How Disney Could Ditch the Doldrums

Seems like the stock has been stuck in neutral forever, but lots of moves -- or a possible takeover -- could start adding value

By Ronald Grover

For the last few years, Wall Street has had a mystery on its hands more perplexing than anything Hollywood could turn out: When would Walt Disney (DIS ) turn around? Throughout the late '80s and early '90s, its stock was among the headiest performers, rising to Goofy heights thanks to a daring management team led by Chairman Michael Eisner.

Today, despite persistent rumors that it's a takeover target, Disney shares, adjusted for splits, are stubbornly stuck at about where they were in 1996, when Eisner & Co. closed on the $19 billion acquisition of CapCities/ABC. Since then, Disney has been on a roller coaster with more twists and turns than its Space Mountain ride. Ratings at ABC have sunk. Disney's Internet bid flopped. And so did lots of its movies, including some from its legendary animation franchise, which turned out a string of ho-hum films like Atlantis and The Emperor's New Groove.

Then came September 11, which whacked Disney more severely than other media companies. Folks stayed off airplanes -- and away from Disney's theme parks -- while ABC's advertising all but dried up. "September 11 showed the soft underbelly of this company," says Peter Kriesky, who heads Boston-based Kriesky Media Consultancy. "A lot of what this company has wasn't working or was very susceptible to changes in consumer tastes."


  Even so, rumblings on the Street say Disney may be through the worst. Analysts, including Merrill Lynch's Jessica Reif Cohen, are upgrading their ratings. On Feb. 1, she moved from a neutral position to a buy. The feeling is that Disney's stable of assets -- including not only Mickey, Minnie, and pals, but ESPN, ABC, movie and TV production, and its theme parks -- is poised to rebound once the economy turns around and folks start traveling again.

Southeastern Asset Management, the Memphis-based parent of the Longleaf Partners Funds, purchased 9.7 million shares after September 11. The fund, which has made a name for itself by investing in beat-up stocks like Waste Management and Aetna, says it was drawn to Disney by its "dominant and irreplaceable brands." In Longleaf's annual report, it says the stock after September 11 fell below the fund's assessment of the Disney's intrinsic value.

Disney is hustling for some short-term fixes. It's paying former Fox football announcer John Madden $20 million over four years in the hope of reversing the ratings decline that has plagued ABC's Monday Night Football. And it has been chasing late-night host David Letterman, whose contract with CBS expires this summer. Getting Letterman won't be cheap -- he turned down a $31.5 million-a-year deal to re-sign with CBS -- but his show produces $25 million a year in profits, about twice what Disney gets from Ted Koppel and Nightline in the same time period (see BW Online, 3/8/02, "ABC Needs More Than Letterman").


  Disney gets high marks is for its effective cost-cutting in recent months. Undertaking its second companywide restructuring in the last three years, Eisner & Co. has cut more than 4,000 jobs and reduced spending at parks and hotels by consolidating purchasing. It dropped an additional $600 million a year by slashing the value of deals it makes with movie producers and trimming film budgets. Disney even saves $1 million a year by having the folks who wear costumes at its theme parks take them home to wash them, says CFO Thomas Staggs.

The cost savings were so significant that the company beat Wall Street estimates for the first quarter, reporting a 7% decline in revenues, to $7.1 billion, and a 42% drop in operating income, to $754 million. Given the harsh post-September 11 ad environment, analysts had been projecting that operating income would drop to as low as $520 million.

More important, say Disney execs, the company isn't spending hefty amounts to build new properties, as it did in recent years for Disney's California Adventure, two cruise ships, and new hotels in Anaheim and Orlando. That will help increase cash flow to $3 billion annually, a 20% hike from 2001, says Eisner. "Billions of dollars in cash flow will bring down the debt if we want to or buy back our own stock," he says. That extra cash flow could allow Eisner to make acquisitions for some of Disney's other businesses, such as more TV stations for ABC or cable channels to show Disney-made shows, he adds.


  Eisner already has made one such acquisition, paying $5.2 billion last year for Fox Family Channel, which was rebranded ABC Family Channel. The deal allows Disney to squeeze more revenues out of some of the programming it airs on ABC. As much as 25% of the programs first shown on ABC are to be aired on the new channel, the company says. On Jan. 1, for instance, ABC Family Channel aired 24 hours of the action drama Alias. And it will offset the $80 million it paid Warner Bros. to air the first Harry Potter movie on ABC by showing it on the cable channel as well.

Disney's $6.1 billion-a-year studio operation is yet another area that's midway through a major overhaul. Eisner has personally taken charge of the studio, although he recently named longtime Disney exec Richard Cook as studio chairman. The game plan is to make movies more cheaply and to spend less on marketing them. Under Eisner's direction, the studio is gearing up to turn out more family-oriented fare like the Cuba Gooding Jr. film Snow Dogs, which cost $30 million to make and has grossed more than $80 million at the box office.

The animated unit is also releasing more lower-budget movies, in some cases using classics as the basis for the films. In February, it released Return to Neverland, the Peter Pan sequel that was made for $20 million by Disney TV animators in Australia. It has grossed more than $30 million so far. That doesn't mean Disney has given up on making original, high-flying animated hits. It has high hopes for Lilo and Stitch, about a girl in Hawaii who unknowingly befriends an alien, being released this summer.


  Disney execs are also taking steps to address some longer-term problems. If those fixes pan out, the stock price will surely benefit. Of late, the company has been spending much of its time on ABC, which last year generated $5.7 billion in revenues -- nearly a quarter of the company's $25.6 billion in overall sales. Ratings at the network are off by 21%, and on one recent night it finished fifth, behind CBS, NBC, Fox, and the WB. What ABC really needs is some old-fashioned hits. While Eisner and Disney President Robert A. Iger, both one-time ABC programming executives, are focusing on that goal, it will take time to find the kinds of shows that mine gold.

Another area that needs a turnaround is Disney's $2.6 billion-a-year consumer-products unit, which has seen operating income drop for four straight years. The problems have been many, from Mickey apparel that wasn't selling to a badly designed 600-outlet Disney Store chain that was losing market share to lower-price mass retailers. Disney brought in new managers for the unit, is closing about one-third of its U.S. stores, and is signing up major merchants like Kmart and J.C. Penney to peddle its products. And it has been licensing Mickey and other characters for display on wireless devices in the U.S. and abroad.

In other areas, Disney has to take a wait-and-see approach. Overall attendance at the theme parks is off 10% to 15% from a year ago, according to Paul Pressler, chairman of Walt Disney Parks & Resorts. That's an improvement from the 20% decline in the months immediately following September 11. The company figures attendance will rise as the economy improves and fears of terrorism continue to wane.


  Still, even with the Street starting to warm to Disney as a value buy, enough concerns remain that no one is predicting an '80s-style resurgence for the stock. It has been wracked by management turmoil that in the last five years has seen the company lose a president, two studio chiefs, a couple of chief financial officers, and two top people at ABC. And it's too early to tell whether its strategies for the network and consumer-product units will fix those problems.

As a result, even the most optimistic analysts project nowhere near Zippedy-Do-Da growth for Disney's shares. ABN Amro analyst Spencer Wong, who recently upgraded the stock, has a 12-month target of around $30 a share, a 25% hike from its current depressed price. Even such Disney bulls as Salomon Smith Barney's Jill Krutick recently wrote: "2002 will be largely discounted as an outlier and a period for rebuilding for Disney." She figures it may take until 2003 for Disney to be "normalized" and return to growth. Still, she says the shares look inexpensive right now.

The biggest boost to the stock price in the near term could be if, as is persistently rumored, a company emerges with a hefty bid for Disney. With a market capitalization of $50 billion, there aren't many likely buyers. But only one is needed to solve the persistent mystery of why Disney's stock won't move. In the interim, the company is making lots of good moves, even if it's still a while before those efforts pay off.

Grover is BusinessWeek's Los Angeles bureau chief

Edited by Patricia O'Connell

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