The Walt Disney Company

Changing Fortunes
"One of the best examples of service through people is Walt Disney ProductionsHow Disney looks upon people, internally and externally, handles them, communicates with them, rewards them, is in my view the basic foundation upon which its five decades of success stand." In Search of Excellence by Peters and Waterman ''In Search of Excellence didn't simplify enough! In the private or public sector, in big business or small, we observe that there are only two ways to create and sustain superior performance over the long haul. First, take exceptional care of your customers via superior service and superior quality. Second, constantly innovate. That's it. There are no alternatives in achieving long-term superior performance. Financial control is vital but one does not sell financial control." A Passion for Excellence by Peters and Austin The Walt Disney Company had enjoyed significant success over a sustained period from 1965 to 1980. The company was seen by many as the leading innovator in the field of customer centricity and attracted talented employees. On the surface, Disney was the feel good company of the NYSE. However, behind the scenes, Disney had become the classic take-over target. In June 1984, the share price was $52, well below its 1983 high of $84, earnings were down for the third straight year, debt levels were low, it had assets which could be sold off or revalued upward for depreciation purposes, cash flow was stable and strong and it had one of the most valuable brands in entertainment. Take-over Dilemma Ron Miller, chief executive officer of Disney, pondered the essence of this dilemma. For the past two and a half months, his company had been the subject of a takeover attempt by Saul Steinberg, a well-known raider. The attempt had started innocently enough with the announcement of the purchase of 6% of Disney's shares. In subsequent announcements, Steinberg's holdings rose to 12%. When Steinberg announced his intention of acquiring a further 37% of Disney, Miller undertook a series of evasive actions, including the purchase of the property company, Arvida Corporation for $200 million in Disney shares (3.33 million shares) and the attempted purchase of Gibson Greetings (a
Case prepared by Andrew Abdo (2010) for class discussion.

company that produces greeting cards) for $310 million in Disney shares. Analysts pondered what Disneys intentions with these seemingly poor acquisitions were? On June 11, 1984, Steinberg retaliated with a public tender offer in the New York Times and Financial Times for 49% of the total shares company at $72.50 per share. The terms of the offer were simple: he would offer the remaining shareholders of Disney on a first come first served basis, the price of $72.50 for their shares. This offer would commence on June 16 at 09h00 and would be valid for the first 37% of outstanding shares presented. Steinberg was doing the unthinkable, he was threatening to take control of Disney and realize the assets of the company at a profit. Before the raid began, Disney shares were trading around $52 per share. The senior executives at Disney were shocked at this turn of events. Consumers identified Disney with wholesome family entertainment more closely than they did any other corporation. The animated characters emerging from Disney were hallmarks of American culture. Millions of visitors delighted in the ingenuity of Disney theme parks, which business pundits cited as a model of excellence. The artistic creativity of Disney Productions was virtually a national resource. It was inconceivable to Miller that such an excellent company would be dismantled, or for that matter, raided in the first place. There seemed to be two possible responses to the tender offer. The first was to fight the offer in the courts and media. However, Steinberg had shown himself to be very determined, so even a successful outcome would be costly. The other alternative would be to pay greenmail1 and offer to repurchase Steinberg's shares. In fact, Steinberg was a notorious "greenmailer," who had been paid $47 million by Quaker State Oil Company only that previous April. Steinberg was believed to own 4.2 million shares of Disney stock, which he had acquired at an average price of $66 per share. The Disney directors pondered over what had caused the company to be under attack. What could be the cause of the share price being so low? Miller wondered what an appropriate action would be to save Disney from being taken over and dismantled. History The Walt Disney Company was formed in 1923 by a young cartoonist named Walt Disney, who arrived in Hollywood, with drawing materials under his arm, $40
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Greenmail is a firms repurchase of shares from a corporate raider at a price above market when all other shareholders are not offered the same opportunity. In return the corporate raider halts all attempts to acquire the firm or change its management.

in his pocket, and hopes that he could get started in the animated film business. In 1928 came the first real break. While the movie industry was still turning its back to the possibilities of sound, Walt produced "Steamboat Willie," the first cartoon with sound. It also introduced a new star, Mickey Mouse. In the decades that followed, Walt became an extraordinary filmmaker, a motion picture innovator and pioneer. And the name "Walt Disney" became universally known as the leaders in family entertainment.' By 1984 the company described itself as a "diversified international company engaged in family entertainment and community development." In fiscal 1983 Disney had sales of $1.3 billion on assets of $2.38 billion. The business activities of the company were in four segments: theme parks films consumer products real estate development The Disney strategy was to form these segments into interlocking pieces of a portfolio, each supporting the activities of another. The entertainment and recreation segment included theme parks and resorts. Theme parks were located in Anaheim, California; Orlando, Florida; and Tokyo, Japan. A new theme park near Orlando (opened in October 1982); EPCOT (for Experimental Prototype Community of Tomorrow) introduced two new themesFuture World and World Showcase. Disneyland covered 344 acres in Anaheim and the Disney World complex in Orlando included 28,000 acres of land (twice the size of Manhattan Island), most of which was undeveloped. Even before the Arvida acquisition, analysts estimated Disneys raw land holdings to be worth $300-700 million higher than the book value of the land. Disneyland was carried on the balance sheet at $20 million, although its replacement value was estimated to be $140 million. The company owned and operated hotels consisting of 400 units of vacation villas and 5,163 rooms in various locations. Management believed that its theme parks benefited substantially from its reputation in the entertainment business and from its other activities. In film entertainment, the company produced films for release under its own label as well as the Touchstone label, a brand oriented toward an adult audience. The company's film library consisted of 25 full-length animated features in color, 123 M1-length live-action features, 8 "true-life adventure" feature films, and over 500 other shorter films. Certain films proved to be an

enduring source of cash, as indicated by the billings of Snow White over the years. The company produced the television program "Wonderful World of Disney" from 1961 through 1981. The Disney Channel, a new venture into pay television, provided 19 daily hours of entertainment through cable system operators. Finally, the company marketed 114 films and cartoon titles to the home entertainment market, principally for use with video recorders. The company's studios included 44 acres in Burbank, California, and a ranch of 691 acres outside of Burbank. Real estate was conducted through the company's new subsidiary, Arvida Corporation, acquired on June 6, 1984. Whereas Arvida was not a factor in the performance predating the takeover bid, it now represented a significant asset in the valuation of the company. Arvida owned or controlled the development of 17,334 acres of land in Florida, Georgia, and California. In the area of consumer products, the company licensed the name Walt Disney, its animated characters, literary properties, songs, and music to manufacturers, publishers, and retailers. Historically, the returns in the consumer products segment were quite high. For instance, in 1978 this segment gave a pretax return on assets of 179% Financial Performance In contrast to the upbeat optimism of management, consumers, and business pundits, securities analysts and some journalists were less enthusiastic. The lukewarm financial appraisal was motivated by worsening performance in the film and theme park segments. Losses in the film segment were not surprising, analysts contended, because only two out of ten films in general did better than break even. Indeed, the film entertainment industry showed highly volatile operating performance. Industry observers also noted the large latent values in the studios' film libraries. Although carried on the balance sheet at historical cost, the film libraries were actually estimated to have a market value of $275 million. The theme park performance was similarly lackluster. Disney's attendance growth had been low or zero over the preceding decade, though as recently as 1978 the entertainment and recreation segment had shown a pretax return on assets of 15.7 %. For the industry in general, attendance over those ten years had grown at about 5 % annually, but the benefits of this growth were diluted by inflation and narrowing margins. The debuts of Disney World and EPCOT center had boosted attendance to a new level. A major question in analysts' minds was why Disney had chosen to grow the theme parks segment as aggressively as

it had. The historical cost of Disney World EPCOT Center was reflected on the balance sheet at approximately $600 million; however the expected market value from EPCOT had accumulated to $1.9 billion. One analyst commented, "The increment to the theme parks' operating earnings from Disney's investment probably did not exceed $80 million before taxes. After charging itself with taxes, Disney is left with about $45 million. That represents less than a 4 % return on EPCOT. If Disney had invested in Treasury Bills it could have done better. Disney's stock price reflected this softened performance. As recently as April 1983, shares had traded at $84. Then in November 1983, Disney announced a 17 % drop in quarterly earnings. In response, the share price dropped from $62 to $47. Goldman Sachs estimated the firm's asset value per share at about $75, and forecasted fiscal 1984 earnings per share to be $3.25; the current P/E was 15. The stock price began to recover in January 1984, but for reasons unknown to the company. The Wall Street Journal published that Disney was unaware of any accumulation of its shares by a hostile party. An aggressor would have to overcome corporate bylaws that require approval by 80 % of the shares for a change in ownership. Including a 4.2 % holding by officers and directors, Disney employees and family members are believed to hold 15 to 20 % of the 34.5 million shares. So what's all the speculation about? Disney, according to merger speculators and others who've been buying the stock, has all the characteristics of a concern that can be bought through borrowing against its property. Its debt is relatively low; it has assets, such as Disneyland, which can be revalued upward to generate tax deductions for a prospective buyer, and its cash flow could turn significantly higher within a brief time. And even if these factors don't prompt a buyout, they significantly reduce the risk that the stock could go lower, says Michael Metz, market strategist at Oppenheimer. Disney's book value is about $40 a share, but the company owns considerable real estate and a film library, both carried on its books at substantially below market values. A recent report by Cyrus J. Lawrence analyst placed Disney's asset value at $64 to $99 a share. All this speculation had finally been fulfilled when Steinberg began his bid for Disneys assets. Question of Leadership Some analysts doubted that this declining performance was temporary, and pointed to the lack of creative leadership after the death of Walt Disney in 1966. One former executive said, if there were projects under discussion, people would

say, "Walt wouldn't do that. Walt was a real genius. He was running the company 15 years after his death. Business Week noted: Change will not come easily at Disney, partially because so many of its key executives worked under the founder that a Walt Disney cult developed. Until recently it appeared that new ventures were undertaken only if Walt had conceived them or if they seemed like projects he would have approved. Ron Miller became head of the Disney film studio in 1976 and was Walt Disneys sonin-law. He came from a property background and became CEO of Disney in 1980. The company CFO, Michael Bagnall was the son of Walt Disneys founding partner and had worked for the company for 22 years. The family leadership seemed to lack Walts ability to innovate and take risks. The Repurchase Proposal As Miller pondered the question of whether to repurchase Steinberg's holdings of Disney stock, he considered what price would be appropriate. He also wondered whether paying greenmail would be fair to other shareholders. And finally, he wondered whether, and if so how, this episode should change the management policies of the company. Questions 1. Why was this excellent company the target of a takeover attempt? Consider both the financial and non-financial causes for the companys share price to be undervalued. 2. Should Disney re-purchase Saul Steinbergs shares? At what price? What implications would this have? 3. What would you do next? Analyse Disneys main business units and recommend a revised corporate strategy.

Exhibit 1 Disney Income Statement 1980 ($ '000) 629,492 179,078 105,936 914,505 486,087 140,189 56,929 683,205 143,405 38,888 49,007 231,300 25,424 -42,110 247,986 112,800 135,186 32,497 4.16 0.72 51.25 1981 ($ '000) 691,811 196,806 116,423 1,005,040 562,337 162,180 65,859 790,376 129,474 34,626 50,564 214,664 30,814 -33,130 216,980 95,500 121,480 32,656 3.72 1.00 52.25 1982 ($ '000) 725,610 202,102 102,538 1,030,250 592,965 182,463 54,706 830,134 132,645 19,639 47,832 200,116 36,104 -14,781 178,793 78,700 100,093 33,253 3.01 1.20 63.25 1983 ($ '000) 1,031,202 165,458 110,697 1,307,357 834,324 198,843 53,815 1,086,982 196,878 -33,385 56,882 220,375 42,849 14,066 163,460 70,300 93,160 34,504 2.70 1.20 52.60

Revenues Entertainment and recreation Motion pictures Consumer products and other Cost of Sales Entertainment and recreation Motion pictures Consumer products and other Operating Profit Entertainment and recreation Motion pictures Consumer products and other Net Operating Profit Fixed Costs (Corporate) Interest Profit before Tax Tax Net Profit No of Shares ('000) Earnings per Share Dividend per Share Share Price

Exhibit 2 Disney Balance Sheet Current Assets Cash Accounts receiv able I ncome taxes refundable I nv entories Film production costs Prepaid expenses Non Current Assets Property, plant & equipment Less accumulated depreciation Net book v alue Film production costs Construction-in-progress Other assets Total Assets Equity Share Capital Reserv es Current Liabilities Accounts payable Non Current Liabilities Long term borrow ings Deferred taxes Other liabilities Total Liabilities Equity & Liabilities 1981 ($ '000) 11,051 66,432 90,000 44,312 42,131 17,881 271,807 1,459,134 -389,765 1,069,369 51,091 178,063 39,679 1,610,009 1982 ($ '000) 13,652 78,968 41,000 66,717 43,850 18,152 262,339 1,916,617 -419,944 1,496,673 64,216 160,186 119,402 2,102,816 1983 ($ '000) 18,055 102,847 70,000 77,945 44,412 19,843 333,102 2,251,297 -504,365 1,746,932 82,598 108,190 110,373 2,381,195

501,650 665,468 1,167,118 181,573 171,886 41,198 48,234 442,891 1,610,009

588,250 686,534 1,274,784 237,313 315,000 180,980 94,739 828,032 2,102,816

661,934 738,594 1,400,528 238,198 346,325 285,270 110,874 980,667 2,381,195

Exhibit 3 Disney Selected Financial Performance Data 1965 20.05% 12.24% 1.31 16.03% 1.61 25.82% 0.63 6.46% 4.06% 22.56 59.25 59.25 1970 22.20% 15.04% 0.66 9.93% 1.72 17.07% 0.90 7.65% 6.49% 26.89 70.69 282.76 1975 23.75% 16.05% 0.68 10.91% 1.77 19.32% 2.00 5.75% 6.76% 31.02 50.18 401.44 1980 25.29% 14.78% 0.68 10.05% 1.60 16.08% 4.16 17.31% 12.05% 33.22 51.36 410.88 1981 21.36% 12.09% 0.62 7.55% 1.38 10.41% 3.7 26.88% 13.60% 35.74 52.25 418.00 1982 19.42% 9.72% 0.49 4.76% 1.65 7.85% 3.0 39.87% 11.10% 38.34 63.25 506.00 1983 16.86% 7.13% 0.55 3.91% 1.70 6.65% 2.7 44.44% 10.00% 40.59 52.60 420.80

Gross Margin Net Margin Asset Turnov er Return on Assets Gearing Return on Equity EPS Div idend Payout Rate Rate on 1 Year Treasury Bills Net Asset Value per share Share Price (actual) Effectiv e Share Price (adjusted for share splits) Ratio Formulae Gross Margin - Operating Profit/Rev enue Net Margin - Net Profit/Rev enue Asset Turnov er - Rev enue/Assets Return on Assets - Net Profit/Assets Gearing - Assets/Equity Return on Equity - Net Profit/Equity EPS - Net Profit/No of Shares Div idend Payout Rate - Div idend per share/EPS Net Asset Value per share - Equity/No of Shares

Exhibit 4 Disney Share Price History Share Price Prior to Split $214 $177 $105

Share Split Date 06-Dec-72 04-Feb-71 26-Oct-67

Split Ratio 2 for 1 2 for 1 2 for 1

Recent Share Price Movements Date Price 30-Sep-82 30-Sep-83 10-Nov -83 03-Jan-84 26-Mar-84 09-Apr-84 02-May-84 11-Jun-84 $57 $62 $47 $52 $63 $67 $66 $52

News

Quarterly eanrings Takeov er rumours Steinberg acquires 6% Steinberg has 12% Steinberg offer for 49%

Disney Share Price 1962 - 1984

200

150

100

50

0
1962/01/02 1963/01/02 1964/01/02 1965/01/02 1966/01/02 1967/01/02 1968/01/02 1969/01/02 1970/01/02 1971/01/02 1972/01/02 1973/01/02 1974/01/02 1975/01/02 1976/01/02 1977/01/02 1978/01/02 1979/01/02 1980/01/02 1981/01/02 1982/01/02 1983/01/02 1984/01/02

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Exhibit 5 Divisional Revenue & Income in Percentages Theme Parks Revenue Profit 36% 32% 49% 36% 67% 45% 70% 55% 69% 60% 70% 66% 79% 89% Films Revenue Profit 51% 55% 41% 56% 22% 39% 18% 21% 20% 16% 20% 10% 13% -15% Consumer Products Revenue Profit 13% 12% 10% 8% 11% 16% 12% 24% 12% 24% 10% 24% 8% 26%

Year 1965 1970 1975 1980 1981 1982 1983

Entertainment & Recreation Data Admissions & Rides Food Sales Royalties Hotels Total Entertainment Rev enue Theme Park Attendances 1980 217,882 185,457 164,422 61,731 629,492 18,946 1981 232,661 193,597 195,443 70,110 691,811 20,231 1982 1983 267,999 370,345 217,705 307,309 158,663 255,443 81,243 98,105 725,610 1,031,202 23,304 32,204

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Exhibit 6 Film Industry Information Annual Revenue from "Snow White" Year $ Millions 1937 10 1944 4 1952 5 1958 7 1965 13 1967 23 1983 29

Estimated Probable Film Library Values - 1983 Value ($ Mil) 500 275 950 275 350 700 450 3,500

Company Columbia Pictures Disney MGM Paramount 20th Century Fox Univ ersial Warner Bros. Total

No of Titles 1 800 films 650 films 6 000 films 700 films 1 400 films 3 000 films, 1 500 TV episodes 1 600 films

Film Indusry Market Share 20th Century Fox 19% 14% 16% 13% 14% 21%

Year 1970 1975 1980 1981 1982 1983

Columbia Pictures Disney 8% 9% 13% 6% 14% 4% 13% 4% 10% 4% 14% 3%

MGM 9% 11% 7% 9% 11% 10%

Paramount 12% 11% 16% 15% 14% 14%

Universial 13% 25% 20% 14% 30% 13%

Warner Bros. 5% 9% 14% 18% 10% 17%

Other 25% 11% 9% 14% 7% 8%

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