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Alex Stroup, Editor

Comcast vs. Disney

Comcast, Disney, and the business of hostile takeovers

Thursday, February 12, 2004
Alex Stroup, editor

More than anything else, this whole Comcast thing is a period of questioning for most of us. The world of high finance, corporate politics, mergers and acquisitions is generally foreign. I've seen a lot of questions asked on our own message boards and by others who know I follow Disney pretty closely.

So, rather than try to turn this section into a regular article, I am just going to present it in a question-and-answer format, covering everything I can think of and also presenting some questions to which I don't begin to know the answer. If you have any questions of your own, or want to correct or expand on anything I say, please send me an e-mail, and we'll include them in a follow-up article or mailbag.

Q. Who is Comcast?

A. From the company's own blurb:

“Comcast Corporation (www.comcast.com) is principally involved in the development, management and operation of broadband cable networks, and programming content. The Company is the largest cable company in the United States, serving more than 21 million cable subscribers. The Company's content businesses include majority ownership of Comcast-Spectacor, Comcast SportsNet, E! Entertainment Television, Style, The Golf Channel, Outdoor Life Network and G4.”

Reading that, it is kind of hard to believe that Comcast is bigger than Disney. After all, Disney has a load of networks, too! Plus a pretty good sized film and television library, four theme parks, a pretty successful cruise, a hockey team, and a publishing company, among other things.

But it turns out that being the nation's largest cable company will really get you somewhere. Think about your cable bill. Think about 21 million other people with the same cable bill, or higher if they're paying for all the HBOs and Showtimes and the occasional pay-per-view. And then start thinking about the people using cable for broadband Internet access. It quickly turns into a pretty good stream of money.

One of the key emotional attachments for Disney fans is the company's rich history. If Disney should become part of Comcast, here is an overview of the new history to be learned and cherished:

Comcast started in 1963 as American Cable Systems when founders Daniel Aaron, Ralph Roberts, and Julian Brodsky purchased a small Tupelo, Mississippi, cable system. By 1969, they'd grown into their current headquarters (Philadelphia) and name.

Since 1969, they've taken good advantage in the growth of cable, but have mostly grown through key acquisitions and golden divestitures. Comcast purchased smaller cable companies all over the country and got in early on Barry Diller's QVC shopping network. Eventually, Comcast gained controlling interest in QVC, and it was a cash cow until they sold it in September 2003 for almost $8 billion.

Comcast became the nation's largest cable operator in 2002 when it completed a takeover of faltering AT&T Broadband for about $48 billion.

In addition to cable operations and networks, a subsidiary (Comcast-Spectacor) owns controlling interest in the Philadelphia 76ers basketball team, the Philadelphia Flyers hockey team (as well as the arenas in which they play), the AHL minor-league Philadelphia Phantoms hockey team, three minor league baseball teams, and a number of arenas and theaters around the country.

Q. What is a “hostile takeover” and how does one work?

A. The key thing to remember here is that Michael Eisner and the Walt Disney Company board of directors do not actually own the company. The company is publicly owned by the thousands of individual shareholders who own Disney stock, and they've selected Michael Eisner and the board to look out for the best interests of the shareholders.

According to Comcast's letter to Disney, Brian Roberts, Comcast CEO, approached Michael Eisner earlier this week about discussing a possible merger.

As an analogy, let's say you own a second house and have a financial manager handle it for you. A neighbor wants to buy the house, and he approaches your financial manager, who sends him packing, telling you that it doesn't make any sense to sell the house at this time to that person.

That's essentially what Eisner has done. He (the financial manager) has told the owner of the house (the shareholders) that selling to Comcast (the neighbor) isn't a good idea. End of story, no sale!

Actually, no. While the financial advisor can make recommendations, he doesn't actually have final authority to say no. The owner does, and can overrule the financial manager.

And that is just what Comcast is going to do. If it can't convince Eisner and the board that the company should be sold, Comcast is going to go directly to the shareholders and ask them if they are willing to sell. That's the “hostile” part of a hostile takeover—it happens against the recommendation of management.

One way this can be done is to simply buy all the shares in the company (or, a majority of the shares). In any publicly traded company, individual shares are trading hands all day long, keeping those people busy on the floor of the New York Stock Exchange. If somebody wanted to, they could just patiently buy shares as they became available for sale until they owned a majority. Since a majority would be able to pass any shareholder resolution, they could then sell the company to themselves.

If you look back over history, you can see this in 1983 when Disney was last going through something similar. Sensing that the company was weak, several investors purchased very large portions of Disney with the intent of either being paid off to leave the company alone or eventually capturing a controlling interest and breaking the company into pieces for a huge profit. Fortunately for Disney fans, this was avoided in a series of maneuvers that culminated in Michael Eisner and Frank Wells taking lead of the company.

But Disney is much bigger now, and it just isn't feasible for one company to buy enough shares on the open market to take control of Disney. As they gained more shares and available shares became scarcer, it would just drive the price up and up.

So, instead, they're going to make an offer and try to get every Disney shareholder to sell their shares for a predetermined price. The price that Comcast offered Wednesday morning put the total value of all Disney shares at about $66 billion (minus around $11 billion in debt).

Not many companies have that kind of cash lying around, so they aren't actually offering you $10 for your $10 of Disney stock. Rather, they are going to offer shareholders $10 of Comcast stock for $10 of Disney stock.

But who would accept that? If the shareholders preferred $10 of Comcast stock, they'd already have it instead of their $10 in Disney. So Comcast has to sweeten the deal. The first thing they do is offer a “premium.” Specifically to this deal, they offered $11 of Comcast stock for every $10 of Disney stock.

So right out of the gate, Disney shareholders would be up 10 percent. Not a bad return for checking “yes” on a form. But still, 10 percent isn't all that much (for example, in the very messy attempt by Oracle to take over PeopleSoft, Oracle is currently offering a 20 percent premium). So Comcast has to not only offer immediate profit for investors with that interest, but also promise improved long-term growth for the long-term investors.

While Comcast will offer money as an incentive, the brunt of its push to Disney shareholders will be arguing that more money is to be made by a Disney-Comcast hybrid than by Disney and Comcast separately.

If Comcast makes that case and 51 percent of shareholders agree, then the “hostile takeover” will be completed.

So, while the common perception is that a hostile takeover forces a company to sell itself, that isn't quite true. Even in a hostile takeover, the true owners of the company have to be convinced to sell (though over the objections of management).

Q. Why now?

A. There are likely many reasons for the timing. The takeover of AT&T Broadband has been completed and most of the wrinkles have been worked out by now. The sale of QVC has loaded its coffers. Also, Comcast can look to the previous examples of other mega-media mergers in recent years such as AOL/Time-Warner and News Corp./DirecTV to help guide it.

From the Disney side, Comcast has many reasons to see a buying opportunity right now. Disney management is under attack, and selling could provide them with a way out as well as new positions on the Comcast board of directors (in addition to sweetening the deal for shareholders, there are things that can be done to sweeten the deal for management).

If Comcast feels that current management has been underperforming with such assets as the ABC television network, it may feel there is plenty of investment return to be found simply by replacing that management.

Jim Hill had some interesting comments on his JimHillMedia.com Web site yesterday about the “coincidence” of Disney's annual shareholder meeting being in Philadelphia next month. While I don't know if I buy the idea that Eisner has something going that would secure his legacy for creating the world's largest media company, the timing of this announcement right before will surely give the shareholders an opportunity to express their feelings about the offer.

However, hostile takeovers are rarely a quick event and it is very unlikely that anything would be concluded by that time. If, however, Eisner and the board are going to approve the offer, it would be a good opportunity to sell Comcast to the Disney shareholders.

Q. What's in this for Comcast?

A. Content. Content. Content.

Many people don't realize it, but cable companies don't get their channels for free. You might think a network would say something like, “Hey, we have something we want to show, you have a way of showing it, why don't we split the income from commercials?”

It doesn't work that way. As an example of this, see the ongoing feud between Cox Cable and Disney over the cost of just one channel: ESPN.

According to numbers posted by Cox at their MakeThemPlayFair Web site (link), they pay $2.61 per subscriber per month. Assuming Comcast pays the same rate and has 21 million subscribers, that would mean that every month, Comcast has to pay Disney $54.8 million just to distribute ESPN (this doesn't include all the other Disney owned cable channels, but ESPN is the most expensive).

To offset that cost, Comcast gets to sell two minutes of advertising per hour. If Comcast owns ESPN, it doesn't have to pay the $54.8 million—and it gets to sell all of the advertising for its own subscribers. Additionally, Comcast essentially get a piece of every non-Comcast cable and satellite subscriber in the United States and beyond. Comcast (a cable company) will charge Cox Cable (another cable company) $2.61 per subscriber, and get 80 percent of the advertising revenue from ESPN appearing before Cox Cable subscribers.

If those at Cox Cable aren't happy negotiating with Disney over the price of ESPN, I'm guessing they'll really dread negotiating with Comcast.

The networks owned by Disney really are the draw for Comcast. The movies are a nice bonus as they'll provide content for the networks Comcast would own.

Q. What's in it for Disney?

A. Synergy and distribution. Owning the content is good for the distributor. Owning the distribution is also good for the content provider.

In a merger with Comcast, Disney assets would gain sweetheart access to 21 million subscribers. Guaranteed placement of the lesser cable networks (and as part of the more lucrative basic cable packages). There are simply many advantages to be had when you don't have to compete with the other content providers for the attention of a distributor.

Synergy is always a difficult thing to assess. Even when it seems obvious it can be very difficult to pull off. There are large parts of the Disney package where you have to wonder if Comcast would really be interested in them.

What do the people of Comcast know about running a major broadcast network, the largest amusement park in the world and a cruise line? This uncertainty leads some to wonder if all Comcast really wants are the networks and eventually the other pieces would be spun off or sold. I certainly don't know.

However, if they are retained, there are several obvious synergies for promoting these fringe elements (to think that Disneyland might be fringe!). You could certainly bet that the PGA events held at Walt Disney World courses would get great play on the Golf Channel.

Essentially, the entire Disney company would be given greater advertising access to over 21 million homes. Comcast will certainly have a lot of explaining to do in this area before shareholders or the board can be sold on an offer. It is interesting to note that in its official term sheet, Comcast barely mentions the theme parks and completely skips over the Mighty Ducks, Disney Cruise Line, or the Disney Vacation Club properties.

It should be kept in mind, though, that at least initially it appears that the Eisner's answer to this question, “What's in it for Disney?” is “not enough.”

Q. What can Disney do to fend off a hostile takeover?

A. There are various things that can be done to avoid a hostile takeover.

Going back to the 1983 troubles, when Disney saw that certain investors were stockpiling shares for an eventual power grab, they didn't do anything particularly subtle to avoid the threat. They paid a lot of cash and bought the shares back from those investors. This is called “greenmail.” The raider says, “Pay me off, or I'll dismantle you.”

But that isn't going to be an option this time, since Comcast isn't buying shares.

One common anti-takeover maneuver is the so-called “poison pill.” This is a section of a company's bylaws that has no business reason to exist other than making a hostile takeover more difficult. Without going into too many details, such poison pills increase the number of outstanding shares, both diluting the value of any one share and increasing the cost of acquisition.

This option isn't available to Disney, however. While there used to be a poison pill in the corporate bylaws, this was allowed to lapse several years ago. If Disney management wants to resist a takeover, they're going to have to find other ways.

Disney could make itself financially less desirable. I don't know enough to suggest ways this could happen, but looking to the Oracle/PeopleSoft battle might provide an insight. In response to Oracle's hostile bid, PeopleSoft ran out and bought another company itself. The hope was that PeopleSoft could make itself too big for Oracle to buy. I personally have one friend at PeopleSoft waiting on the edge of his seat to know if that'll happen.

Another thing Disney could do would be to try to set up anti-trust problems down the road. Unfortunately, it isn't clear just what would trigger such a response… Perhaps if Disney could buy into a different distribution system such as satellite.

Finally, if Comcast is really most after the cable networks (particularly ESPN), then to prevent a total takeover, Disney could either try selling those most desired assets to Comcast or someone else.

Q. Can I go to bed now?

A. I'm going to whether I should or not. This column has become much longer than I planned when I started. We're going to run it in two parts, and I will include good responses to this part in the next part. Additional questions I want to discuss include:

  • “What history do Disney and Comcast have together?”
  • “How does all this affect the anti-Eisner campaign being waged by Roy Disney and Stan Gold?”
  • “Does this affect the Pixar relationship?”
  • “What are the regulatory approvals required and will there be any snags?”
  • …and most important, “Which hockey team will be sold: the Mighty Ducks or the Flyers?”

So, until the next installment, thanks for reading—and hope this helps.


Send your comments, questions and feedback to Alex here.


ABOUT THIS COLUMN

The Business of Magic column looks at the Walt Disney Company as a business entity, and all of the various business issues related to it.

The column was originally founded by Dan Steinberg, who is currently focusing on the success of his own business career. The column's current editor is Alex Stroup, MousePlanet CEO. Alex holds a graduate degree in library & information science, and works for one of America's top-level financial institutions, and lives in the San Francisco Bay Area.

Send your comments to Alex here.

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