Company Town: Disney’s Mega-Merger : The ABCs of a Deal : THE DEAL : Analysts Call the Price Fair, the Potential Tremendous
Wall Street had almost universal praise Monday for Walt Disney Co.’s purchase of Capital Cities/ABC, as analysts and institutional shareholders of both companies called the price fair and the potential synergies tremendous.
But some investment pros noted that Disney, for now, can provide only generalities--not specifics--as to how the combined mammoth company will achieve the same 20% annual earnings growth that Disney alone has been famous for.
Meanwhile, the deal sparked a flurry of buying activity in other entertainment stocks, as investors bet on much more consolidation to come in the industry.
Shares of CBS Inc.--awaiting a long-rumored takeover offer from Westinghouse Electric--rose $1.875 to $77.75 as traders bet that the purchase price may now have to exceed even the $81-a-share that CBS was said to be demanding.
“CBS just went up in value,” said Gordon Crawford, analyst at investment giant Capital Group in Los Angeles. “This is a game of musical chairs, and another one of the chairs just disappeared,” he said, referring to Cap Cities.
But while Westinghouse stock fell 25 cents to $13.625 on Monday--a sign that more investors may be worrying that the company will ultimately overpay for CBS--Wall Street appeared largely convinced that Disney’s $19-billion price for Cap Cities is rational.
The best indication of that sentiment was the action in Disney’s own stock: It closed up $1.25 at $58.625 after trading at a record $61.375 early in the day.
“The market thinks they’re paying a good price and I agree with that,” said Crawford, whose company is a major shareholder in both Disney and Cap Cities.
Disney’s offer of $65 in cash and one share of Disney stock for each Cap Cities share amounts to a total value of about $124 a share for the network company, and its stock soared accordingly, closing at $116.25, up $20.125, or 21%.
Typically, Wall Street values takeover targets slightly below the expected deal price, allowing for the amount of time it will take to close the deal and for possible fluctuations in the acquirer’s stock price.
At $124 a share, Disney is paying 24 times Cap Cities’ estimated 1995 earnings per share of about $5.10. In contrast, if CBS is purchased for $81 a share, that would be about 23 times its estimated 1995 earnings.
But analysts also note that CBS may be less expensive than it appears, because its earnings have been depressed in part by its last-place showing among the networks.
With the ABC network in first place, meanwhile, some analysts say an argument can be made that Disney’s purchase price for Cap Cities is more expensive than it appears, given the cyclical nature of the broadcasting business.
“Cap Cities is probably near a cyclical peak in advertising” revenues, said Jeffrey Logsdon, analyst at Seidler Cos.
But in judging the logic of takeover prices, Wall Street is more attuned to expected cash flow--that is, the earnings generated by a business before deducting non-cash charges such as depreciation.
Logsdon figures the combined Disney/Cap Cities is now valued at 10 to 11 times its estimated 1996 earnings before interest expense, taxes, depreciation and amortization, one of the broadest measures of cash flow. That is still a quite reasonable valuation, he said.
Capital Group’s Crawford agrees. At $58.625, Disney’s stock price “is quite inexpensive [relative to earnings] for such a world-class portfolio” of assets, including Cap Cities, he said.
In any case, few analysts or institutional shareholders were inclined to argue against a deal that was publicly blessed by investment legends Warren Buffett and Sid Bass on Monday. While synergy is an overused word on Wall Street, many large investors say this merger offers more potential for true synergy than most.
“There are a lot of things Disney can do for [Cap Cities] and vice versa,” said Robert Kommerstad, a principal at Pasadena-based Provident Investment Counsel, a major Cap Cities shareholder. “Who can design programming for prime-time [TV] better than Disney?”
Analysts also noted that Disney appeared to go to great lengths to ensure that the deal’s structure would please its shareholders.
The company said it is borrowing half the purchase price, or about $10 billion, because the decline in bond yields this year makes it attractive for a low-debt firm like Disney to use leverage.
The debt will also allow the company to avoid overly “diluting” current shareholders’ earnings per share, because the number of new shares Disney will issue will be capped at 154 million. Disney now has 520 million shares outstanding.
Still, Disney’s net earnings per share will probably decline next year because of accounting charges related to the takeover. Over the next 40 years, Disney must write off the $16-billion difference between the takeover price and the value of Cap Cities’ physical assets.
Analysts estimate that means a 50- to 60-cents-a-share hit to earnings per year. So the combined company’s net earnings could be about $2.50 a share in fiscal 1996, compared to this year’s expected $2.60 for Disney alone.
But Disney officials indicated Monday that excluding the accounting charge, or “goodwill” write-off, Cap Cities should actually add slightly to earnings as early as 1996--despite the added interest expense.
Beyond the hype and excitement of the next few days, however, analysts say Disney’s longer-term challenge will be to convince shareholders that the combined entity, with $20 billion in annual revenue, is capable of at least 20% annual earnings growth--the target Disney earlier this adamantly insisted it would continue to achieve in the 1990s.
Cap Cities’ earnings growth has averaged 14% a year over the past decade, much slower than Disney’s. And bigger companies in general can find it tougher to grow rapidly.
But for now, many shareholders are giving the world’s largest media and entertainment firm (post-merger) the benefit of the doubt. “We have to assume they’re not going to take on an acquisition that would slow their growth rate,” said Ned Brines, analyst at Pasadena-based Engemann & Associates, one of Disney’s largest institutional shareholders.
