Welcome to the second in the series of articles looking in detail at the Walt Disney Companies merger with Lucasfilm. All opinions are my own, formed from my own background and training as an Accountant and do not necessary reflect those of this site or its owners. No information is provided in this series as advice on investment.
Every week between now and the actual anniversary of the deal I will look at a different aspect of the merger. I encourage you the Jedi News readers to join in the debate and discussion Twitter @JediNewsUK, Facebook, Instagram and your own blogs using the hashtag #JNDEBATES.
This week we will look at the purchase of Lucasfilm and the Movie & TV Studio impact for Disney.
THE WALT DISNEY COMPANY MERGES WITH LUCASFILM LTD
PART TWO: The Motive & Return on Investment
THE MOTIVE
On the 21st December 2012 Disney merged with Lucasfilm with the terms of the merger being a cash payment of $2,208,199,950 with a further consideration of 37,076,679 shares from Disney. The share price on the 21st December 2012 was $50.00, valuing the transaction at approximately $4.06 billion. But what was the attraction of Lucasfilm to Disney…?
The question is both simple business and yet complicated by emotion. As disclosed in the second paragraph of the press announcement over the deal, the purchase continues “Disney’s strategic focus on creating and monetizing the world’s best branded content, innovative technology and global growth to drive long-term shareholder value”
The deal for Disney was simple; they were securing one of the world’s largest, most successful brands, and with un-paralleled longevity in Star Wars. Further to the already global success of Star Wars, they believed that with their marketing and infrastructure that they could even further monetize the success the brand already had. This would improve their revenue stream, as well as profitability not only in the movie studio element of Disney but also in their licensing, TV, and parks business as well. The Star Wars brand could enhance all aspects of the Disney business. The deal appealed to the Disney culture both for its portfolio of content, and visionary filmmaking, but in the increasing corporate world of delivering near sure-fire shareholder value.
For George Lucas the 100% owner of Lucasfilm the deal would see him receive $4.06 billion for the business he built from scratch. His terms being a mix of cash and shares in the new enlarged Disney. As a sweetener to the deal he would have Lucasfilm prepped and ready for a new trilogy of films starting in 2015 with Episode VII.
Formed in 1971 as a vehicle to develop and film American Graffiti, Lucas’s break through film with Universal Studios the distributor; it would be 1977’s Star Wars with 20th Century Fox that would allow Lucas to seize creative control of all his future body of work. Lucas was famed for hating the studio model, having never recovered from the anger that saw the studio, in his eyes; destroy the cut of American Graffiti he envisioned.
Having never worked with Disney in the distribution of any of there films, Lucasfilm, and George Lucas would turn to Disney to secure the legacy of his films beyond his life. The irony not being lost that it is a studio he required to protect the franchise he unintentionally created and which had dominated his career and life.
For Lucas it was never about money, it was about protecting the world he created for not just this generation, but for all future generations. He said “For the past 35 years, one of my greatest pleasures has been to see Star Wars passed from one generation to the next, it’s now time for me to pass Star Wars on to a new generation of filmmakers. I’ve always believed that Star Wars could live beyond me, and I thought it was important to set up the transition during my lifetime. I’m confident that with Lucasfilm under the leadership of Kathleen Kennedy, and having a new home within the Disney organization, Star Wars will certainly live on and flourish for many generations to come. Disney’s reach and experience give Lucasfilm the opportunity to blaze new trails in film, television, interactive media, theme parks, live entertainment, and consumer products.”
Star Wars had dominated George Lucas’ life, it had prevented him from doing many of the things he had dreamt of, but undoubtedly afforded him many opportunities to work outwith the studio model. In releasing Star Wars to Disney, he was unleashing a massive burden from his shoulders – but it was also a hugely emotional transaction. It was vital that his company and its creations were protected, and he had spent many years restructuring the company and putting people in place he knew in key roles to ensure that legacy continued. This moment had long been planned.
Lucas had never worked with Disney on any movies but had worked with Bob Iger many times through ABC on cartoons, and most importantly on the Young Indiana Chronicles. It was here in the early 1990s with Bob Iger as Chairman of ABC that he green lit Young Indiana. Iger supported the show through two seasons despite it struggling to find an audience – believing in its creative and quality. It was hailed as a critical success but commercially failed. Lucas did not forget the support that Iger gave him.
After the purchase of ABC in 1996 – Bob Iger climbed the Disney hierarchy becoming CEO in 2005. A much-criticised appointment of a “non-creative” CEO, Iger shocked everyone in his success. He understood Disney’s track record, and the importance of characters that endeared audiences. He also understood creative. In purchasing Pixar from Steve Jobs in 2006 he spent more time negotiating the social side of the deal, and the assurances of creative freedom outside the Disney model than he did the nuts and bolts of the financials. He understood the culture of studios and the necessity to embrace and support creative freedom. Pixar of course has once been part of Lucasfilm. In 2009 the purchase of Marvel, was again highlighted by the fact that Iger retained the leadership of Marvel, again he showed the passion of working with, not over bearing studios within his company.
Having seen the way Iger protected Indiana’s creativity and the way that he protected the cultures of Pixar and Marvel; by 2011 Lucas had seen enough in the man to enter discussions with Iger about buying Lucasfilm. He hurt inside selling his company, but in the same hand trusted Iger to protect his legacy. Lucas always commented on the fact that on his death he would be referred to as the Star Wars creator. It was his child, and it was difficult giving it away. In Iger he had found someone he could trust.
THE FINANCIALS
For Disney the perspective must not be lost that their board must deliver shareholder value in everything that they do. Unlike Lucas as the sole owner of Lucasfilm, who could act and develop products to his whim – and he did indulge without attempting to excuse it.
There needs to be justification to any Lucasfilm future action under Disney. Why is Lucasfilm the right fit for Disney from a financial perspective? The company accounts show the hole that Star Wars can fill – specifically in the Studio Entertainment Division of the business.
I want to keep this simple so as to not confuse the non-financial minded reader, and so will show the company finances in very simplified summaries of the accounts, for the full accounts and a complete perspective please click here.
Despite a dip in 2009, Disney have seen solid growth both in revenues (income) and earnings (profits.) In 2012 they hit record levels on both revenue and income. People may well debate the quality of the movies made on Iger’s watch, but you cannot question his business acumen, and he has delivered.
On a basic level, the higher the number the happier the shareholder should be. This is best summarised by looking at the earnings per share. This is effectively how much profit the company has delivered for each share issued. Shareholders want to see this number rise, and Iger has achieved this with great success.
Disney is due to give their latest financials on the 7th November, which again looks to be a strong year. We show in our image for 2013 the accounts up to and including QTR3 (9 months). These are all reported figures from Disney and there are no estimates shown.
Disney’s performance has undoubtedly boosted in 2010 with the purchase of Marvel, and will be again by Lucasfilm in 2012 albeit most of the revenues and profits fall into the current financial year so we are yet to see the Lucasfilm impact clearly.
When you breakdown the revenues into their respective market areas you can see Media Networks (ABC, ESPN etc.), Parks & Resorts, Consumer Products, and Interactive Media show continued growth in incomes year on year. This is a strong positive sign to any shareholder.
The one area of the business that struggles up and down is the Studio Entertainment division. Whilst this is to be expected in the movie world, it to this area of the business shareholders will seek for improvement. Acquisitions of studios such as Pixar, Marvel and Lucasfilm allow for fast growth and development of this business area, as well as providing more predictable income and profit streams.
Because this is the area of the business where Lucasfilm will be expected to deliver most, we will focus on that for analysis.
When you look at the Studio Entertainment business of any studio it has to be done with the perspective of the movie releases, and DVD releases in any given year.
Back in 2008 with National Treasure 2 and Wall-E in the theatres, Disney has £1.23 billion revenue in the theatres. This paled insignificance to home entertainment revenues taken from DVD releases such as Pirates of The Carbabian At World’s End, Ratatouille, and Enchanted. It’s a sharp reminder that not only are strong theatre revenues important for the company, but also DVD and Digital sales after theatre releases. Disney does not have the rights for DVD releases of the first six Star Wars films. A New Hope remains with Fox forever, with Episodes 1, 2, 3, 5, and 6 held by Fox until 2020. This may not be important now to the Disney model, but it will be something they may seek to resolve as they start DVD sales of future Star Wars movies. An Episode I to IX multipack anyone? How about some straight to DVD Clone Wars of Rebels specials?
Television was also a huge success back in 2008 for Disney. A main driver for this was a pre-twerking Miley Cyrus on her concert tour for TV as Hannah Montana. Again this points to a potential revenue stream that has never been tapped by Lucasfilm. A Star Wars live-action TV show would see globally, and be a major revenue generator. ABC have been quoted as being keen to discuss this in the future. I do not see this happening pre 2015, but there is potential for specials such as the Darth Vader TV Specials recently unearthed by Jedi News.
2008 was the most successful year for Disney in recent years for there Studio Division. It does not go without coincidence that a strong mix of movies, DVDs, and TV delivered this. Disney will be keen to utilize Star Wars across all of these mediums.
Profits for the division went from over $1 billion, compared to a mere $175million in 2009. The reasons for this drop in 2009 are painfully obvious. The only two releases of note that year were Up and The Proposal – the mix of movies, DVD, and TV was not there. Massive injection of talent and creative was needed in the Studio Division. Iger would deliver it in speed and style in 2010 with the purchase of Marvel.
The turnaround and impact was massive. In 2010 Disney delivered its own billion-dollar mark movie with Alice in Wonderland, Pixar added its own billion-dollar breaking movie with Toy Story 3. The first time the Disney studio had two films pass the billion-dollar mark at the global box office in the same year.
Marvel had Iron Man 2 that year, which added some value to Disney in the year of purchase. However, as Iger was keen to point out the purchase was more significant than immediate results. As he said in his report in the annual accounts that year they were buying “world-class artists, a fantastic stable of well-known characters like Iron Man, the Hulk, Thor and Captain America, and loyal fans who express their passion every day in much the same way fans of Disney do.” Added to that there were two Marvel films on the horizon in Thor and Captain America: The First Avenger, as well as “Marvel TV Shows, games, comics and merchandise now flowing through our global marketing and distribution network, we couldn’t be more excited.”
Iger was delivering exactly what Disney needed, and what the shareholders needed. Multi-Platform Studio franchises, with seemingly never ending potential.
Since the strength of 2010, the finances have held strong. 2011 saw the movie releases of Disney’s Pirates of The Caribbean On Stranger Tides, Cars 2 form Pixar, and Marvels Thor and Captain America. TV revenues were boosted by the highly successful series of Marvel TV Shows.
2012 would continue this trend with The Avengers passing the $1.5billion mark, and the success of Brave from Pixar and the Muppets. Profits soured to $722 million for the studio, and that was in the year of the failure that was John Carter. The Avengers would be the first Marvel film marketed and distributed by Disney allowing for the increased profits. It’s highest profit making year for the studio since 2008.
It would be the second year that Income, Profits, and Earnings per Share for the whole company would break records. It would also be the year that they bought Star Wars with the December 2012 completion of the Lucasfilm merger.
In the 2012 annual report Bob Iger, waxed lyrical on what the Lucasfilm purchase could mean for Disney.
“Each of our strategic acquisitions has generated tremendous new opportunities and creative potential across our entire company, and we are thrilled to add Lucasfilm and its beloved Star Wars franchise, with its universe of more than 17,000 characters, inhabiting several thousand planets, spanning 20,000 years. Star Wars offers infinite inspiration and opportunities, and we’re already moving forward on a new feature film to continue the epic saga. Star Wars Episode 7 will be in theaters in 2015, with more feature films planned – along with television programming, games and merchandise, and an expanded Star Wars presence in our parks around the world.”
Shareholders immediate reaction was not positive, after initial delays to the stock market due to Hurricane Sandy, when the market reopened Disney shares dropped 2%. This was against the wider stock market that showed a small gain.
Why the initial negative reaction? Simply put there would be no initial return on the Lucasfilm deal that would offset the cost. There would be high administration costs as the merged companies were combined, it would take two years to deliver the first movie from the brand, and as such earnings per share were projected by Disney to fail to reach market expectation pre-deal. With short term gain investors dropping the stock on this news, it would be fair to say that long term investors who hold out for 2015 and the start of significant Lucasfilm benefits may see the benefit (if the rest of the business goes as well as planned.)
Market analysts were quick to point out that the deal looked promising. Barton Crockett of Lazard Capital Markets commented that “Our initial, necessarily abbreviated [due to Hurricane Sandy], analysis says this deal looks more promising than the Marvel acquisition in 2009, a deal now widely lauded” adding that “For about the same purchase price [as Marvel], Disney is buying another big, young male skewing franchise to expand its diversification from young females.”
This deal would not deliver the fast returns of the established and working studio that Marvel was. Lucasfilm was a sleeping giant starting to reawaken. It would take to crystalize the benefits of the deal, but the potential was huge. In a few years time, the Lucasfilm deal could smooth out the performance of the Studio division. When coupled with Marvel, near guaranteed returns year on year for the Studio business.
Disney were quick to point out that there was no guarantee of success, and that “in order to achieve increases in earnings per share as a result of the merger, the combined company will, among other things, need to effectively continue the successful operations of Lucasfilm after the merger, develop successful new content (including future feature films) based on Lucasfilm’s intellectual property and successfully integrate Lucasfilm’s products into the combined company’s various distribution channels.”
With a number of months into ownership, how is the deal fairing? It is always difficult to tell in the first year of any merger. Acquisition costs, and restructuring costs always make the figures difficult to truly assess. Disney have experienced $121 million of restructuring costs in the past 9 months, compared to $50 million in the previous year. There has been a very well reported restructuring process within Disney’s other divisions so it would be unfair to point too much on Lucasfilm but it will be a significant figure to merge the two companies. This will no doubt be an on-going process for some time.
In the 9 months accounts the purchase price of $4.1 billion was allocated as such:
- Fair Value Intangible Assets: $2.6b
- Goodwill $2.3b
- Deferred Income Taxes ($0.8b)
Intangible assets are the non-physical assets, such as Intellectual Property based on Star Wars, i.e. the Darth Vader character. Disney has chosen to write this off over a 40-year period. Based on Disney’s plan of one Star Wars film a year from 2015, this could mean that in 2053 we will sitting down to watch Episode XLV (That’s Episode 45 People!) In all seriousness, this shows how committed and how much belief Disney have in the purchase. They believe they can benefit from the deal for the next 40 years.
Goodwill is the additional value placed on the deal that can’t be allocated to assets. In this case it is the value to Disney of being able to use Lucasfilm Intellectual Property across all of the distribution channels, and global avenues. In effect the additional premium paid to make the deal for which you get nothing, bar the belief you turn this into income.
Disney also reported an increase in revenues for TV and Subscription Video on Demand which it says was “driven by an increase in other revenue from the inclusion of Lucasfilm’s special effects business.”
Further benefits were seen with growth in licensing and publishing revenue, mainly derived from Lucasfilms revenues in this area.
The purchase certainly seems to be working for Disney, and it SHOULD deliver more regular consistency to its Studio Division revenues and profits. Looking at the last trilogy of Star Wars films, and Indiana Jones (which Disney largely ignore in all official comment but remains an untapped Intellectual Property) earnings you see a strong pattern. Adjusting for inflation, the three Star Wars films would have averaged around the $1.5 billion
- Star Wars Episode I: The Phantom Menace (1999): $1,027,044,677
- Star Wars Episode II: Attack of the Clones (2002)$649,398,328
- Star Wars Episode III: Revenge of the Sith (2005): $848,754,768
- Indiana Jones and the Kingdom of the Crystal Skull (2008): $786,636,033
Episode VII will be expected to hit the $1.5 billion mark that The Avengers reached, and go further. Some watchers may look for the $2 billion barrier to be broken; Disney will certainly be planning on being conservative with their own projections and expectations.
The deal was in place, and optimism for the positive effect it would have on Disney, as a whole was high. But how would it affect the current licensing activities of Lucasfilm. Next week we look at Lucas Licencing, Star Wars Comics, Novels, and Toys.
Sources:
lucasfilm.com
thewaltdisneycompany.com
businessweek.com
thehollywoodreporter.com
forbes.com
For more Jedi News Debates entries, click here.
