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Business of Magic
A look at the business of Disney
|Alex Stroup, Editor|
Disney's Purchase of the Fox Family Channel, Part One
The Walt Disney Company's offer to purchase the cable Fox Family Channel has been all over the news. Disney is willing to pay $3 billion in cash to Fox Family Channel's two owners, News Corp. and Saban Entertainment, and also assume $2.3 billion of the channel's debt. That's a total of $5.3 billion (that's "billion" with a "b"). Some analysts have questioned whether Disney is paying too much. To find out, let's look and see what Disney is getting for its $5.3 billion.
In case you haven't read the news stories, Disney intends to quickly turn the Fox Family Channel into the "ABC Family Channel", which will feature "repurposed" programming from other Disney venues; in other words, reruns from other Disney-owned channels such as ABC, EPSN, SoapNet and even the Disney Channel. But these won't be reruns from old series - well, perhaps some of them will be. Instead, these will mostly be rebroadcasts of current programs. For example, ABC's Nightline may be rebroadcast the next afternoon on the ABC Family Channel. Or, as Disney President Robert Iger mused, after ABC broadcasts My Wife and Kids on Wednesday, it might be shown again on Friday on the cable channel as part of a reconstituted "TGIF" line-up.
This repurposing concept is supposed to be beneficial for both Disney and the audience. The company, obviously, doesn't need to spend money to create new programs, and can fill up the new channel with material that has effectively already been paid for. In addition, Disney can sell advertising space twice or more for the same program. Michael Eisner is promoting this as a way for ABC to continue to be able to afford to produce high quality but expensive TV programs. On the other hand, Mr. Eisner has also said that there "will be original programming as well, not just a repeat network."
For the viewer, the benefit is that it will easier for you to catch your favorite shows. Can't stay up to see Nightline or Politically Incorrect? Watch it tomorrow on cable. Missed Drew Carey last week? No problem, you'll get a second chance when it airs on the ABC Family Channel.
Rather than critique this repurposing concept now, let's instead use it as background to help value what Disney is buying. I'll revisit the concept later.
The best way to see what the $5.3 billion is buying is to break up what Disney gets into pieces. Basically, every corporation is some combination of a profit stream, assets, brands, loyal customers, intellectual property such as patents and trade secrets, and other pieces. So let's look at the pieces of the Fox Family Channel:
Profit Stream: Fox Family's revenue has been fairly flat, dropping from $664 million in fiscal year 1998 to $642 million in fiscal year 2000. This means that the company has not been growing much lately. Their operating income -- the profit from ongoing business, and before write-offs and other one-time events -- has been steady around $110M. The net profit -- the profit after everything has been taken into account -- has been pretty much non-existent. The company lost a total of $91 million in 1998 and 1999. It had a net profit of $61 million in fiscal 2000, but this was only due to the $153 million gain by selling stock in Fox Kids Europe in an initial public offering (IPO).
Perhaps this is a good place to point out that there is more to the Fox Family Channel that just what is seen on cable and satellite systems in the U.S. It also includes 76 percent of the Fox Kids Network in Europe (although not Fox Kids in the U.S., which News Corp. is buying back as part of this deal) as well as other children's channels around the globe. Fox Family has access in 73 countries overall. It also has a large library of children's programs and made- for- TV movies: more than 6,500 separate episodes.
Getting back to the profit stream, Fox Family has made very little profit so far. Disney's CFO (Chief Financial Officer) Thomas Staggs has already stated that Disney believes it can double the cash flow from this business to around $300 million by 2003. This is only about a 10 percent annual return on the initial $3 billion investment, assuming Mr. Staggs means this $300 million cash flow is after making payments on the existing debt. A 10 percent rate of return isn't bad, but it is much lower than the usual 20 percent return that Disney tends to look for.
Assets / Equipment: When you buy a company, you get everything it owns -- the assets of the company. What does Fox Family own? According to its last quarterly financial report, it has $2.6 billion in assets. But the accounting definition of "assets" can be kind of tricky. In this case, more than half of the Family Channel's assets -- $1.4 billion in this case -- are listed as "intangible assets", that is, assets that have no physical representation. These are just accounting entries that usually come from acquiring other companies, not physical assets that can be used or sold.
When you buy a company for more than the accounting value of its physical assets, the accountants assume that the rest of the money is used to purchase these phantom intangible assets things like brand names and customer loyalty which are lumped together and called "goodwill". Anyway, the point is that this is not a physical asset that Disney is receiving but an accounting construct.
The Fox Family Channel does have some actual physical assets. These include a state- of- the- art, post- production studio in Los Angeles, and a full- service animation studio in Paris that provides cartoons for Europe. But these may not be all that valuable to Disney. Disney already has its own post- production facilities and animation studios and, in fact, is laying off animators here in the U.S. Fox Family's accounting statements only list a mere $46 million in property and equipment for the entire company. Fox Family has another useful physical asset -- cash -- but only about $76 million of it. Most of the remaining physical assets are the library of programs it has bought or produced, which we'll discuss in more detail shortly.
Brand: As Disney is quite aware, a brand can have a lot of value, in terms of defining what the brand stands for and making it easy for customers to remember that it exists. This brand value and the consumer recognition that has been built up would be valuable to any other buyer who was interested in keeping Fox Family running, and were certainly factored into the purchase price that Fox Family agreed to.
Unfortunately, Disney is throwing most of that away. They are only intending to keep the "Family" part of the name, with the types of programming that the name "Fox Family" stands for in people's minds to be replaced by ABC programming. So basically, Disney is paying for Fox Family's brand equity and throwing it out.
Content: In what we've looked at so far, Disney isn't getting very much for its $5 billion. But now we're starting to get to the pieces that are important to Disney. First is Fox Family's library of television programs, also called "content". Fox Family's last annual report listed "4400 hours of completed family programming and made- for- television movies" and "6200 half- hour episodes of completed and in-production children's television programming", including the Power Rangers shows. All this content cost about $2.29 billion to produce or acquire, if I read the financial statements correctly.
There are two questions here: What are these programs worth today? And what does Disney plan to do with all this content? Since these programs have already been aired at least once, and some may already be several years old, their value is certainly less than the $2 billion it cost to make them. Still, this is 7,500 hours of television programming -- enough to run 24 hours a day for 10 months.
And that brings us to the next question: What does Disney intend to do with all this programming? Sell it for cash? Repackage it under the "Disney" brand and sell to consumers? Use some of it on the new cable channel? I suspect it will be a combination of these.
Disney's current agreement with its ABC broadcast affiliates only allows 25 percent of ABC's programming to be repurposed, which means the other 75% of the new ABC Family Channel will need to be filled with something. That something will likely be repurposed content from ESPN, the Disney Channel, E!, Lifetime and some of the other Disney-owned cable channels, or it could also include multiple showings of those 25 percent of ABC shows. Still, I expect there will be unfilled airtime available, and this library's content will essentially be free once Disney buys it.
The programs that Disney doesn't want to use (either being to old or perhaps too racy) will likely be sold off to collect cash rather than dust. Other programs may be repackaged with a Disney name or label and sold as video tapes or DVDs directly to consumers.
Viewers: Fox Family Channel has 81 million subscribers in the U.S., and reaches 95 percent of all cable and satellite households. This is important because unlike small so-called "disposable" goods (such as food or clothing) which we purchase frequently and often change brands, once a cable viewer (or, more precisely, the cable company they are connected to) subscribes to a channel, they tend to keep subscribing for a long time.
So effectively, Disney will be getting 81 million subscribers to its new ABC Family Channel immediately instead of spending several years and lots of money to get to that point if they were to build up a new network from scratch. This is extremely important to Disney, as the company can charge advertisers for 81 million pairs of eyeballs from day one.
Access: This is probably the most important piece of Fox Family that Disney is buying. If Michael Eisner's idea of a new channel re- showing programs is a good one, the company needs a path to get it to the viewers. This is not as simple as it may sound, as many older cable TV systems across America are at maximum capacity. In order to add an entirely new channel from scratch, Disney would have to convince cable operators to remove something else. And as the cable industry in the U.S. consolidates into fewer but larger companies, these cable companies holding ever greater power could conceivably keep a new ABC channel off viewers' sets unless Disney were to agree to onerous terms.
Instead by buying an existing channel, Disney simply takes Fox Family's place on all those cable systems. Fox Family's affiliate agreements run for three, five or 10 years, and this gives Disney a guaranteed place to run those ABC Family programs for at least that long. And unlike the Disney Channel, Fox Family is a "basic cable" channel. This means every viewer in a subscribing cable system gets it, not just those who pay extra for the "premium" slate of channels. A final bonus is that Fox Family's agreements with the cable system operators provide for annual per-subscriber rate increases, so Disney also has an ability to raise the fees it receives.
Disney gets another kind of access from buying Fox Family: international access. Fox Family, through its Fox Kids subsidiaries, has 21 million subscribers in Europe and another 10 million in Latin America.
This guaranteed access is a very important and recurring theme at Disney. Its spat with Time Warner Cable in 2000 (when Time Warner pulled ABC off 11 cable systems with 3.5 million viewers during the crucial May "sweeps" week in a dispute over which other Disney cable channels it would carry) may have scared Disney into making this purchase. But Disney has been concerned about the access issue for years before that.
Access was also a driving factor in the decision to purchase ABC as well. Disney was afraid that the big broadcast networks would shut out Disney programs for their own in-house creations so that the networks wouldn't have to share the profits (especially the syndication profits) with Disney. Eisner even talks about this in his autobiography Work In Progress, comparing the network's access to the viewers as a tollgate on the freeway you need to drive on to get to work. Eisner's fear was that eventually the toll-taker won't raise the gate now matter how much you offer to pay him. This analogy would also apply to the cable industry, as there are now only a few larger toll-takers running most of the cable systems in the U.S.
Personally, I believe this fear is, in the long run, overstated. The TV networks will only prosper if they put on programming that the viewers want to watch. If Disney continues to produce better programs than the networks can and charges a reasonable price, then the networks will continue to buy Disney's programs. And the same logic applies to cable system operators: they will only keep subscribers if they provide channels that viewers want to watch.
Furthermore, even if in Eisner's metaphor the toll-takers won't let Disney pass, new technologies such as satellite receivers and broadband-based systems are being developed that will create side roads around the tollbooths. If big cable systems won't show Disney programming, would some up-and-coming technology jump at the chance to get Disney's quality shows? Absolutely! And remember, this has happened once before: the fledging ABC-TV got its first big boost in the 1950s by trading an investment into Walt's soon- to- be- built Disneyland theme park in exchange for Disney- created programming such as Davy Crockett. However in the short term, if Disney wants another cable channel, this is probably the quickest way to get one.
That just about covers what Disney is buying from the Fox Family Channel. But there still are a lot of questions: why is Disney doing this, how will they pay for it, and is this deal worth all that money?
Let's continue our analysis in Part Two.