The biggest and best media companies are not wringing their hands over the lingering economic slump or simply slashing costs. They are reinvesting in their core businesses to reposition themselves for better times.
The Walt Disney Co. is a good case in point.
Its recently announced $5.3 billion cash and debt acquisition of Fox Family Worldwide is an obvious example. But other deals are in the works.
Disney’s recently expanded $7.5 billion shelf registration for a variety of securities offers financing options for the Fox Family acquisition, to reduce existing debt, or to underwrite additional acquisitions and equity stakes.
“Our filing of a $1 billion shelf is normal business and is not indicative one way or the other of anything except that we expect to close Fox Family,” Disney Chief Financial Officer Tom Staggs recently told me.
But Mr. Staggs concedes, “A big mistake companies want to avoid making in the tough economic times is to just get into a foxhole and not find opportunities to invest for growth in their core businesses. You can’t just manage your way through a downturn.”
So not surprisingly, high-level industry sources say Disney is prepared to invest in other healthy cash flow businesses in the next 12 months with strategic links to its core operations-such as other cable networks, TV and radio stations and other production-related concerns. During a time of declining cash flow and price multiples, continuing consolidation and even generational changes in family ownership of public companies, the normally conservative Disney could surprise Wall Street with another big deal.
Generating cash flow
An increasingly important measuring stick for Disney as well as for other media and entertainment players is return on capital, or the cash flow generated from a business relative to the capital investment made.
Some analysts say that to survive the cyclical economic downturns that inevitably hurt many of its core businesses, Disney must shift more of its spending to operations that even in the worst of times are big cash flow generators but require minimal capital investment. Cable and broadcast properties generally fit the bill.
Disney’s consolidated cable networks represent about 28 percent of the company’s overall asset value, compared with 11 percent for the ABC Television Network and TV stations, 12 percent for the film and television production operations, 4 percent for radio, 21 percent for theme parks and 7.5 percent for consumer products. Morgan Stanley Dean Witter estimates Disney’s overall asset value at roughly $85 billion.
Last year’s banner ad spending led to record earnings for Disney’s media networks group-more than $600 million for the TV stations alone. But that won’t be repeated any time soon.
Still, Disney could significantly boost its media networks cash flow simply by acquiring more TV or radio stations or cable program networks at the right price. For instance, Disney has been maneuvering to acquire Allbritton Communications (or at the very least, its Washington station); the California stations owned by Young Broadcasting; or such lucrative, closely held affiliated groups as Scripps Howard Broadcasting Co. or Hearst-Argyle Television. But it wants to hold price tags at around 15 times cash-flow multiples. By adding TV or radio stations to its mix, Disney can better amortize existing costs and realize additional cost synergies while increasing its negotiating leverage and scale.
With its cable networks growing at a faster pace than broadcasting, even in a down year, it is not all that surprising that Disney paid what appears to be an exorbitant 35 times estimated cash flow, or about $65 per subscriber, for Fox Family Channel, which is expected to post $150 million in earnings this fiscal year. Although the full economics of the deal won’t be evident for at least another 12 months, Disney paid well ahead of the 17 times cash flow Viacom paid for BET and the 28 times cash flow MGM paid for a 20 percent stake in Rainbow Media Holdings.
Disney’s existing cable networks (including ESPN and The Disney Channel) generate 22 percent of the company’s annual cash flow, or more than $1 billion. Even in a beleaguered advertising year, analysts estimate the ABC-owned TV stations will generate nearly 10 percent of Disney’s overall cash flow, or about $483 million on nearly $1 billion in revenues.
But Disney will invest only about $200 million in its media networks this year-about the same as in fiscal 2000. That compares with last year’s other business investments of $67 million for consumer products, $50 million for film production facilities, $117 million for corporate facilities and $58 million in its Internet operations, which are being substantially reduced.
Expensive amusements
Although theme parks contribute an estimated 43 percent of Disney’s overall $5.3 billion in annual cash flow, they require at least $1 billion in annual reinvestment, which is why broadcast- and cable-related acquisitions look so good. Put another way, although the theme parks generate twice as much cash flow as Disney’s media networks, they require five times more capital.
Disney’s capital investment in theme parks already is substantialy down from last year’s $1.5 billion, due to the opening of its California Adventure and Tokyo DisneySea theme parks. A second gate will open in Paris and a new park will open in Hong Kong in 2006. There is growing speculation Disney will build a park in China to coincide with the 2008 Olympics there.
Key in these expensive endeavors is that Disney has shifted much of the cost and risk to local partners while assessing a hefty management fee to oversee the ongoing theme park and resort operations as only it can.
It is an example of how media conglomerates are modifying their business practices as well as their growth and investment strategy for the times.
While Disney will save more than $350 million eliminating 4,000 jobs this year and an additional $100 million over three years by streamlining its infrastructure, such moves are hardly the key to its economic survival plan.
In its most recent quarterly earnings call, Disney management told analysts it will counter the tough economic times with a five-pronged strategy. It wants to own more content, own more cable channels, invest in new distribution technologies, make the most of theme park management fees and continue building direct-to-retail relationships for its consumer products to rely less on its own costly stores.
Disney’s flagging film and television production operations represent one of the most interesting opportunities for growth.
While producing for traditional theatrical release and prime-time broadcast continues to be an expensive crapshoot, a digital world represents more opportunity for endlessly burning off the initial production costs and generating more licensing or advertising revenues from the same product.
Wall Street analysts say it is too early to know what the economics of repurposing programs on a grand scale will be, but it eventually should yield far more lucrative returns than content giants now enjoy, except for the occasional stellar hit.
Opportunities wanted
Though Disney is looking for more distribution opportunities for its content, that doesn’t mean Disney is about to step forward and buy AT&T Broadband for $40 billion-plus. On the contrary, the more modest returns, assumed debt and general lack of operational experience for such an acquisition suggest it doesn’t at all fit with Disney’s investment strategy.
But there has been speculation Disney may invest $2 billion to $5 billion in exchange for a 20 percent stake in AT&T Broadband along with controlling interest, carriage agreements for its existing cable services and guaranteed digital space for new services.
Disney has generally shied away from partnerships it didn’t inherit through acquisitions, such as A&E, Lifetime and ESPN, which came with Capital Cities/ABC. But it has a standing offer to buy the stakes it doesn’t own in those popular cable services from its partners.
Clear
ly, Disney is not going to hand over what it calls its most prized asset-its branded content-except under the most rigid conditions, which pretty much makes it a buyer.
And what could it buy?
If Disney wants to remain in the radio business, it must acquire or align with other major station groups to bolster its Radio Disney and ESPN Radio reach in major markets. Clear Channel has been most frequently mentioned as a potential good fit. “Don’t expect Disney to exit radio. It’s a local business that matters,” said a well-placed source. “Disney could be a new radio consolidator.”
With the cable network upfront and summer theme park attendance each down as much as 15 percent to 20 percent this year, Disney needs backups.
The same 12 months that many on Wall Street say is the wait time for the first signs of an advertising recovery also is Disney’s window of opportunity. It must strike before business, confidence and prices improve.
In a year in which entertainment stocks have declined more than 34 percent, the kicker is what has happened to Disney for the better part of two years. No matter what it does right, its stock keeps taking a mighty hit. On Aug. 30, Disney’s beleaguered stock hit a 52-week low of $24.65 a share. There is widespread investor concern that the sluggish advertising and economy will cause Disney to fall short of management’s single-digit-percent cash-flow growth guidance for the fiscal year ending Sept. 30.
Standard & Poor’s, like many industry analysts, is giving Disney the benefit of a doubt, calling for “neutral net cash flow after capital spending, dividends and share repurchases so long as Disney uses its free cash flow to reduce its existing $3.2 billion in debt and the debt associated with the Fox Family acquisition.
We’ll just have to wait and see if the Mouse really does roar.