Has the Kingdom of Disney Lost its Magic?

Despite the popularity of its megahit movie The Lion King, the Walt Disney Co. these days is hardly king of the jungle. Its revenues are sagging amid declining theme park attendance, a lack of movie hits, and poor ratings for its ABC network. On August 1, the entertainment giant warned of worse-than-expected earnings this quarter, and a credit ratings agency later downgraded Disney debt. Shares of Disney have dropped from nearly $25 in May to less than $15, under-performing the S&P 500 index.

 

The troubles have put long-time Disney CEO Michael Eisner on the hot seat. Reports suggest the powerful Roy Disney family and its chief advocate on the Disney board of directors, Stanley Gold, have lost patience with Eisner and may be pressing for new leadership.

 

If so, they aren’t alone in thinking the key to restoring the magic to Disney’s kingdom is dethroning the current king. Eisner, according to marketing professor Pete Fader, has an inflexible style that no longer serves Disney in today’s dynamic, high-tech environment. “Eisner has done great things for the company,” Fader says. “But he’s not really the right man for it anymore.”

 

Yet Eisner still has his supporters, among them marketing professor Jehoshua Eliashberg who claims that Eisner and Disney are largely victims of a corporate witch hunt. “[I]t [has] become popular to criticize companies and to criticize CEOs,” he says, adding that Eisner doesn’t deserve the harsh reviews he gets from the press.

 

After all, Disney’s fall from its place as an American business darling is mild compared to other corporate flame-outs this past year. No one is accusing Disney of accounting fraud or executive shenanigans, as is the case at Enron, Andersen, WorldCom and Tyco International, among others. Still, the firm famous for its flying fairy has crashed down painfully.

 

In the nine months ended June 30, three of Disney’s four major divisions took big hits as overall revenues dropped 4% year-over-year to $18.7 billion. The media networks division – 39% of total sales – saw operating income fall 40% year-over-year. At Disney’s theme parks – which make up 26% of the firm’s total revenues – operating income dropped 27%. The studio entertainment unit – 25% of total sales – suffered a 48% fall-off in operating income. Consumer products – 10% of total sales – fared better, with operating income down just 1%.

 

On August 1, Disney met analysts’ expectations for the second quarter with pro forma earnings per share of 17 cents. But the company warned that its September quarter results would fall short of Wall Street’s expectations. The stock fell 9% the next day, and brokerages J.P. Morgan and Goldman Sachs downgraded the shares.

 

The earnings news seemed to fuel dissatisfaction on the Disney board. The New York Times has reported that several people on the 16-person board have expressed concerns about the company to Eisner. They include Stanley Gold, who manages the Roy Disney family investments as CEO of Shamrock Holdings, and Roy Disney himself, nephew of the late Walt Disney. Roy Disney owns a total of 18.1 million Disney shares, second on the board only to Eisner’s 20.3 million. According to the Times, “terse words” were exchanged after the earnings warning.

 

A partner at Shamrock Holdings said neither Gold nor Disney would comment on leadership issues at Disney. But he did confirm the validity of this comment from Gold in the New York Times: “The family owes a great debt of gratitude to Michael for what he has done,” Gold was quoted as saying. “But my goal is to try to get the Disney Company to perform at a level of efficiency it hasn’t seen for a number of years, given its fine assets.”

 

In the wake of the Times story, Disney took another blow, this time from Fitch Ratings service. Fitch downgraded Disney’s senior unsecured debt of $14 billion based on the company’s higher debt in the wake of its $5.2 billion Fox Family acquisition in October 2001 and the declining performance of Disney’s businesses. According to Reuters news service, Disney responded by calling the Fitch downgrade the result of “short-term business conditions,” and expressed confidence in its overall financial health.

 

But there’s no doubt Disney is struggling, and recent events amount to a dramatic plot twist for CEO Eisner. The former president of Paramount Pictures took the helm of Disney in 1984, thanks to the support of Gold and Roy Disney. Under his watch, the company recorded a series of movie successes, most notably The Lion King. Eisner also made Disney one of the world’s media giants with its acquisition of Capital Cities/ABC in 1996. Eisner guided Disney’s stock to its peak of more than $43 in April 2000.

 

Eliashberg points out that Eisner also deserves credit for not jumping on the Internet bandwagon. Eisner was wise to avoid investing heavily in Internet technologies or casting his lot with an Internet partner, as media firm Time Warner’s executives did with AOL, says Eliashberg, adding that Eisner’s attitude was more “Let’s wait and see.” 

 

Ailing Animation

 

Disney is not an easy ship to steer these days for any captain. For one thing, the firm’s business – especially its theme parks in Florida, California, Europe and Japan – are sensitive to economic and political winds beyond Disney’s control. The Sept. 11 attacks dealt a blow to travel plans, sagging consumer confidence threatens to eat further into Disney’s bottom line, and the risk of future terrorist attacks continues. “This a different world than what Disney has operated in during the past 15 years,” says SoundView Technology Group analyst Jordan Rohan. “The theme parks unit is operating efficiently, but needs travel to return to normal to operate very profitably.”

 

In addition, the entertainment industry is by nature a high-stakes game. It requires big up-front investments and carries little guarantee that a movie or TV show will be a hit. “Film and television production is capital-intensive and inherently risky,” CIBC World Markets analyst Michael Gallant wrote in late August. “Disney manages this risk through diversification and through creative financing arrangements, such as co-productions.” Eliashberg says the partnership approach to movie-making is sound, because it allows the company to be selective about its investments.

 

But Disney is also under fire for its silver screen strategy and performance. Fitch, for one, offered a withering assessment. “Live-action releases have been disappointing and the company has only been partially successful in reducing its overall exposure in this area,” the ratings firm said. “Further, animated films, a core Disney franchise, have not achieved the success in recent years characteristic of the business in prior periods … Competitive pressures, which were thought to be easing, may now intensify with the success of releases from other studios.”

 

SoundView’s Rohan, who worked at Disney as a business planner from 1993 to 1995, agrees that Disney’s animated division is ailing. According to SoundView’s analysis, Disney studios are leading the animated film industry in box office receipts from 1998 to the present – but just barely. Disney took in 28% of the market, followed by DreamWorks with 25%, Pixar with 24%, Paramount with 12%, Fox with 6% and Warner with 5%. “Disney owned the space,” Rohan says.

 

Disney supporters might counter that the numbers are misleading, because Disney and Pixar are production partners. But Rohan suggests the reliance on Pixar is troubling. There are only three more non-sequel movies left in Disney’s deal with Pixar, and Pixar will have the ability to renegotiate its contract early next year, Rohan says. Although Rohan expects Pixar to stick with Disney, he suggests Pixar could do so under better terms than it now has.

 

What’s more, the fact that some of Disney’s biggest animated hits in recent years – Monsters. Inc, Toy Story II and A Bug’s Life – have come from Pixar, raises questions about the future health of the Disney empire. That’s because the popularity of everything from theme parks to pajamas depends in part on compelling characters like Mickey Mouse, Simba the Lion King, the Little Mermaid and Buzz Lightyear. “The animated division touches just about every other division at Disney,” Rohan says. “That’s the core and heart” of the company.

 

Rohan also points out that Disney has lost some key animation division people in recent years: Jeffrey Katzenberg, who helped launch DreamWorks SKG in 1994, and Joe Roth, who started Revolution Studios in 2000. “One thing Eisner could do is add capable executives to the team,” Rohan says.

 

The ABCs of TV Hits

 

Adding to Eisner’s woes is criticism of Disney’s management of ABC, whose ratings have fallen into the basement along with those of Fox. One argument is that ABC rested on its laurels after the success of its show, “Who Wants to Be a Millionaire?” ABC has a new fall line up that observers say will be critical to the network. “Promising shows include John Ritter’s ‘8 Simple Rules’ and ‘Hope Nevada’ from Ben Affleck,” UBS Warburg analyst Christopher Dixon commented in a recent research note. But Dixon said ABC TV’s relative lack of cash-producing shows in syndication means the network is betting heavily on the success of the new offerings. “[W]ith seven new shows for the fall season and six mid-season shows,” Dixon wrote, “the potential for programming write-downs can not be overlooked, should ratings not materialize.”

 

In a September newsletter to investors, Eisner said initial responses to ABC’s new direction have been positive: “Recent reaction to both the upcoming [primetime] schedule and to ABC Entertainment’s new president, Susan Lyne, suggests that the confidence we have in our new schedule is shared by both advertisers and television critics.”

 

Rohan says a turnaround at ABC could happen fast. Look at how “American Idol” reversed the fortunes of Fox this summer, he points out, adding, “One or two hits can really make a difference.”

 

But Rohan warns of another Disney weak spot: debt. Like Fitch, Rohan sees a red flag in the company’s balance sheet, which he says used to be much cleaner. Disney’s debt of $14 billion represents about 3.5 times the firm’s earnings before interest, taxes, depreciation and amortization, Rohan says, and he suggests it could become much more burdensome given another terrorism event that disrupts Disney’s business. “Things can get worse in a hurry. It doesn’t have to be much. It could be a car bomb.”

 

One way for Disney to reduce its debt is to auction off assets, such as its two sports teams, the Anaheim Angels baseball team and the Mighty Ducks of Anaheim hockey team. “I think those teams would be for sale at the right price right now,” Rohan says. Wharton legal studies professor Kenneth Shropshire agrees it’s no secret that Disney is looking for a buyer for the Angels.

 

Disney’s investments in the teams initially made sense for cross-marketing purposes, Shropshire says. He points to the Mighty Ducks and Angels in the Outfield movies. But Disney may have found the sports business much different than its other entertainment operations, he suggests. In particular, making a sports franchise a winner is typically a long-term project. “With motion pictures and music, you can have one that fails and you can jump right back with another. In sports, the whole product is the team. You can’t go out and get a whole new team.”

 

On the other hand, Shropshire says, sports could be the ticket for Disney to increase its global reach. For example, he suggests that Disney could establish a bigger presence in Brazil by investing in a Brazilian soccer franchise, or in Japan by investing in a baseball team there.

 

For now, though, Eisner and Disney seem focused on the more immediate issue of resurrecting ABC’s ratings. And the company faces still other challenges. For example, journalism watchdogs see Disney as part of an industry consolidation trend that threatens independent perspectives. Others have criticized Disney on charges that include using violence as a selling tool for ESPN and spewing out mindless drek in the form of “The Anna Nicole Show” – a production of Disney’s co-owned E! Entertainment network that captures the life of the former Playboy model.

 

To Wharton’s Fader, however, Disney has erred on the side of being too careful about preserving its family-friendly image. Concern over controlling its brand extends to digital file-sharing over the Internet, he says, noting that Disney has opposed the sharing of digital movie previews. He points out the firm has gone to court with a company called Video Pipeline to stop it from streaming home video release previews. In effect, Disney is missing an opportunity to adapt to the public’s interest in file-sharing and build a business model around the new technology: “They haven’t shown the least bit of progressive behavior,” Fader says.

 

Disney’s tight grip on its digital files, Fader adds, is part of Eisner’s top-down management style. He believes Eisner would be better off running a more narrowly-focused company in a slower-paced market, such as consumer products. As it stands, Eisner’s rein over the Disney kingdom is only making Mickey Mouse fans frown: “He’s an all-or-nothing guy. (But) the all that they’ve been trying to do isn’t working.”

 

Whether the Disney board of directors agrees with Fader may not be known for a few months. The New York Times reported that Eisner will likely have until November at least to demonstrate he is improving matters at the company. By then, for example, it should be clear how well ABC’s fall schedule has done with audiences and advertisers.

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