Has Eisner’s Kingdom Lost Its Magic Formula?

Walt Disney Co. Chairman Michael Eisner will be on the hot seat next week when he testifies in the increasingly contentious lawsuit brought by former studio chief Jeffrey Katzenberg.

As far as investors and Wall Street go, he’s already there.

This week’s release of Disney’s quarterly profit continues what has become an uncharacteristic, nearly yearlong string of disappointing earnings announcements from the once very Magic Kingdom.

In short, Eisner hasn’t been delivering the kind of results shareholders have come to expect. He even conceded as much this week in Disney’s earnings release when he said that “we are not satisfied with our current performance,” suggesting across-the-board cost cutting lies ahead.

Earnings fell 30% to $269 million in the second quarter ended March 31, excluding the effect of Disney’s acquisition of a 43% stake in Internet portal Infoseek.

Disney’s stock, usually the leader among the media and entertainment giants, has been a laggard in a bull market, easily outperformed for the last two years by such competitors as Time Warner Inc. and Viacom Inc. In the last 12 months, Disney’s stock has dropped 26% while the Standard & Poor’s 500 index during the same period has climbed nearly 23%. Since the beginning of 1997, Disney’s stock has increased just 31%, while Time Warner’s has soared 277% and Viacom’s 145%.

All this comes as Eisner is under attack in the high-profile lawsuit by Katzenberg, who claims Disney owes him more than $250 million stemming from a special bonus he had negotiated during his 10 years as studio chief. Katzenberg lawyer Bert Fields has taken aim at Eisner personally, accusing him of lying about Katzenberg’s deal and saying the lawsuit is rooted in his “personal animus” toward Katzenberg. Disney lawyers deny the accusations.

To be fair, analysts still like Disney’s underlying business, its invincible brand name and lucrative animated-film franchise. Major analysts still recommend by a 2-1 margin that investors buy the stock for their portfolios.

Before 1997, it was the stocks of Time Warner and Viacom that lagged while Disney easily outperformed them. Whatever his problems, Eisner’s place as Disney’s chief is as secure as slugger Mo Vaughn’s starting job for the company’s Anaheim Angels. Eisner continues to enjoy the strong support of the directors, analysts and investors he has made rich through the years.

“The company has phenomenal brands positioned to take advantage of the core underlying trends affecting the entertainment industry,” said Christopher Dixon, an analyst with PaineWebber. That, Dixon said, includes the expansion of international markets and the implementation of strategies to use the Internet and new technologies such as DVD to generate ever higher returns.

Eisner wouldn’t comment for this report. Earlier this year, he told shareholders that one reason for Disney’s dip in profit stemmed from spending by the company on such new big-ticket items as a cruise line, the Animal Kingdom theme park in Florida and development of the Go Network on the Internet.

In an interview with The Times in September, Eisner downplayed what even then was softness in company earnings and stock, saying: “I don’t think about the company quarter to quarter. I think about what is the company going to look like five years from now and 10 years from now.”

According to sources, Eisner has been telling people that he doesn’t feel cornered by the latest problems--and actually views them as an opportunity to galvanize the company’s managers into reining in bloated costs, perhaps by getting rid of overlapping departments that run through a company that has been on a growth track since Eisner took over in 1984.

Still, Eisner’s troubles are growing rather than shrinking, putting him in what is shaping up to be the most challenging period since Disney struggled with huge losses from the Disneyland Paris theme park in the early ‘90s.

Disney’s video division, which once could be relied on to churn out a huge profit, hasn’t been doing much of that lately since it has already tapped most of the company’s library of animated classics. It didn’t help that the company earlier this year had to spend an estimated $30 million to recall video copies of the 1977 film “The Rescuers” when it was discovered that two frames showing a topless woman had been inserted by a prankster when the film was made.

Disney’s consumer products group, which sells all those “Mulan” shirts and figurines, has been soft as well, as has the company’s Disney Stores. Analysts say toy retailers have been cool to merchandise from Disney’s upcoming animated feature “Tarzan,” in part because they are far more excited about products tied to next month’s “Star Wars: Episode I The Phantom Menace.” Disney executives are bullish that “Tarzan” will be a commercial hit despite the “Star Wars” competition.

Results from Disney’s broadcast network, ABC, continue to drag. And some analysts expect that Islands of Adventure, a new theme park from Seagram’s Universal Studios unit, will cut into Disney’s lucrative Walt Disney World business in Florida. Internally, Disney executives are known to believe that the park will cannibalize Universal’s own nearby theme park more than it will hurt Disney World, and may even help by bringing more tourists to Florida.

Eisner’s barometer is Disney’s stock, which continues to slip. It lost $2.13 to close at $30.38 on Thursday on the New York Stock Exchange, off 29% from a record high of $42.75 reached about a year ago. In a report to clients this week, analyst David J. Londoner of Schroder & Co. said, “We have to think this is a soft stock for a while.”

Speculation is increasing that Eisner may take major action to boost the stock, in particular a large share buyback. Disney has periodically bought back shares when its stock has been depressed, and it has plenty of cash to do so.

Also taking a broader view, PaineWebber’s Dixon said that because Disney keeps reinvesting in its parks and retail stores, the company “finds itself in a place where its mix of business is too capital-intensive relative to its competitors.”

What Disney needs to do, Dixon suggests, is “change its business mix in order to get much higher returns on lower capital.” For example, instead of building another retail store in a mall in Anaheim, Disney should focus even more on developing its online retail sales with the Go Network.

“The critical challenge for Eisner and his team is to invest in and grow those businesses that require less capital and yet still benefit from the extension of the Disney brand,” Dixon said.

He noted that Disney is in a situation similar to that of Time Warner three years ago when it was restrained by capital requirements in the cable TV business, and that of Viacom when it was struggling with its Blockbuster Video chain before it came up with a more lucrative arrangement to split revenue with studios.

Despite what Dixon characterizes as Disney’s current “speed bump,” the analyst said he remains “very bullish” on the entertainment giant’s long-term prospects.

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It’s a Jungle Out There

Disney Chairman Michael Eisner faces a host of problems, including sluggish earnings and a stock price that has failed to keep pace with the S&P; 500 and the stocks of such competitors as Viacom and Time Warner. Disney executives are bullish about their summer animated feature, “Tarzan,” although toy retailers have been cool to its merchandise because they are much more excited about toys from next month’s “Star Wars: Episode I The Phantom Menace.”

Mickey Mouse Stock?

Monthly closes and latest:

Percentage change in stock price from Jan. 31, 1997, to Thursday:

Time Warner: 276.7%

Viacom: 144.9%

S%P 500: 81.3%

Disney: 30.7%

Source: Bloomberg News