internationally and locally. Work is already underway on a $1 billion expansion for the California Adventure section in Disneyland, besides planned additions to the Magic Kingdom. They are investing $500 million in the expansion of Hong Kong Disneyland and recently launched a Toy Story attraction worth $100 million in Disneyland Paris. Meanwhile, the company is awaiting the Chinese government’s approval of its Shanghai resort.

Disney Expanding into Younger Age Demographics
Disney is also lowering its target age group by expanding into the newborn and preschooler market. Earlier last month, to promote Disney Baby, the company launched a marketing campaign to distribute free the Disney Cuddly Bodysuit, a newborn onesie, in 580 maternity hospitals in the country. Disney will be distributing over 200,000 onesies by May before selling them online and in physical retail stores. Besides apparel, the company is developing other products including bath items, strollers, and baby food.

For preschoolers, Disney recently rebranded Playhouse Disney as Disney Junior. While Disney Junior plays for only a few hours on the Disney Channel, it is expected to become a new channel by next year. The programming is aimed at two- to seven-year-olds with the goal of introducing more learning into the programs by engaging children with tales that teach them lessons about social skills and health habits. This move begs the question whether Disney should buy LeapFrog.

LeapFrog’s educational toys are geared toward children aged zero to 8+. Its Tag and Leapster Explorer products have received rave reviews and were among the hottest toys in the recent holiday season. While some of its products double as e-readers and cameras, all of the company’s toys are created to teach children skills such as the alphabet and math and could complement Disney’s baby and preschool segments. LeapFrog ended last year with revenues of $433 million, growing 14% over the year. As of the end of last quarter, Disney had cash and equivalents of $3.04 billion and can look at spending some of those funds to acquire LeapFrog, which is currently trading with a market capitalization of $290.7 million.

Disney’s stock is trading at $43.56 with a market capitalization of $82.7 billion. It touched a 52-week high of $44.05 earlier this month.

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