• Short interest in Walt Disney shares remains very high despite having declined considerably over the past one month.
• A lot of the shorts are counting on ESPN to continue underperforming.
• Should investors jump into the bandwagon or is it easier to long the shares?

Since June this year, Walt Disney (NYSE:DIS) has consistently ranked among the five most shorted stocks on the Dow Jones (DIA). Although Walt Disney’s Days to Cover has fallen from 8.55 a month ago to 5.39 currently, it’s still much higher than the average reading of 3.68 across all Dow components. A high days to cover reading for Disney stock implies that traders are using Disney stock to hedge a long bet elsewhere or that investors believe the stock will decline.

From all the pessimism surrounding Walt Disney, it’s more likely that traders have been betting that Disney stock was going to decline pretty dramatically. A lot of the pessimism is linked to subscriber loss by ESPN, Disney’s biggest cash cow bringing in one third of the company’s revenue and 39% of operating income. Disney reported during its latest earnings release that ESPN subscribers had fallen to 92 million, which in effect means the channel has lost a staggering 7 million subscribers over the past two years alone.

Interestingly, Disney shares have fallen just 1% over the past one month, which perhaps explains why the shorts have been covering.

Walt Disney 1-Month Share Returns

Source: CNN Money

Of course it’s possible to make money from price declines as small as that. But I believe that it’s far easier to just long Walt Disney, the pessimism surrounding ESPN notwithstanding. Despite its ups and downs, Disney shares are up 13% over the past 3 months; up 3.8% over a 6-month period, and up 21.3% YTD.

Yet the shorts have been unrelenting. Doug Kass of The Street says that Walt Disney remains on his Best Short Ideas list. Other than the usual worries about ESPN, Kass says that Walt Disney’s theme parks could begin to suffer from demand elasticity after a long runup of ticket price increases. Kass goes on to add that after averaging EPS growth of 20.2% over the past five years, EPS growth is likely to clock in at 10% (the consensus is at 13%-14%) over the next five years.

But despite all the negative ink flowing about Disney’s impending doom, the worst has not come to pass as predicted. Disney’s Media Networks, (largest revenue segment contributing 43% to the top line) where ESPN belongs, grew at a healthy 12% during the fourth quarter and 10% over the course of the entire year. Meanwhile, the segment’s operating income grew 27% during the fourth quarters and 6% for the whole year.

Walt Disney has so far been successful at offsetting the negative effects of revenue loss through increase in its affiliate fees. Of course the company cannot continue increasing its affiliate rates indefinitely. But this is more of a long-term challenge than a short-term one. Disney is set to increase its affiliate fees by another 10% in 2016, which will be more than enough to offset the ~3% loss in subscribers.

Regarding the expected weakness in Disney’s theme parks, that too is exaggerated. Revenue from Disney’s Park and Resorts was up 7% during the year while operating income increased 14%. And Disney’s theme parks could receive a huge boost soon. Disney plans to open one of its biggest theme parks yet, the Shanghai Disney Resort, in China during the spring of 2016. The theme park will cover 1,000 acres, and place it within easy reach of more than 300 million people in and around Shanghai. That’s like the entire U.S. population. Disney has sunk more than $5 billion into the giant theme park, and will own a 43% stake with the rest going to three state-owned enterprises.

I think the biggest opportunity for shorting Disney stock lies, ironically, in the company’s biggest opportunity: Star Wars. Disney’s Studio segment has continued to do well and give a nice boost to the company’s consumer products segment. Star Wars: The Force Awakens is widely expected to become a blockbuster, with related consumer products expected to fetch $5 billion during the first year alone thus breaking the previous record of $2.8 billion set by Star Wars. Disney has already doubled the royalty rate on Star Wars products, which will make it all the more easier for the company to hit or exceed that target.

Disney is generally enjoying a good time, even with movies based on less well known characters which have been averaging at least $500 million in box office receipts. Disney has historically struggled at times with movies that feature characters that are completely new out of the block. But right not it seems like everything the company is touching is turning to gold.

Star Wars is widely expected to perform exceptionally well, and any slips here might provide the last straw for Disney stock. But shorting Disney on expectations that Star Wars might not meet expectations requires some chutzpah since all indications point to the contrary. Star Wars: The Force Awakens has already sold $50 million in tickets a full month in advance before launch of the movie. That’s double the previous record of 25 million set by Dark Knight Rises.

Takeaway

I believe that Disney’s most promising products are where real opportunities to short the stock lie due to heightened optimism and the possibility that the company might fall short of those expectations. That’s food for thought for contrarian investors. But ultimately I believe it’s far less risky to long Disney stock than to short it. The company has a lot going for it, and the huge amount of short interest presents opportunities for good gains as the shorts rush to cover.