It is 1984, and Disney is the target of a potential takeover by notorious greenmailer Sual Steinberg. Disney is faced with the option of fighting the takeover through the courts and media, or to repurchase Steinberg’s shares, in effect, giving in to his greenmail attempt. However, there are many other important issues which are facing Disney. These range from Disney’s abysmal return on investment in recent theme park investments, to the complete failure of Disney’s motion picture division, to Disney’s alarmingly high dividend payout rate.
In the following four sections, we will address these four issues Disney faces and recommend solutions to improve the financial health of Disney. Theme Parks Issue Recently, Disney has been following a bad investment policy. Disney invested a total of $1. 9 Billion in Epcot over a 6 year period and has increased its capital expenditures on theme parks by a total of $1. 277 Billion from 1981 to 1983. Despite these massive investments in its theme parks, Disney has only earned a return of 4% on Epcot and an overall return on Theme Park assets of 6% in 1983.
Disney needs to find a way to more efficiently invest its capital and produce greater returns on its investments. Analysis In order to understand why Disney’s Theme Park investments have been so unsuccessful, we must analyze a number of different contributing factors. Why Disney is investing in Theme Parks? In order to understand why Disney is investing in Theme Parks, we need to take a look at the financial results of Disney’s different segments.
Out of Disney’s 3 segments, Entertainment and Recreation (or theme parks) is Disney’s only segment which is nicely growing its profits in addition to attaining a healthy profit margin.
Motion pictures is currently suffering, and actually losing money. Whereas, Consumer Products is producing profits and holding the greatest profit margin, however profits are not growing significantly. After looking at this analysis and nothing else, it appears as though Entertainment and Recreation is Disney’s most profitable segment and the one which they should be investing in. This is exactly what Disney is doing. Why are additional Theme Parks are the Wrong Investment? Before the expansion on new theme parks, Disney’s older theme parks had enjoyed much success.
As recently as 1978, Disney’s Entertainment and Recreation segment had experienced a return on assets of 15. 7%. However, as Disney introduced new theme parks, they reached a point where the optimal supply of theme parks had surpassed the demand. This “oversupply” of theme parks can be seen by taking a look at the United States Demographic data provided in the case. First, it must be understood that Theme Park attendance, and in turn revenues, are driven by the younger demographic. According to the information above, the population group that drives Theme Park revenues (0 to 14 years old) is actually shrinking from 1970 to 1995.
This represents a decrease in demand for Disney’s Theme Parks. Yet, at the same time, Disney is investing in and opening new theme parks. Essentially, Disney is increasing the supply despite a decrease in demand. This is counter intuitive by any economic standard. To further back the claims that Disney’s increased investment in theme parks is a bad move; let’s quickly analyze some measures of financial performance for their theme park segment. Clearly, the Entertainment and Recreation segment has experienced an abysmal return on assets recently.
These numbers are even more disappointing when considering the Entertainment and Recreation segment produced an ROA 15. 7% as recently as 1978. Disney has made the wrong move in investing heavily in additional theme parks despite the population decrease in its main customer segment. In order to improve Disney’s position, it must make some changes. Suggested Changes Overseas Theme Parks The demand for additional theme parks does not exist in the United States, as can be seen from looking at the demographic data above.
Therefore, there is no reason for Disney to continue expanding and investing in additional United States theme parks. Disney needs to immediately stop United States theme park expansion. However, this does not mean that Disney must stop investing in theme parks altogether. Disney should look to other countries where there is a demand for theme parks. By looking for countries where the demographics are in their favor and there is sufficient demand without oversupply, Disney can begin to earn sufficient returns on their theme park investments. Management Change Disney’s management should have foreseen the downside of overexpansion.
It’s even possible that management did realize the lack of demand, however they may have wanted to extract us much demand as possible by building more theme parks. Either way, the decision to invest so heavily in theme parks despite their main market segment shrinking for the foreseeable future is incomprehensible. Earning a ROA of 6% in 1983 on theme parks assets when a 1983 T-Bill earns 8. 86% shows an abysmal utilization of assets. Management responsible for the decision to invest so heavily in theme parks needs to be fired from the company. Implementation How to Expand Overseas
First, Disney needs to conduct market research in numerous modernized foreign countries. The focus of this research needs to be on the demand levels for a theme park, and whether the demand outweighs the current supply of theme parks in each country. Once Disney chooses the country with the most favorable supply and demand situation, it can begin analysis to determine whether or not they should actually construct a theme park in that country. They will estimate costs and future cash flows in order to conduct a NPV analysis in order to determine whether or not Disney should actually construct a theme park in that country.
How to Implement Management Change Ask around management, and conduct interviews with high level managers in order to determine who was responsible for the decision to invest more heavily in theme parks. Once you have identified the main individual or individuals responsible for the decision, you let them know that they are being let go for their ineptitude. Then, search for top management at other similar companies (or any promising prospects within Disney) to fill the open positions. Motion Pictures Issue The motion pictures business has been historically one of Disney’s strongest segments since the company was founded.
Over the years, classic films like Snow White and Cinderella have provided valuable revenue streams for the company. Films have accounted for a significant amount of Disney’s earnings and had a large impact on the performance of the company. However, in recent years the motion picture segment’s performance has been lackluster and recording an operating loss of $33. 3M in 1983. The recent failures in the motion picture segment had a profound ripple effect on Disney’s financial performance. Just two years ago the same division boasted a 17. 59% profit margin and operating income of $34. M. Analysis The recent missteps can be attributed to a failed TV channel startup, lack of a blockbuster movie hit, and the cancelation of a new Disney TV show on CBS. Although the film industry in general was suffering in 1983, the performance of Disney’s motion pictures division was abysmal. Suggested Changes New Management Performance in this division has steadily declined over the past three years. New talent needs to be brought in to help revitalize this division. Disney has been a household name since the advent of cinema and should not be lagging behind their rivals.
Management needs to be held accountable for these failures. Increased Investment in Film Disney has arguably been one of the most successful film companies in the world since it was started in 1923. Creating, distributing, and selling films have been a core competency of Disney for many years. Disney needs to invest more money into creating innovative films and future blockbusters. For the past several years, there has been a disparate amount of funds invested into their park business compared to the motion picture segment. Disney needs to focus on their core competency of film and invest into motion pictures.
Historically, this business has proved to be lucrative and these additional resources will help finance future blockbuster movies. Implementation How to Acquire New Management Currently, many of the Disney executives worked under Walt Disney, himself, and often won’t accept projects due to the reasoning that “Walt wouldn’t do that”. It is hard for creative talent to come up with great ideas and have them put down without any reasoning, other than a dead man wouldn’t have approved their ideas or projects. The current executive’s ties are too strong to the late Walt Disney and at least some of them need to be replaced with fresh blood.
Fire the executives who are the most repeat offenders of the above mentioned offense. In order to replace them, we suggest that Disney looks to other top movie studies for executive talent. How to Increase Investment in Film While Disney is halting its theme park expansion in the United States and conducting market research overseas for new sites, a lot of additional capital will be lying around waiting to be invested. Once the new executives are in place, we suggest that Disney allocates a considerable amount of its free capital to motion pictures and see what kind of results that its newly hired executives can produce.
Dividend Policy Issue One of the many vital points of interest that Ron Miller must address as Disney moves into the future is making a decision on its dividend policy. When looking at the dividend policy of the company, it is critical to conduct a financial ratio analysis of the company. Upon doing so, certain trends can be noticed. One of these noticeable trends happens to fall within the dividend payout rate. For over a decade, the dividend payout rate fluctuated only slightly staying in the range of 4% to 8%. Then beginning in 1978, the dividends began to increase exponentially arriving at a rate of 44. 4% only five years later in 1983. This five year spike in the dividend payout rate has come at the same time as the earnings per share continue to fall. This immediately should raise concerns for the financial security of the company. Analysis In deciding on a dividend policy, it is crucial for the company to decide how growth oriented it would like to be. Speaking simply, the more dividends Disney decides to pay out, the less retained earnings it has to put into future positively valued projects. This can be seen in the company’s sustainable growth rate.
Calculating for 1883, the growth rate is only 3. 70% Given the large dividend payout rate of 44. 44%, Disney cannot grow with retained earnings at anything more than a modest 3. 70%. If Disney wanted to grow more than that, it could consider taking on more debt. The company has historically been averse to taking on too much debt and will most likely want to continue that trend into the future. If Disney wants to continue to grow without taking on debt, the company will need to consider lowering the dividend payout rate. Suggested Change Lower Dividends
To align the dividend payout rate more closely with earnings per share along with setting the company up for more future growth projects, it is crucial in Disney’s financial planning that they cut back the dividend rate. It is our suggestion that Disney reduces its dividend so that its dividend payout ratio is in line with its historic payout of about 7. 50%. This will require Disney to cut its dividend down to $. 20 per share (based on 1983 EPS of $2. 70 per share). Decreasing the dividend to $. 20 per share would nearly double Disney’s sustainable growth rate, increasing it to 6. 16%.
As a result, Disney would be able to finance more projects through retained earnings and continue to keep its leverage down. Implementation How to Lower Dividends Obviously, shareholders are not going to be happy to hear that you want to cut the dividend by 83%. This is why you have to issue a press release for general shareholders and at least a conference call or meeting with major shareholders to inform them of your intentions. During the conversation with shareholders, you are going to have to explain how it was a mistake in the past to increase dividends as earnings per share continued to slide.
Let the shareholders know that you are going to correct this mistake now, rather than letting it continue to slide. Finally, mention that decreasing dividends will also help Disney remain a financially healthy company by keeping its debt low. Corporate Takeover Attempt Issue Possibly the most important issue faced by Ron Miller and the leadership of Walt Disney Productions is the imposing takeover attempt by well-known corporate raider, Saul Steinberg. This attempt has been sparked by Walt Disney’s current financial situation and performance.
Currently, Disney seems to be an ideal target for a takeover. Disney has a great amount of cash on hand, totaling about $18 million. This, along with Disney’s underperformance and inefficiencies, are strong motivating factors for Steinberg’s attempt. It is likely that Saul Steinberg believes Walt Disney Productions to be undervalued. This is a conclusion shared by most raiders about the targets in takeover attempts. Disney is currently trading at $50 per share. Steinberg just initiated a tender offer for 49 percent of the company for $67. 50 per share.
This is where Ron Miller must face a difficult decision by giving in to the greenmailing attempt by agreeing to purchase back Steinberg’s shares at a premium, or letting Walt Disney Productions fall victim to a takeover. Analysis It is essential for the future of Disney for us to examine the value of the company. From there, Disney must decide at what price, if any, should they buy back Steinberg’s shares. As stated earlier, Disney’s stock has been recently trading at $50 per share. (Graph) For our analysis of valuing the company, we calculated a WACC of 16. 6%, as well as three different possible growth rates of 8%, 11%, and 13%.
From these calculations we were able to surmise an estimated company value of $68. 12 per share. This would lead us, as well as Saul Steinberg, to believe Disney to be undervalued. Recommendation Don’t Buy Steinberg’s Shares To successfully ward of Steinberg and his attempted takeover, Disney must offer him a hefty premium for the purchase of his shares. With his ownership of 12% of the company and his recent attempt for 49 percent of it, a pivotal decision must be made. However, after valuing the company and weighing possible options, we have come to a recommendation.
For the sake of both the shareholders and stakeholders of the company, it would be not be wise to buy the shares owned by Saul Steinberg. A decision to succumb to Steinberg’s greenmail would greatly cripple the company from a financial standpoint. If Disney were to buy his share of the company, investors would experience a huge decline in their shares. Such a decision would be made solely to preserve the jobs and welfare of top managers of the company. Disney would be failing to maximize shareholder value, thus weakening Disney’s position in the market.
We concluded that in order to avoid the takeover attempt, Disney would have to pay Steinberg $69 per share. This is $0. 88 more than our estimated value of the company and a 38% premium with respect to the current share price. This would leave Saul Steinberg with $289. 8 million, or a profit of $24 million at the expense of Disney’s shareholders. Implementation Don’t Buy Shares, Improve Company Instead of buying the shares, Disney should focus on cleaning up its act as a financially sound company, as well as a leader in its respective industries.
With the likely replacement of Ron Miller and top executives, Disney would find itself in a position to change its current business policies. Disney is already highly capital intensive, with the recent increased spending on theme parks. The company should not be acquiring more debt by purchasing two new companies with no apparent synergies. Disney should immediately dump these unwisely obtained businesses. The money from these sales would enable Disney to invest in new business ventures, like expanding abroad and tapping into new markets.