Disney Stays the Course in a Maze of Challenges

It’s hard to imagine Tomorrowland looking more daunting for Walt Disney Co.

Hampered by an already slow economy, the Burbank entertainment giant is now suffering through one of its worst chapters amid fallout from last month’s terrorist attacks. Tourism and TV advertising--the fuel for Disney’s key theme park and broadcasting businesses--are being pummeled, thwarting efforts to turn Disney around.

And investor patience is being sorely tested. A top-tier media investment through much of the 1990s, Disney’s stock has faltered badly. In the market turmoil of the last six months, Disney’s stock dropped 31%, well below its competitors’. In the same period, AOL Time Warner Inc. fell 8%, News Corp. declined 12%, Viacom Inc. dropped 15%, and Vivendi Universal was off 26%.

Last month, Disney’s stock hit a seven-year low. Although Disney’s stock has recovered nearly 24% since hitting a low of $15.50 last month, closing at $19.20 on Friday, it still trades at less than half its 52-week high.

Disney executives now find themselves in the unusual position of being on the defensive, trying to calm investors in a series of meetings and press interviews over the last two weeks.

“These are tough jobs in good times,” Disney President Robert Iger said. “You can’t imagine how much more challenging they become in times like this.”

Top Disney officials said in interviews that they remain upbeat and plan no draconian measures. The company’s executives “are up to the challenge,” said Chief Financial Officer Thomas Staggs.

Chief Executive Michael Eisner remains bullish in the long term, confident the company’s theme parks will be highly profitable because Disney’s building boom in that area has eased.

“We’re not changing our strategy about the way we run each division,” Eisner said. “Obviously, you don’t like your company to be undervalued. But if you look at people in our sector for the last 18 months, they’ve had about the same drops.”

Wall Street analysts historically are gentle on Disney, giving the company plaudits in good times and patient understanding during rough ones. Even when Disney’s performance lags, mainstream analysts rarely advocate selling the stock. Indeed, 15 of 25 analysts who follow Disney continue to recommend buying the stock.

“We have not viewed it as the best-positioned media company around,” said Larry Haverty, senior vice president and portfolio manager at Boston-based State Street Research, a longtime Disney institutional stockholder. “That said, the company has very, very powerful brands and an enormous amount of staying power that spans generations.”

Since January, the number of analysts who placed a “hold” on Disney stock has increased from six to 10, according to Zacks Investment Research. Salomon Smith Barney is the only company to upgrade its rating on Disney this year.

Several analysts estimate that Disney’s cash flow could drop more than $1 billion, or about 20% during the next year, as a consequence of the attacks and soft economy. The estimate is calculated by computing earnings before interest, taxes, depreciation and amortization--Wall Street’s principal yardstick for media companies.

“Very few people have seen fit to attack the [stock] performance, but compared to the S&P; 500 it’s been terrible,” said Graef Crystal, an executive pay consultant who has closely tracked Disney since 1984, when he designed a performance-laden contract for Eisner.

Over the last five years, the benchmark Standard & Poor’s 500 index rose 50.3% and the S&P;’s 14-company entertainment and leisure index increased 35.2%, while Disney stock fell 17.7%.

All media companies have suffered since the terrorist attacks as advertising dropped and TV schedules were preempted by nonstop news coverage. But Disney executives said the company was victimized more than others because it depends so heavily on tourism, with theme parks and hotels generating about 35% of operating income.

Wall Street and Deal-Making

Long term, Disney executives point out that Wall Street is enamored with deal-making, bidding up the prices of companies such as Viacom and its CBS acquisition or the merged AOL Time Warner rather than a company such as Disney that is more conservative.

The last major acquisition for Disney came in 1996, when it purchased Capital Cities/ABC for $19 billion. The company has pending a $5.3-billion deal to buy the Fox Family Worldwide cable network.

“When everyone is marching in a certain direction, if you don’t march in that direction you’re criticized for not being manly,” Eisner said. “The difficult time is when something is on the horizon that makes you want to act in a way different than everyone else.”

Disney executives contend the dot-com crash of companies such as Yahoo Inc. validates their caution. Yahoo frequently was mentioned last year as a potential Disney merger partner after AOL and Time Warner united.

Executives, Investors See Firm Differently

Nonetheless, Disney executives believe Wall Street still under-sells the company’s strong family label, lucrative ESPN sports franchise, profitable Miramax film unit and global network of theme parks. Because those assets are strong, the executives predict the company will rebound with a vengeance when the economy eventually turns around.

“I think Disney lines up rather nicely, in some cases rather favorably, to a large number of media conglomerates,” Iger said. “I look at ourselves versus Viacom. . . . We each have our strengths, and I don’t think theirs are stronger than ours.”

Many investors remain concerned that Disney is no longer the formidable moneymaker it was during much of the 1990s. Indeed, some of Disney’s most dependable breadwinners in years past--video, consumer products and animation--were stumbling well before the recent economic downturn set in.

Eisner, who led a revival of the company starting in 1984, insists that the company is undervalued, has unrivaled brands and still has the magic.

Iger and CFO Staggs added that although they still don’t know the full effect of the economy and the terrorist attacks on their business, Disney is showing signs of recovery.

They stress that attendance at the company’s theme parks is recovering, and predicted a further boost from such releases as the Disney-Pixar film “Monsters Inc.” in November and Tuesday’s release of the classic “Snow White and the Seven Dwarfs” on DVD.

“A turnaround at Disney is a matter of when, not if,” Iger said.

Many analysts and investors note that the company’s balance sheet remains solid.

“There are some inherent values to Disney, and those remain firmly intact,” said Salomon Smith Barney entertainment analyst Jill Krutick, who has a “buy” rating on Disney stock. “The recent events aside, the fundamentals of Disney and what they are building haven’t changed.”

Still, analysts and investors say Disney is clearly under intense pressure to boost the company’s stock and bolster investor confidence.

Last month, Disney suffered a symbolic blow when the wealthy Bass family of Texas, Disney’s largest shareholder and staunchest ally for most of Eisner’s 17-year tenure, sold more than two-thirds of its shares to raise cash amid the stock market’s woes.

Another big shareholder and ally, investor Warren Buffett, who in 1997 stood up to defend Eisner publicly at a raucous shareholder meeting, divested Disney holdings in 1999 and 2000.

Bass spokesman Clive Bode said the stock sale should not be interpreted as a setback.

“We have the utmost confidence in Disney, Mr. Eisner and his entire management team,” Bode said. “It was an excellent investment over the years.”

The Bass sale, combined with Disney’s plunging stock price, has even led to some speculation within the entertainment industry that Disney could be a takeover candidate.

But major investors, analysts and Disney executives don’t see that largely because there is such a scarcity of buyers with the financial wherewithal to take on an acquisition of at least $60 billion. They said that uncertainty over the economy will blunt any interest, and that any logical suitor such as another media company would face extensive antitrust and legal hurdles.

One large shareholder, Haverty of State Street Research, said he is skeptical of any takeover possibilities. “I always ask two questions: ‘Who?’ and ‘How?’ ” he said.

Eisner said he isn’t concerned with any potential takeover. “Disney is better off being independent,” he said.

To keep shareholders content, Disney’s brass must confront a host of problems that started before the terrorist attack.

At ABC, ratings softened as the “Who Wants to Be a Millionaire” phenomenon ebbed and advertising revenue dropped as the economy slowed. Iger predicts advertising will remain soft for much of 2002.

Months before the attacks, Disney executives also were projecting attendance declines at its theme parks because of the economy. That outlook has worsened since the attacks as flights to Orlando, Fla., that feed Disney’s giant Walt Disney World resort are being cut as much as 20% by some airlines.

Disney also has to pump life into the $1.4-billion California Adventure theme park next to Disneyland. The park has been a disappointment. The most recent setback came last week when Wolfgang Puck’s Avalon Bay restaurant and Robert Mondavi’s winery attraction closed their eateries amid weak attendance.

Analyst Katherine Styponias of Prudential Securities now estimates a 45% drop in operating income for Disney’s theme parks over the next year. Styponias, who has a “hold” rating on the stock, noted the slashing of services to Florida by Delta Air Lines Inc. “as an ominous sign.”

Both Iger and Staggs dispute the 45% drop-off estimate, saying they can’t even produce one of their own.

“That’s an absurd number,” Iger said. “It would be wrong to project the experience of the last three weeks on the future of that business.”

To blunt the effects, Disney plans an aggressive marketing campaign to lure more Californians to Disneyland and Florida residents to Walt Disney World. It also will use ABC, ESPN and other networks to promote its theme parks, films and TV shows.

Economy Takes Toll on Merchandise

Efforts to turn around Disney’s struggling consumer products business also are being thwarted by the economy, according to a report from Moody’s Investors Service, which downgraded Disney’s debt rating late last month for the first time in five years.

Sales of Disney merchandise are off 50% in the last three years. Disney said last week that it may shrink the number of U.S. stores from 478 to 350 over the next three years as leases expire, shuttering 50 more stores than originally planned.

Disney merchandise hasn’t sold as well in recent years in part because the company’s animation division has been unable to replicate successes such as “The Lion King,” “Aladdin” and “Beauty and the Beast.” The company’s most recent animation feature, “Atlantis,” fared poorly at the box office, and merchandise sales suffered.

Staggs and Iger said that although “Atlantis” was a disappointment, it was profitable. “It did make money but not as much as we would have liked,” Staggs said.

None of the Disney executives suggest sweeping changes at the company such as widespread layoffs, especially because Disney slashed 4,000 jobs this summer as part of an ongoing cost-cutting move. One possibility is that Disney also could sell the Anaheim Angels and Mighty Ducks of Anaheim sports franchises, as it nearly did in 1999.

Staggs said the company would entertain serious offers, but “we haven’t put a for-sale sign out” and would insist the teams stay in Anaheim.

Instead, Disney is likely to continue cutting costs, such as trimming hours of part-time workers at theme parks. Iger said Disney will continue its ongoing program of belt-tightening.

“Nothing is sacred,” Iger said. “Expenses that were considered untouchable by practice, habit and tradition are no longer protected.”

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Key Events

* December 1996: Michael Ovitz leaves Disney after a rocky 14 months as president. Investors are outraged when it is revealed that Ovitz’s severance package is worth an estimated $90 million, including nearly $39 million in cash.

* Mid-1999: Disappointing results caused in part by lower profit from videocassettes and merchandise sales. Settles breach-of-contract lawsuit with former studio chief Jeffrey Katzenberg for about $270 million.

n January 2000: Former ABC executive Robert Iger named president, making him second in command to Eisner.

* May 2000: Buoyed by ABC “Who Wants to Be a Millionaire,” Disney’s earnings beat Wall Street estimates.

* February 2001: Disney’s California Adventure opens in Anaheim.

* July 2001: Agrees to buy Fox Family Worldwide for $5.3 billion.

* Sept. 5, 2001: Tokyo DisneySea theme park opens.

* Sept. 20, 2001: Bass family sells 135 million shares, or 6.2% of Disney’s stock.

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What’s Working, What’s Not

Disney Chief Executive Michael Eisner faces one of the biggest challenges of his career: steering the company through a battered economy and the fallout of the terrorist attacks.

On the Up Side

* Disney remains one of the world’s most recognized brands.

* Despite tourism downturn, Disney still dominant in theme parks. New Tokyo park is expected to boost profit next year. Building boom in the division has eased, which frees up cash.

* Growth opportunities in China strong. Disney is building a theme park in Hong Kong and may build a second one in mainland China.

* Prospects good for Disney/Pixar’s “Monsters Inc.” film and DVD version of “Snow White and the Seven Dwarfs.” Miramax films highly profitable.

* ESPN remains a lucrative asset.

* Despite increased debt, balance sheet remains relatively strong.

On the Down Side

* Terrorist attacks have pummeled tourism and TV advertising.

* Consumer products division has struggled for years as merchandise and Disney Store sales slowed.

* Before the attacks, advertising market softened considerably for Disney’s TV and radio operation.

* Results from new California Adventure theme park are disappointing.

* Animation performance declined steadily during the late 1990s, leading to job cuts this year.

Source: Bloomberg News