Disney Has Plenty to Worry About

Dec 8, 2003  •  Post A Comment

Comcast Corp. and Cox Communications have given Michael Eisner a competitive challenge to worry about that could do serious damage to The Walt Disney Co. and its balance sheet long before dissident shareholders Roy Disney and Stanley Gold launch their campaign to unseat the embattled chairman.
The cable operators made separate, potent strikes at the ESPN steamroller that is one of Disney’s single biggest profit contributors with nearly $1 billion in annual operating income, supported by an industry-high affiliate license fee that distributors are now rejecting.
These strikes came during a week when Mr. Disney, vice chairman and nephew to founder Walt Disney, and Mr. Gold, Mr. Disney’s financial adviser, resigned from the company’s board of directors, issuing a hailstorm of criticism and a vow to wage a vocal and visible campaign against Mr. Eisner. Mr. Gold and Mr. Disney, who brought Mr. Eisner to the company in a similar 1984 management upheaval, could wage an expensive proxy fight and could recommend independent board candidates, all of which will take a year. But their constant pummeling will surely result in more demoralization, or worse, at Disney.
A more immediate threat is Cox’s new six-year expanded basic cable pact with rival Fox Regional Sports Networks for an average 9 percent to 10 percent annual rate increase, with guaranteed carriage of Fox’s Fuel digital sports and National Geographic networks, and retransmission of Fox-owned TV stations thrown in for good measure. The deal makes Fox and its corporate parent, News Corp., look smart and agreeable just weeks before they assume a controlling 34 percent stake in dominant satellite provider DirecTV, affording unprecedented negotiating leverage as a broad-based distributor and content provider.
Just as important, it allows Cox to put the squeeze on ESPN, with which it is locked in a testy and public license fee renewal battle that by March will result in ESPN either being yanked from Cox’s cable systems, being bumped to a more narrowly distributed paid tier or swallowing a single-digit rate increase instead of the annual 20 percent hike it’s demanding.
Comcast, Cablevision Systems and DirecTV will take their cue from whatever Cox secures as they maneuver through their own negotiations with the leading sports programmer.
But Comcast, which is insisting on fee increases based on the rate of inflation, is in the process of developing another intriguing and potentially lethal strategy that could destabilize ESPN’s industry stranglehold in other ways.
Wall Street and industry experts note Comcast has the financial, management, strategic and distribution clout to launch a formidable TV sports programming competitor to ESPN by securing licensed rights, content alliances and other agreements its own cost-effective, constructive way.
While Comcast this week announced plans for a 30 percent stake in the newly launched branded SportsNet Chicago with four professional Windy City sports franchises, company officials say they are not likely to repeat the same arrangement elsewhere, or to buy into costly sports teams.
But Comcast is close to acquiring Cablevision’s 50 percent stake in Rainbow Holdings, which includes the six Fox Regional Sports Networks, and is likely to swap out some of its $3.2 billion in Cablevision stock for that stake, which analysts value at about $550 million.
Comcast also has been talking to professional sports team owners and leagues, including the National Football League’s Steve Bornstein, a former Disney/ABC cable executive who welcomes the opportunity to back a new ESPN rival. Comcast and others declined to comment on their talks or intentions.
These are hardly idle threats, considering ESPN generates 30 percent of Disney’s overall operating income. (The lion’s share of that 30 percent comes from ESPN’s $2.8 billion in annual affiliate fee revenues.) Cox contributes $400 million in annual affiliate fees and advertising revenues to ESPN.
As Disney President and Chief Operating Officer Bob Iger pointed out to analysts, Disney’s record $3 billion box office sales have helped reverse the company’s fortunes, but the more stable performance of its cable networks will help to sustain the gains. That ESPN will emerge from its current affiliate license fee battles with reduced revenue and earnings makes that proposition more dicey.
The fiscal fourth quarter’s improved financial picture is no guarantee for fiscal 2004 and beyond, bolstered by one-time or short-term cost-cutting, growth spurts and amortization changes.
“Almost two-thirds of Disney’s fiscal 2004 earnings growth will come from the noncash, nonrecurring amortization benefit at ESPN and the tremendous success of recent Disney filmed entertainment product, which will be exceedingly hard to replicate in fiscal year 2005, even before the potentially more onerous Pixar economics come into play,” said Fulcrum Global Partners analyst Richard Greenfield.
Analysts generally are expecting about 21 percent growth in Disney’s operating income to $3.8 billion on 6 percent growth in revenues to $28.7 billion in fiscal year 2004 just begun, but they are stopping short of calling it a return to Disney’s glory days of reliable 20 percent-plus annual earnings growth.
In fact, too many of Disney’s core businesses are either cyclical, unpredictable or tied to sporadic economic upticks. Steady gains in the general economy, ABC’s prime-time ratings and film sales at the box office and in DVDs are among the sometimes elusive growth catalysts on which Disney is betting.
The latest boardroom fracas exploded against a backdrop of this improving financial performance and the troubling accusations that Mr. Eisner has turned the company into a “rapacious, soulless” entity that is always looking for “the quick buck” and losing public trust. Mr. Gold wrote about the creation of “an insular board of directors, serving as a bulwark to shield management from criticism and accountability.”
Those claims in open resignation letters from Mr. Disney and Mr. Gold had Mr. Eisner and other top Disney executives on the telephone last week with investors and others doing damage control. A two-day Disney board meeting in New York was consumed with public relations strategies for “protecting” the company.
Protecting the company from what? Claims about poor management and misguided corporate governance, even from the largest shareholder with an ax to grind, are serious matters that demand thoughtful and serious responses-not manipulative public relations or a smear campaign.
Clearly Mr. Eisner, top management, the Disney board and the company as a whole are spending considerable time, money and resources trying to deflect or defend against unsettling charges that have become so familiar in recent years they are ingrained in Disney’s otherwise proud heritage.
All of that needs to be redirected to openly address and fix what’s broken, invest in what’s working and permit the unfettered winds of creativity to blow through an organization that is quite obviously in pain.
Time is of the essence. Early next year many of these same sensitive issues will be raised in a shareholder lawsuit over the $38 million in compensation paid to Michael Ovitz for his 15-month stint as president. It’s a stark reminder of how long Disney’s strained existence has gone unchecked.