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January 30, 2006

Thoughts on the Disney-Pixar Merger

It is hard to add value on the Disney-Pixar transaction. I received a dozen virtually identical analyst reports and CNBC was basically DisneyPixarVision for two days. I do want to highlight notes by Rich Bilotti of Morgan Stanley and Dave Miller of Sanders Morris Harris. It is not really anybody's fault that the notes were similar as the story has just been awfully well covered.

You can find a slide presentation on the DIS and PIXR websites along with the press release and a replay of the conference call. There was one slide that did jump out at me and I think it explains why the merger is receiving universal praise. Here is the key excerpt: (See Continued Reading...)

Value Opportunities
• Consolidate 100% of profit and current and future films
• Positively impact Disney feature animation
• Maximize sequel potential
• Recapture distribution fees and eliminated duplicative company costs
• Leverage Pixar's intellectual property across Disney's core businesses (e.g. theme parks, licensing, videogame publishing, etc.)
• Increase Disney's overall brand strength and base of powerful, high quality content which can:
o Enhance opportunities offered by new digital distribution platforms
o Increase Disney's ability to capitalize on new consumer preferences and emerging business models
o Improve and accelerate international growth opportunities

I know that most mergers in any industry don’t work out. I also know that media mergers have about the worst record. Heck, Viacom just broke apart, Clear Channel did the same, and Time Warner is under pressure to restructure after a disastrous merger. However, after reading that list, you have to admit that the purchase of Pixar seems pretty damn straightforward. This is a simple transaction between two companies that have been working incredibly closely togther for a decade.

That is not to say it is without risks. Culture shock and dilution from a hefty price tag are obvious risks. The risk of Pixar missing on a film was there before for Disney and is offset by the risk of Disney losing Pixar completely to another studio's distribution agreement.

There were a couple of other highlights from the conference call and slides. First, Disney said it would buy back all 287 million shares it would issue to Pixar by the end of 2007. This would be partly paid for with $1 billion of Pixar's cash. Second, Disney reaffirmed its guidance for low double digit EPS growth through 2008 despite dilution from Pixar.

On the first point, as Rich Bilotti effectively noted, DIS could have bought 287 million shares without this deal. It was planning on buying over 100 million anyhow and it had plenty of borrowing capacity to up that the rest of the way. Had DIS followed this strategy, the share buyback would have added 10 cents to EPS.

I think this shows that Bob Iger and Steve Jobs, as the largest shareholder, were making a strategic decision with this deal. Pixar is all about sustaining or accelerating Disney's growth rate and better positioning the company for the digital media transition. Choosing operating strategy over financial strategy is a smart move given the ease with which Pixar slides into Disney. I think Disney should be commended for the choice and the market agrees given that it has greeted the deal favorably.

I remain long DIS in all Northlake client accounts on the basis of strong fundamentals in most of the company's businesses including cable networks, ABC, theme parks, and consumer products. The movie studio has been the one laggard and Pixar increases my confidence that it can be turned around. Add in tangential benefits from the Pixar deal like more licensing and better theme park attractions and you could argue that positive trends in the non-studio businesses were reinforced.

I think Disney is a buy with a target in the low $30s with the caveat that the December quarter represents a down year over year comparison and financials for FY06 are backend loaded, even more so now that Cars is 100% controlled and will hit late in the company's third quarter with video sales not until the first fiscal quarter of 2007 (late Fall of 2007). I own Disney in every client account and my personal accounts.

Posted by Steve Birenberg at January 30, 2006 02:03 PM in DIS