Entertainment Merger Mania : WALL STREET : So Far, Disney Stock Eludes Historical Hiccup

The history of large media mergers goes like this: Within days or weeks of a deal announcement, the acquiring firm’s stock dives, providing a much better opportunity for long-term investors to buy in.

So far, however, Walt Disney Co. stock is showing no respect for history.

Disney shares zoomed $2.875 to a record $61.50 on Tuesday after rising $1.25 on Monday, when the company stunned the world with its $19-billion deal to buy Capital Cities/ABC.

Even in celebrated corporate marriages like this, there often are technical reasons why the acquirer’s stock stagnates or falls after the purchase is announced.

For one, when a stock swap is involved (as in the Disney offer), Wall Street arbitragers--whose business is trading in takeover stocks--will usually sell “short” the acquirer’s stock and buy the target company’s shares. That is simply a play on the narrow price spread between the two stocks until the deal is finally closed.

Selling short involves borrowing shares and dumping them on the market, which adds to the normal selling that fundamental investors might be doing.

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And those fundamental investors often have good reason to shave off some of their holdings in the acquirer.

With any takeover, after all, there are always concerns about the fairness of the purchase price, the level of debt incurred (in Disney’s case, about $10 billion) and the potential for unforeseen problems down the road, between the companies or with regulators.

Consider Viacom Inc.’s case. Its stock, about $60 when the company’s takeover of Paramount Communications was announced in September, 1993, quickly began to slide as investors focused on the huge debt involved.

And when QVC Network launched a bidding war for Paramount later that fall, the pressure on Viacom shares became immense. By the spring of 1994, Viacom, finally victorious, saw its shares collapse to $25.

In retrospect, that was precisely when investors should have been buying. The stock is at $50.50 today.

Likewise, Seagram Co.’s stock was punished in April after the firm’s bid for MCA Inc. became public. The stock dived more than 15% in a matter of weeks, bottoming at $25.50 in late April from $31.75 at March 31.

That, too, proved to be an opportunity: Feeling better about the deal, Wall Street has pulled Seagram stock up to $36.125 now.

Is Disney stock also due for a hiccup soon, as the initial euphoria over the deal wears off?

Many Wall Street analysts are reluctant to advise their clients to hold out for a decline. Even allowing for the usual tendency of analysts to be eternally bullish, it’s clear that many of them are genuinely convinced that the Disney/Cap Cities combination is so good it immediately warrants a higher stock price.

“Definitely, the consensus is that this is a very compelling deal”, says Jill Krutick, analyst at Smith Barney in New York.

Near-term, her target price for Disney is the “high-$60s”. But she concedes she could raise her target if the stock quickly gets there. “We’ll have to take a look at it as we go forward”, she says.

What is keeping many analysts and shareholders entranced is much more than the generic excitement over the joining of two powerful media franchises. Rather, in the dry act of putting pencil to paper on this deal, current and potential Disney investors are raising their estimates of what the combined business should be worth, based on the cash it could generate over the next five years or so.

Richard Simon, analyst at Goldman, Sachs & Co., says he starts with the assumption that the operating earnings of the new company can grow 14% to 15% yearly, just adding what the two firms would have done separately.

That growth in operating earnings could produce a 23% to 24% annual increase in net income per share, Simon says, because of the leverage Disney should get from its use of relatively low-cost debt to substantially increase the combined firm’s cash flow.

And on top of that, Simon says, is the much-touted benefit of synergies. “We really don’t know yet how to quantify that”, he says, but assuming there is any synergy at all, “That should be added to” the earnings equation, Simon says.

Using that formula, he is telling clients that the combined company should earn $2.60 to $2.65 a share in 1996, then about 20% more in ‘97, or $3.20 a share. At $61.50, or about 19 times that 1997 earnings estimate, Simon says Disney stock is still a buy--though he doesn’t have a price target.

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For some Disney owners, the greater allure of the stock is based on the idea that Disney simply has more legs to stand on: What had been a filmed-entertainment and theme-park firm now is a much bigger enterprise in TV programming, entertainment distribution and publishing.

Disney has bought “a reduction in their exposure to hit-driven entertainment,” meaning the volatile movie business, says James Craig, manager of the Denver-based Janus stock mutual fund. And while that greater diversification is in itself attractive, an expected comeback for the company’s live-action film unit and a continued recovery in the theme-park division enhance the story, Craig says.

Hence, despite the price run-up he isn’t inclined to sell his Disney stock--at least not yet.

Paul Wayne, money manager at Los Angeles-based Kayne Anderson, figures that based on expected cash flow, the lowest fair value he can affix to the new Disney is $50 a share, and the highest is $90. So at $61.50, he says, even if there’s a hiccup in the stock, the downside is limited, and it pales next to the upside.

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What (Usually) Happens to Acquirors

Shares of Viacom Inc. and Seagram Co. both fell sharply after their respective takeover offers for Paramount Communications and MCA Inc. were announced. In contrast, Walt Disney stock is surging in the wake of its deal to buy Capital Cities/ABC.

Viacom

Tuesday: 50.50

Seagram

Tuesday: 36.13

Source: Bloomberg Business News