Pixar deal shows pitfalls of Disney's Lucasfilm and Marvel acquisitions

Tuesday, August 6, 2013

Jeffrey Goldfarb, Grace Dai

Walt Disney Co. boss Bob Iger has another Pixar hit on his hands. Monsters University should provide an eighth consecutive animated lift to Disney's bottom line when it reports quarterly results today. But a Breakingviews analysis suggests the studio's value to the Magic Kingdom falls short of the $7.4-billion (U.S.) purchase price. High-priced deals for Marvel and Lucasfilm may also disappoint investors in the long term.

Sorting out Disney's relationship with Pixar was one of the first things on Mr. Iger's agenda when he took over in 2005, and remains a hallmark of his tenure. Their lucrative co-production and distribution deal was on the rocks after Pixar chief executive Steve Jobs clashed with Iger's predecessor Michael Eisner.

The successful Weinstein brothers also were expected to decamp. Disney's own storied cartoon shop was struggling. The whole movie division was in trouble. Allowing Pixar to fall into a rival's hands only would have further weakened the company.

Buying Pixar was practically a necessity. Mr. Jobs became Disney's biggest shareholder and a director. Pixar's creative force, John Lasseter, also infused Disney with a fresh spark. To acquire all that from a position of weakness, Disney paid over the odds at an estimated 45 times earnings when the deal was announced.

Disney says Pixar's value "far exceeds" the acquisition price calculated using "net present value" across its businesses. Absent more specifics, the statement requires a certain amount of wishing upon a star.

According to Box Office Mojo, Toy Story 3, Brave and the other films have generated some $4.5-billion in ticket receipts worldwide. Margins generally clock in at about 10 per cent. Generously assume Disney makes 15 per cent, and that's $675-million of pre-tax profit over the seven years to 2012, excluding the still-developing Monsters University.

Consumer products are the second-biggest source of revenue. Pixar films account for 12 per cent of Disney's lifetime box-office revenue. Suppose they represent the same percentage of merchandise sales. At a 25 per cent margin, that would mean some $580-million of profit before tax.

Using estimates by research firm The Numbers and an industry standard 50 per cent profit margin, DVD sales have reaped around $575-million. Finally, if income from broadcast and pay television, along with streaming video, amounts to 20 per cent of total box office - a figure based loosely on estimates by analysts for other film franchises and studios - that would translate into $900-million.

Tot it all up and the average annual profit from Pixar, excluding Monsters University, has been about $390-million. If accurate, that's an impressive 60 per cent more than the pre-tax income Pixar generated in the year before selling itself. Subtract the 33 per cent that goes to Uncle Sam, however, and put the after-tax figure on the 20 multiple of earnings at which Disney trades, and Pixar would still only be worth around $5.2-billion.

That doesn't account for any extra allure Pixar characters and rides may bring to Disney's theme parks. It's hard to gauge the impact, especially considering the related costs that are attached to revamping these properties.

After taking all that into consideration, though, shareholders seem to be under a spell, believing Disney - and Mr. Iger - can work magic through acquisitions. Another $8-billion has been splashed out on Marvel and its superheroes - again at some 40 times earnings - and Lucasfilm's Star Wars franchise. Disney nevertheless still regularly trades at a stock market valuation higher than those of its competitors.

Suspension of disbelief is part of what Disney sells, but investors shouldn't so easily fall for it.