Disney Pixar Report_M&A

Mergers & Acquisitions .ESADE Full-Time MBA December, 20111

Mergers & Acquisitions

CHAPTERSOverview Movie Industry with Porters 5 Forces Pixar Company Overview Walt Disney Company Overview

Merger Walt Disney-Pixar Merger, Background Context Valuation

Negotiation and Agreed Conditions Benefits, Synergies and Trade-Offs of the Deal

Post-Merger


OVERVIEW Movie Industry Analysis with Porters 5 ForcesSupplier Power: Moderate Suppliers in this industry are defined as people with technical and creative film-making skills. We assess this threat to be moderate since with technology, hand-drawn animation is being replaced by computer technology. In addition, the needs for these computer animation skills start to be outsourced from North America to Asia Pacific where there are significant lower costs coupled with high quality computer animation production. Barriers of Entry: High The industry is dominated by a few key players (Sony, News Corporation, Disney and Time Warner). With the lack of access to distribution channels and the intense capital needed to create blockbuster films and hire famous actors, it is very difficult for a new player to enter the market. Buyer Power: Moderate Buyers in this industry are defined as the end consumer or viewers of the films. We assess this threat to be moderate as there are many potential consumers with limited financial impact on the industry. In addition, the industry is dominated by key players thus is able to limit the options for the buyers. On the contrary, even though there are only a few options, there are effectively zero switching costs for customers. Hence, watching a film by one company does not make it more costly or difficult to then watch a film from a competitor. Threat of Substitute Products: Moderate We consider substitute products to be theater or other forms of entertainment. Internet is also a substitute form of entertainment as the concept of instant messaging was very popular at this time. Also, we can see the beginning of the popular social network Facebook gain traction as it was launched in 2004.


Rivalry: High Since there are only a few key players with similar percentage of market share (ranges from 14%-19%), the competition between them is strong. To be more competitive, the growing trend is to consolidate and acquire other studios. For example, Vivendi acquired Universal in 2000, which was then acquired by GE in 2004 and Viacom acquired DreamWorks in 2006.

Pixar Company OverviewPixar begins in 1979 as the Graphics Group, which is a part of the computer division of Lucasfilm. Initially the group started selling a computer system called Pixar Image Computer to government agencies and the medical community. However, imaging the computer Distributor Sony News Corporation (Fox) Disney Time Warner (WB) NBC Universal Viacom (Paramount) Lionsgate Other Market Share 19.20% 17.00% 16.70% 14.90% 10.80% 10.80% 3.60% 7.00% To show off the devices

never sold well. In 1984 John Lasseter left his job as the animator at Disney and joined the

computer animation group of George Lucas.

capabilities, the group started developing short animated clips, which then


turned into animated commercials, including campaigns for Tropicana, Listerine, and Terminator 2. In 1986 Steve Jobs bought the company from George Lucas for $5million and ads another $5million of capital. The newly formed company was headed by Jobs, who served as Chairman and Chief Executive Officer of Pixar. At the time, 44 people were employed at Pixar. Between 1987 and 1989, two short films Luxo Jr. and Tin Toy received Academy Award nominations for Best Animated Short Film and various other awards such as the Golden Gate Award at the San Fransisco International Film Festival. In 1990, Pixar went through a rough time selling its hardware technology and imaging software to Vicom Systems and had to reduce its workforce to 42 people. However, the following year it managed to secure a $26 million deal with Disney to produce three computer-animated feature films, the first of which is Toy Story. The alliance had begun. In the meantime, Pixar continued to make award winning commercials. In 1995, Toy Story was released and became the highest grossing movie of the year, making $192 million in U.S box office and $362 million worldwide. The movie was distributed by Disney and received numerous awards. At the same time Pixar went public, offering 6,900,000 shares at $22, beating Netscape as the biggest IPO of the year.

Walt Disney Company OverviewWalt Disney is one of the major companies in the world that has provided entertainment to generations of fans since 1923. The company together with its subsidiaries consists of four main segments: media networks, parks and resorts, studio entertainment and consumer products. Since the very beginning, the company has been known for its creative content and great storytelling. In 1923 Walt arrived in California, started the Disney Brothers Studio and began making independent movies. In 1927, Walt decided to pursue all-cartoon series and the mouse is born. After his distributor took the rights of the first character, Walt created the


mouse, named Mortimer, which his wife changed to Mickey. Mickey Mouse became an overnight sensation and a series of cartoons followed. In 1932, one of his cartoons of the Silly Symphony won the Academy award for best cartoon, the first year that the award was offered. Until the end of the decade, Disney won that award annually. In 1934, Disney decided to move into animated feature films and created the Snow White and the Seven Dwarfs. This was a radical concept and in 1937 after the film was finished, it became the highest grossing film of all time. During World War II, Disney lost most of its markets and the company lost money on the next several films, bringing financial problems to the company. During the 50s Walt Disney was constantly trying to come up with new ideas, and he felt that there should be a place where adults and children should spend time and have fun together. Thus he created Disneyland in 1955. The park was a huge risk for the company, as it had taken millions of dollars in bank loans to build it. But it paid off. It became an enormous success and finally put the company in solid financial footing. After Walts death in 1966, his successor Roy Disney continued his brothers vision of creating a second park in Orlando. It opened its doors in 1971 and immediately became the top-grossing park in the world with more than 11 million visitors in its first year. Japanese and European parks followed. However, during the years of parks construction, the revenue from movies dropped. Thankfully, in 1984 Mickael Eisner became CEO and managed one of the most impressive turnarounds in history. He revitalized TV and movies, with a strong commitment to quality programming. Disneys next 33 movies were profitable. In addition, he maximized theme parks profitability by raising prices, expanded working hours and lifted restrictions on the number of visitors allowed in the park. In 1995, the company acquired ABC and launched its internet division, Disney Online. Eventually total revenues rose up to $32 billion with a net income of $2.5 billion.


MERGER Walt Disney-Pixar Merger. Background ContextIn May 1991, Pixar and Walt Disney entered into the Feature Film Agreement. Under this Agreement as mentioned, Pixar would develop and produce three computer animated feature films. Disney would be responsible for its marketing and distribution. A few years later in 1997 Pixar and Disney entered into Co-Production Agreement, which replaced the Feature Film Agreement established in 1991. This new Agreement defined, on an exclusive basis, Pixar to produce five animations for distribution by Disney - A Bugs Life, Monsters, Inc., Finding Nemo, The Incredibles, and Cars. The movies revenues of these movies were shared 50% to each partner. This partnership built huge profits for both companies; the total box-office revenue from these 5 movies was more than $3 billion. However as time passed by, some issues occurred amongst the two parties. For example, Disney refused to include Toy Story 2 within the 5 movies mentioned in the Co-Production Agreement. Disney ignored Pixars request in launching Toy Story 2 in form of Home Entertainment, instead of motion pictures. In 2004 both companies attempted to reach a new agreement, which ended up failing. The conditions under the negotiation included Pixar having control of the entire products, getting the ownership over the films and also the films in production under their old agreement. Pixar also wanted financial freedom, which means that they would finance the films on their own and collect all the profits. Disney would only do the films distribution and get 10 to 15 percent from the distribution fee. In early 2006, Disney agreed to acquire Pixar with 2.3 Disneys shares issued for each Pixars share and merged two companies worth $ 7.4 million in an all stock deal. Pixar Vice President, John Lasseter, would become Chief Creative Officer of the combined Disney-Pixar animation studios as well as


the Principal Creative Advisor at Walt Disney Imagineering, to help with the design of new attractions at Disney theme parks. Current Pixar President, Ed Catmull, would become President of the new combined Disney-Pixar animation studios. This alliance would enable both Disney and Pixar to collaborate without the barriers that comes from producing the product from two different companies with different shareholders and management teams. Time Line "I don't think Disney had any choice about doing this deal with Pixar," said NPR correspondent Kim Masters, author of Keys to the Kingdom: The Rise of Michael Eisner and the Fall of Everyone Else. "They had tried for a long time to rejuvenate their own animation operations, and they just couldn't get it nailed. The options were: Bring Pixar in, or let Pixar go somewhere else."1 The time to complete this deal was limited, the sides knew each other from previous mutual work and they knew what was in stake. It was either acquiring Pixar or having a possibility of a competitor purchasing it. The fact that Steve Jobs was the major shareholder with more than 50% allowed this deal to be done quickly. The deal was agreed on 24.01.2006 and was pending the approval of the shareholders. On May 5th the shareholders of Pixar agreed on selling the company to Disney, and the whole acquisition was completed shortly after that. As any other major merger, the deal had to be approved by regulation, for anti-trust considerations. All the regulatory approvals were received before the final vote of the shareholders. Advisors Three investment banks helped to create this deal. From Pixars side it was Credit Suisse, while from the opposite side there were Bear Stearns and Goldman Sachs lead by the head of technology M&A. It could be seen that 1http://www.techzone360.com/news/2006/06/12/1678408.htm


the top investment bank with a senior officer was involved in the deal, and the importance the investment banks. The Transaction The actual transaction of Disney purchasing Pixar was relatively straightforward. Disney agreed to convert every share of Pixar into 2.3 shares of Disney, so it was a 100% equity transaction. Disney issued 279 million new shares in order to do the transaction. However, in order not to dilute the excising shareholders, Disney bought back 225 million shares in the market. So the actual impact on the balance sheet of Disney could be seen as paid in cash for 80% of the deal, and sharing the remaining 20% of the capital with Pixar shareholders (of course, assuming that the existing shareholders did not sell their shares during the buyback). The price (in stock) that was set by Disney was $7.4 billion, with Pixar having $1.1 billion in cash and equivalents. So effectively, Disney paid $6.3 billion dollars for Pixar. At the time of the merger announcement, the price of Disneys stock was $25.52/share and Pixars was $57.50/share. The exact price of Pixars stock for the transaction was an average market price for 5 consecutive days, ending at 2 days before the announcement. Steve Jobs founded Pixar and was a major stakeholder with 50.6% of the shares. Upon the completion of the transaction, Jobs became the biggest sole holder of Disneys stock (with 7% control).

Multiples According to Thomson Financial, Pixars stock was trading at 84 times the annual earnings and was the most expensive in the industry. Disneys stocks, however, were trading only at 17 times to the earnings, making them one of the cheapest in the industry. We believe that such difference in multiples was due to the fact that Pixar was a leader in the industry with 6 blockbuster movies, while Disney was looking for a driving engine to increase sales. The result was that Steve Jobs exchanged expensive stock into a


cheaper stock, and a transaction like that might look decretive to Disneys shareholders. However, there was, of course, a strategic angle in this acquisition, as mentioned above.

ValuationAs a matter of fact, Disney paid $59.78/share to Pixar by giving Disneys stock. If we calculate the premium over Pixars stock price at the moment (Jan-24th-2006), it is about 4% (the share price was $57.75 on Jan24th). Considering that this deal took several months to complete and the stock price surged 10% since the beginning of 2006 due to the speculation over this deal among investors, we could consider the real premium to potentially exceed 10%. However, considering that Disney paid much more premium to the target companies shareholders when they merged ABC and Marvel, this 10% could be considered as cheap.

Year 199 6 200 6 200 9

Target Deal size ABC Pixar Marvel 19 billion USD 7.4 billion USD 4.3 billion USD

Premium Payment 27% 4% 29% 60% Cash + Stock 100% Stock 60% cash + Stock

We cannot specify the reason behind this difference because there could have been many environmental factors, which might have affected. However, we consider that the main idea of compensation for the shareholders of Pixar (Steve Jobs owned 50%, which could affect the price as well) was meant to be achieved by future capital gain coming from both companies synergy.


Negotiation and Agreed ConditionsEven though Disney acquired 100% shares of Pixar and made it a wholly-owned subsidiary, it appears that Disney tried not to dilute Pixars competency as much as possible and leveraged Pixars strengths to enhance Disneys creative capability rather than controlling it strictly. To start with, both companies agreed to keep both Disney and Pixars production units (Disney animation studios and Pixar animation studios) separated. Pixars animation studio kept its location in Emeryville, California with Pixars sign on it even after the merger. Furthermore, according to the Agreement And Plan Of Merger registered in SEC about this deal, Disney agreed to keep Pixars HR policy basically intact. It shows that Disney took motivation and loyalty of employees of Pixar fully into account to avoid having many employees leave due to the merger. In addition to separating Pixar at the organizational level, Disney tried to leverage Pixars brand and capability to enhance Disney. Instead of branding new films as new Disney product, it chose to keep Pixar brand by using Disney-Pixar brand for the products produced by Pixar after the merger (Cars was the first product distributed under the new brand). Furthermore, Disney appointed Steve Jobs as a board of director at Disney, Ed Catmull (president of Pixar) as a president of both Disney and Pixar animation studios, John Lasseter (Pixars creative director) as a chief creative officer of both Disney and Pixar animation studios. Having those persons from Pixar as top executive of Disney shows that Disney expects them to be an enabler to enhance Disneys struggling performance in production. As we discussed already, Disneys main target is not only the existing Pixars highly recognized product lines but also the talents who can make a difference in Disneys future performance. To put it the other way around, Disney loses most of its fruits of the deal if it loses those talents. To prevent this, Disney put several clauses in the agreement. First, losing John Lasseter or Ed Catmull can be a deal-breaking event. Second, Disney named some key employees who are critical to keep Pixars creative capabilities and


culture as required for employees to join new company. Those employees include Andrew Stanton, the director of "Finding Nemo"; Peter Docter, the director of "Monsters Inc."; Brad Bird, the director of "The Incredibles"; the director and writer Bob Peterson; the story artist Brenda Chapman; the editor and director Lee Unkrich; and the sound designer Gary Rydstrom.

Benefits, Synergies and Trade-offs of the dealThe alliance between Disney and Pixar will yield great benefit to both parties. The benefits for each partner can be identified as the followings.

Disney To acquire core strengths of Pixar in producing computer motion pictures. At the time Disney started developing its computer animation films, Pixar already generated more than 30 billion dollars from its 6 animation motion pictures. Decrease in competition mainly because Pixar is the large player in the industry in terms of developing and producing computer animation


films, which in collaboration with Disney can greatly increase its market power. Increase in revenue by merging with Pixar. Merging with Pixar will help Disney to generate new sources of revenues from high-quality new type of films and to get more profit from merchandise and theme park tickets. Access to computer generated imaging technology.

Pixar Focus on its core strengths in producing the computer animation, without investing in production line for making merchandise and home entertainment. Disney has the various lines to produce merchandises and have a place to distribute so Pixar also gain the benefit of being able to produce the other lines of products such as apparels, toys, and so on. Moreover, after the deal, stockholders got an increase share price from merging the two companies. For example, shares of Pixar gain nearly 3% from after-hours trading and Disneys stock gained about 1.8% in regular trading. With regards to synergies, the team up of these two big animation production companies will enable better human resource. They can exchange the valuable human resource between Disney and Pixar, which enables them to better, produced even top hit motion pictures. Both parties can market its production together and get more profit. Considering the structure of this deal, both companies can concentrate on their individual strengths, which will turn in an increase of productivity and generate more sales.


Post MergerOverall it was a very successful integration, which was intensely discussed in the press as well as the management literature and research. The financial results (and here we only look at the Box office success, not taking into account the retail revenues Disney achieved through its wide distribution and sales network in its Parks, etc) clearly prove this success. Since the merger, Disney-Pixar generated $4.1 billion in Box office revenues in only 5 years. Compared to $3.2 billion in the previous 9 years. There were two major issues that the public and Wall Street feared after the acquisition of Pixar through Disney. One was that Disney with its Title Monster University Brave Cars 2 Toy Story 3 Up Wall E Ratatouille Cars The Incredibles Finding Nemo Monsters, Inc Toy Story 2 A Bugs Life Toy Story Year 2013 2012 2011 2010 2009 2008 2007 2006 2004 2003 2001 1999 1998 1995 Box office $552M $1,063M $731M $521M $624M $631M $631M $868M $526M $485M $363M $362M sheer size - would trample Pixars creative power and turn the Pixar executives into mere Disney-puppets. The other scenario depicted a spoiled team of Pixar executives and animators, completely unwilling to make this partnership a success and not respecting the requests of its new owners. But luckily, both apprehensions didnt materialize. On the contrary, the merger is noteworthy for the success it had and how apparently easy the integration was so far.

Despite many mergers that destroyed more value than they were anticipated to create (especially in the media sector), Disney and Pixar made it work. Wall street showed its content with this deal with an average stock price of $25 before the deal, about $35 after one year and still a stable $30 after almost two years. The main reasons for this great result are as follows: 1) The investors see potential for Disney to leverage Pixars computeranimated character to be used across its vast network (parks, channels,


etc). One successful example for this opportunity is Cars. While it was not one of the biggest blockbusters for Pixar/Disney (only $460million in the cinemas and $27million in DVD sales), the revenues in retail products reached about $5billion for Disney for Cars only (through an online world, an ice-skating show and a Cars world in Disney World, etc).

2) Pixars willingness to change and adapt to being part of an international conglomerate. Not only did Pixar decide to not mainly push for new movies anymore, but also allow for sequels (Toy Story, Cars). The executives also changed their mind on another production channel: Direct-to-DVD was now also a part of Disney-Pixars portfolio. Pixar even allowed the partial production of these movies to be performed by outside animators from India, which was categorically impossible, before Pixars executives feared a loss in quality and damage to the brand. 3) The experience of Bob Iger (having been bought with his companies twice himself) how a merger should be done was also a key influencing factor for its success. The two companies strictly followed the well-known tactics to make a merger work, like effective communication to the employees but also came up with some more unusual approaches. For example, the executives agree on a detailed list of things that Pixar would not have to change after the merger (e.g. the health benefits) and concrete guidelines on how to protect Pixars creative culture. There is a steering committee


that oversees animation for both Disney and Pixar studios, with the mission to maintain and spread the Pixar culture. Also Pixar employees were not forced to sign an employment contract, whereas this policy exists in Disney. Regarding this list of promises, a Pixar executive was quoted in the NY Times2: Weve never had to go back and look at it. Everything theyve said they would do they have lived up to. 4) One of the key-learnings of Mr. Iger was that a successful merger cannot happen in a rush. There is an assumption in the corporate world that you need to integrate swiftly, Mr. Iger said. My philosophy is exactly the opposite. You need to be respectful and patient. This becomes visible in many details (such as keeping the same email-addresses for Pixar employees or no forced adaption of the strong corporate culture of Disney) but mainly the overall trust that was build over time and acknowledged by Mr. Lasseter when he said: It took about a year before there was a collective letting down the guard. 5) Analysts identified another key-factor for the success of this merger. Bob Iger gave the new talent acquired through Pixar extra responsibilities to help improve Disney and drive it into a new direction. One analyst, familiar with the deal, commented in the NY Times3: If you are acquiring expertise, then dispatch your newly purchased experts into other parts of the company and let them stretch their muscles. Disney did exactly this by assigning the Pixar team to turn around Disneys animation department, which they achieved! The influence Pixar had at Disney becomes clear when John Lasseter says: Disney has become a filmmaker-led studio and not an executive-led studio. We are very proud of that. Another key factor to ensure Pixars influence at Disney was that the deal required that Pixar's primary directors and creative executives also had to join the combined company. 6) The transformational leadership of the key-leaders (Steve Jobs and John Lasseter) in Pixar was brought into and widely adopted by Disney. Their 2 www.nytimes.com/2008/06/01/business/media/01pixar.html? pagewanted=all 3 www.nytimes.com/2008/06/01/business/media/01pixar.html? pagewanted=all


ability to lead teams that bring a willingness to quickly adapt to new challenges in a rapidly changing environment is legend and (as seen above) also works in Disney. 4

Additional bibliography: (Disney.com) http://corporate.disney.go.com/corporate/complete_history.html (Pixar.com) http://www.pixar.com/companyinfo/history/index.html http://en.wikipedia.org/wiki/Pixar

4 Haley and Sidky 2009: Making Disney Pixar Into A Learning Organization

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