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Alex Stroup, Editor

Comcast vs. Disney

Comcast, Disney, and the business of hostile takeovers—Part 2

Tuesday, February 17, 2004
by Alex Stroup, editor

In Part 2 of this series, Alex continues his look at Comcast's bid to buy the Walt Disney Company. [Part 1 was published last week, and is available here.]

Q: Is this a hostile takeover?

A: In my lengthy explanation last week of what hostile takeovers are and how they work, I forgot to answer the more fundamental question, “Is this a hostile takeover?”

The answer to that is “not yet,” but it is pretty clear that it is a road Comcast is willing to travel. What we have at this point is an unsolicited offer, which will be considered by Disney's Board of Directors. When the board rejects the offer, Comcast will either sweeten it—getting further consideration from the board—or it will begin taking more aggressive measures to circumvent the board.

After this story was filed, it was released that the Disney board was officially rejecting Comcast's first offer. With the offer less than the current value of Disney, it was a no-brainer. Now the ball is back in Comcast's court. We'll likely see a quick reaction.

Q: Does this impact the situation with Pixar?

A: From now until Pixar officially signs a new distribution deal with someone, this is going to be one of the side questions to every Disney event.

Yes, this could impact the situation with Pixar. There are a lot of hints that the problems between Pixar and Disney are mostly personal issues between Michael Eisner and Steve Jobs. If that is the case, removing one of those people from the picture certainly changes things. Pixar still has two years before they have to sign a new deal with someone, and that is plenty of time for everything about the Disney/Pixar relationship to change.

However, when it comes to a deal between Disney and Pixar, Eisner and Comcast have to look at it in fundamentally different ways. As part of a new deal, Jobs is asking Disney to give up several valuable things it already has (including certain rights to the existing movies, giving up the existing lucrative terms for The Incredibles and Cars). Michael Eisner has to look at that and say, “You're asking us to give up things we know to be worth millions of dollars for reduced rights to movies that may be worthless.” When you're an executive trying to turn performance around, it must be pretty hard to give away known assets in favor of potential ones.

For Comcast, it is much easier to promise away things they wouldn't otherwise have. Also, nobody on the Comcast team has any real experience in the movie business. They don't know much about making them, marketing them, or leveraging them. From this group of people, one would have to think it would be easier to get a sweeter deal than from Eisner (who has been making movies for almost 30 years now, going back to his days at Paramount).

Q: What about X part of the company?

A: At this stage of events, it is certainly impossible to say anything with certainty. So far, Comcast has not indicated there is any part of the Disney Company it's not interested in, that it would sell or spin off various divisions should its bid succeed.

It is obvious, though, that it is ABC and the cable networks that are of most interest to Comcast's current business. If it weren't for the presence of former Disney executive Steve Burke in all of this, it would be much more cut and dry that such things as Hyperion Books, Disney Cruise Line, Disney Vacation Club would be way out on the fringe of a new Comcast-Disney company.

But Steve Burke and his past experience at Disney does raise the possibility that Disney might continue pretty much as is. That Burke would be put in charge of Disney operations and continue running it pretty much intact (minus the networks) as almost a subsidiary of Comcast would probably be the best outcome for the fan of “Disney magic.”

But at this point in time, it is impossible to say how the future would change for specific divisions of Disney.

Q: Who is Steve Burke?

A: If the merger happens, Steve Burke is the Comcast executive likely to be the guy who will end up running all things Disney. And let's face it, if someone is going to buy Disney, it probably isn't a bad thing if the guy in charge is already listed in Dave Smith's encyclopedic Disney A to Z.

Stephen Burke has very long ties to the current Disney company that go all the way back to childhood. Steve's father spent 30 years working for Thomas Murphy at Capital Cities and then ABC/Capital Cities. Murphy, a personal friend of Burke's, is now one of the members of the Disney board of directors that will be charged with accepting or rejecting Comcast's offer (until his forced retirement as of the next board elections).

According to Disney A to Z, Burke joined Disney in 1985 and by 1987 was a vice president of The Disney Store, where he played key roles in its phenomenal growth. In 1992, he went to Paris to join the staff of Euro Disney, and by 1995, was the President and Chief Operating Officer of Euro Disney, having helped turn the company around to profit, refinanced its significant debt, and changed its name to Disneyland Paris.

In 1996, he moved over to ABC after it was purchased by Walt Disney, and continued to rise in the ranks.

Not included in Disney A to Z are the frequent mentions from that time of Burke as a possible successor to Eisner. But as with so many other possible successors who left, he eventually left the company to run Comcast's cable operations (where he received high credit for a smooth merger of AT&T Broadband into the company). When he left, many had the impression that not working for Eisner was a plus in Burke's book.

If nothing else, Burke certainly knows the right things to say to mollify the Disney fans. How could you not like quotes like these:

“And one of the first things that we would like to do is—if we're fortunate enough to put these two companies together—is do everything we can to empower the existing animation group to make sure that they feel like they're right in the heart of the company.”

And

“The second area where we think that there's room for revitalization and improvement are the Disney theme parks. It's hard to think of a product or service in the United States that families love more than the Disney theme parks. And we believe that there are ways to revitalize those businesses, restore some of the creative spark to the attractions and hotel and concessions side of those businesses.”

So, if you believe that Eisner is actually harming the Disney image, this merger may not be such a bad thing. This guy knows Disney and knows the history of the company. There is every reason to hope that he'd be a great candidate for marshaling the magic that many feel has gone missing.

However, he is a businessman. He has never been directly responsible for creative content, and all of his greatest achievements at Disney were financial. Just a cautionary note.

Q: Why is Comcast a “bigger” company than Disney?

A: Market capitalization. It essentially boils down the fact that something is worth as much as people will pay for it. For a publicly traded company, it is the stock market that demonstrates what someone will pay for a company.

Let's keep the math simple and say that Disney is owned by 10 people, each of whom owns one share of Disney stock, for which they paid $1,000. That means that Disney is worth $10,000 (its market capitalization).

Owner #1 decides he wants to retire to an island in the Caribbean and needs cash to bribe a local government official into selling it. So he announces his share is for sale, and nine people come forward to buy it. A bidding war happens and eventually the share is sold for $1,000,000.

Since something is worth what people will pay for it, not only is that share now worth $1,000,000, but the nine other identical shares also become worth $1,000,000 each. So, based on the sale of that one share, the market capitalization of the whole company has gone from $10,000 to $10,000,000.

Based on this, the nine other shareholders all realize they're rich and want to own islands as well. So they sell theirs. But it turns out the remaining eight buyers were the only ones in the whole world particularly interested in owning Disney. Owners #2 through #9 are all able to sell their shares for close to $1,000,000 but owner #10 has nobody to sell to. So she starts dropping her price, and finally finds a buyer when she gets down to $50,000.

So, at that moment in time, a share that was once worth only $1,000, and then $1,000,000, is now worth only $50,000, and the whole company is valued at only $500,000.

And that is how the stock market works. It is constantly resetting the value for a single share of company stock and therefore can wildly increase or decrease the total market capitalization of companies that have millions of shares.

On the day that Comcast announced the offer, Disney had about 2 billion shares worth $23.85 each. Comcast had about 2.25 billion shares worth $33.40 each. In other words, as far as the stock market was concerned, Disney was worth about $49 billion and Comcast was worth about $75 billion, or 50 percent more than Disney.

I'm certainly not going to get into why those are the stock prices, but that is why, in the world of business, Comcast is clearly the larger company, while to the minds of most people Disney appears much bigger.

Keep in mind, though, that much bigger (as measured by market capitalization) doesn't necessarily mean everything. It is entirely possible that if Disney's stock continues to rise and Comcast's to fall, they'd end up with similar market capitalization. That doesn't necessarily kill the deal. Market capitalization is most important for all-stock deals of the type Comcast has offered. We already know that isn't going to be enough, and Comcast may look to pile cash on top. And a smaller company with lots of cash can be just as dangerous as a huge company with valuable stock. See the answer to “What is a white knight?” below for more on this.

Q: How has the market reacted to the offer?

A: When Comcast made its initial offer to buy all outstanding shares of Disney stock, the offer was 0.78 shares of Comcast for each share of Disney. At that moment, this was a premium of about 10 percent (that is, the value of 78 percent of one Comcast share was 10 percent higher than the value of a full share of Disney).

Immediately, Disney shares rose and Comcast's fell. By the end of the day, the change was such that 78 percent of a Comcast share was worth less than that of a Disney share. On Friday, the trend continued. What this indicates is that investors expect a takeover to have a good chance of success, but that Comcast will have to significantly increase its offer, or a third party will enter the fray with an even better bid.

Interestingly, the market also made some speculative predictions on ways that Disney might defend against a takeover. One of the things a company can do is try to make itself too big to swallow. In addition to the greenmail mentioned in Part 1 of this series (Disney repurchased shares from raiders at a significant premium), this tactic was also taken by Disney back in 1984. To puff itself up, Disney quickly purchased Arvida, a Florida real estate developer, which it then sold in 1987 after the crisis passed (Disney, however, is still embroiled in ongoing lawsuits resulting from 1992's Hurricane Andrew, which showed many Arvida projects to have been poorly constructed).

Analysts seem to agree that it will be difficult for Disney to buy itself out of this one, but should it try, the common name mentioned is Echostar, a provider of satellite television. Such an acquisition would make Disney a bigger pill to swallow—about $11 billion—and would also throw a significant antitrust wrench into a Comcast/Disney purchase, since it is unclear if government regulators would allow a company to own both cable and satellite delivery channels.

There are many aspects that make it unlikely, but on news of the Comcast offer, Echostar shares rose more than $2, and the price remains up more than a dollar.

In a side story, investors in Disneyland Paris were excited by the Comcast announcement. Shares in the holding company that owns Disneyland Paris (Euro Disney S.C.A., of which Disney owns about 40 percent) rose about 15 percent on the day of the announcement. It is somewhat perplexing to figure, though, as it is expected that a Comcast/Disney merger would have little effect on the financial standing of Disneyland Paris, which is well separated from the actual Walt Disney Company.

Q: What is a “white knight”?

A: A white knight is an investor brought in by a company to fend off an unwanted takeover. The white knight could either be a different purchaser who would buy the company on preferable terms, or someone who simply makes it much more difficult for the takeover to happen.

One name bandied about freely the last few days is Microsoft. Not only is Microsoft one of the top five largest companies traded in the United States—with a value over $280 billion, the combined Comcast/Disney company would still be less than half as large as Microsoft—but Microsoft has something not many companies have: Over $50 billion in cash. You know that fantasy we've all had of walking on to a car lot and saying, “How much if I just pay cash?” Well, Microsoft could just about do that with Disney; just show up at a board meeting and write a check.

If Disney could negotiate a deal on its terms with Microsoft, Comcast wouldn't be able to do anything about it. Disney would be offering something to Microsoft that it used to want. For a while, Microsoft was investing heavily in media networks (MSNBC, for example), but that is a position it has moved away from in recent years.

After much initial speculation, the analysts seem to have agreed that Microsoft isn't likely to be Disney's white knight. In fact, they've now flipped and wonder if Microsoft will be Comcast's white knight.

It is clear that Comcast will have to improve its offer. The current offer is stock only, but if it gets much more expensive, Comcast is going to have to start using cash, and Microsoft has both a lot of cash and an interest in seeing Comcast succeed—Microsoft is one of Comcast's largest stakeholders, owning about 7 percent of the company. If Microsoft has an interest, it could significantly increase its ownership of Comcast, providing the company with a hefty bankroll for an improved offer.

Other than that, there aren't a lot of candidates out there for friendly takeovers. There just aren't many companies that have both the ability and the desire to purchase a company the size of Disney. So, if it isn't going to find someone bigger to be a white knight, what are its options?

Disney could find someone smaller to take up a significant ownership interest in Disney and help block the shareholder vote on a takeover. If 10 percent of Disney stock is in one person's hands and that individual opposes the deal, that means that Comcast would have to muster the support of 56 percent of the remaining shares. If 20 percent, then 63 percent.

And this is just another way that Disney has exposed itself to a takeover. Disney let its poison pill expire, it has full slate board elections, and it has no large stakeholders. So it could try to get some large shareholders. There has been some mention of Warren Buffett, who has previously been quite invested in Disney. It is unlikely, however, that he'd return while Eisner is still around, since it was a large part of why he divested in the first place.

Disney could also purchase a large company with a large shareholder who would be friendly to Disney's interests. In the Echostar scenario mentioned previously, for example, founder Charles Ergen might end up with voting control of as much as 10 percent of a combined Disney-Echostar company. If he were opposed to a Comcast-Disney merger, it would create a significant hurdle. But as mentioned, there are many reasons this is unlikely (Ergen is apparently unlikely to sell the company he founded, and Eisner remains firm that Disney has no interest in distribution; just content).

As many watchers have pointed out, Disney's best hopes for a white knight may be Disney itself. Most stock analysts already consider Disney an undervalued stock, and continued numbers like those just announced for the last quarter could do a lot to naturally raise the price Comcast would have to pay for Disney, and Comcast has shown itself willing to walk away from deals that get too expensive.

Q: What say does the government have in this?

A: In the United States, this deal is going to be reviewed by two agencies: the Federal Communications Commission and the Department of Justice.

The FCC is responsible for regulating the broadcast airwaves and certain areas of the cable industry. The Department of Justice is tasked with enforcing antitrust laws.

FCC Chairman Michael Powell immediately indicated that a Comcast/Disney merger would be reviewed through the agencies' “finest filter.” However, there may not be much he can do. The FCC used to have regulations that prohibited companies from owning cable and broadcast outlets in the same markets. If still in effect, this would have required that the combined company sell many of its radio and television stations (including one in Philadelphia). That rule, however, was ruled was struck down in 2002 because the FCC failed to adequately justify it.

The deregulation-friendly FCC and Bush administration let the rule lapse rather than pressing the case. Several consumer advocacy groups are pressing for legislation that would reinstate the rule. If that happens before a deal is finalized and approved, it would create a hurdle.

Under the new regulatory environment, a similar deal between News Corp. (owner of the Fox family of networks and several television stations) and DirecTV (a satellite TV provider) was approved. There were stipulations intended to guarantee that the new company would continue to provide access to Fox channels and content without giving too much advantage to its own distribution network. If a Comcast-Disney merger happens, experts expect that similar approval and requirements would be forthcoming.

Similarly, experts see little trouble from the Department of Justice. While the DOJ is very concerned about horizontal monopolies (one company dominating a single market) it has shown less interest in inhibiting vertical monopolies (one company owning the entire development and distribution process). And again, there is recent precedent of the DOJ allowing similar mergers that make regulatory trouble unlikely.

However, with each of these mega-media mergers, it seems that the public concern over consolidation increases, and politicians are eventually going to try to find new ways to hamper it.

It is always possible that Powell will face a political reality of needing to find a creative way to stop the deal. Disney is a name that everyone knows and most have some emotional reaction to (though not always good).

It isn't unlikely that this will make a good case for the consumer groups and friendly politicians (many of whom are still upset about other recent FCC rule changes that allowed more consolidated media ownership) to fight on. If they are sufficiently successful, Congress can find all kinds of ways to hamper a deal. But if so, it can't be predicted at this point.

Internationally, the deal may also face review in any country where both Comcast and Disney do business. The European Union reviews all mergers and acquisitions involving companies that do more than €250 million per year within Europe.

While Disney readily meets this requirement (about $3.2 billion last year), Comcast's numbers are unclear and will have to be reviewed. Comcast used to do significant business in Germany and the United Kingdom through its ownership of the QVC shopping network. However, they sold that business last year.

If there are regions other than Europe where both companies have done significant business, I haven't been able to find them (Australia, possibly).

Q: What will happen to the employees?

A: From the perspective of the employee, the worst-case scenario for a merger is one with high “overlap”—how much of the existing businesses of the separate companies overlap.

Looking yet again to the ongoing Oracle/PeopleSoft battle, that is a true worst-case for PeopleSoft employees. Oracle CEO Larry Ellison has already said that the purpose of the takeover is to convert PeopleSoft customers to Oracle products and that almost no existing PeopleSoft employees would be needed.

Fortunately for the employees of Comcast and Disney, their merger would be on almost the opposite end of the spectrum. The two companies have almost nothing in common, except that both run some cable networks and both own a sports team (or several, in Comcast's case).

Comcast's primary business is delivering cable and broadband Internet services. Disney produces entertainment content, runs entertainment destinations, and has a huge consumer products business. Comcast is not going to be able to use many on the current staff to continue any of those businesses.

In its press conference last Wednesday announcing details of the offer, Comcast's Steve Burke was asked about redundancies, and he responded, “What we mentioned was that there were about $300 to $400 million worth of cost reductions due to overlap. That represents—I think—less than one percent of the combined company and that overlap would be in very specific areas.” [Thanks to Jim Hill for getting a transcript posted at his Web site (link) so that I didn't have to navigate the press conference again looking for this question.]

Those specific areas are almost entirely within the cable networks (but even then, not so much) and within the corporate management part of the companies. A lead cast member at Disneyland or a departmental IT tech will not have to worry about losing their job to someone at Comcast. A middle manager in human resources or a compliance lawyer in the legal department, however, may have some reasons for concern.

Q: What will happen to the Disney name?

A: No one can say for sure at this point. There are only a half dozen broad possibilities.

Since the Disney brand is one of the most valuable brands in the world, it is already unlikely that Comcast would try to rename everything under a Comcast brand. Add to that Comcast having absolutely no name recognition in most of Disney's marketplaces, and it is even more unlikely.

At this point, is seems pretty safe to say that should a takeover happen, most of the Disney products will remain Disney products, even if they are just part of a different company.

As for what the new combined company would be called, there are four options: It could remain Comcast; Comcast could take Disney as the name for the whole company; some kind of blended name could be fashioned; or a completely new name could be picked.

I've received one e-mail wondering if “Newco” was really going to be the new company's name. At its press conference last week, the Comcast team used this to refer to the blended company several times. But it is just a placeholder common to such deals; it is not a serious proposal for a new name.

The option of Comcast taking Disney's name isn't so far-fetched as many might think. In 1998 when NationsBank purchased Bank of America and Norwest purchased Wells Fargo, both decided that the purchased names were more valuable. Thus, today, most people think Bank of America purchased NationsBank and Wells Fargo purchased Norwest, though the opposite is true.

As I said earlier, the Disney name is one of the most powerful marketing brands in the world. Most people are not going to switch their cable company (in fact, most people can't switch their cable company) because of the name on the bill. But there is an immediate boost to a movie when it has the Disney name on it, and it is the same for hundreds of other consumer products.

Joint names are pretty common in some industries (ExxonMobil, Morgan Stanley Dean Witter), but the recent example of AOL Time Warner (which recently decided to drop the AOL and just be Time Warner) will probably be the prevailing precedent here.

Q: Where would the company be headquartered?

A: Disney is headquartered in Burbank, California, and Comcast in Philadelphia, Pennsylvania. A top Comcast executive indicated last Friday that the headquarters would remain in Philadelphia, where the company has deep roots.

The Disney headquarters in Burbank may not have the same deep roots as Comcast, but it has pretty significant business roots. It would be pretty hard to run major film and television divisions from Philadelphia, and even if they tried to move all the top management out there, the people spending the money would still be in Hollywood.

Either the company will end up with a split personality (if Philadelphia management tries to maintain tight control from 2,700 miles away) or they will just give the Hollywood-centric portions of the company loose reins. Or they might eventually decide to that it is easier to run cable operations from Burbank (or nearby) than running Hollywood from Philadelphia.

In other words, I have no idea what would happen. The executives at Comcast have said one thing, but it seems it would be difficult to pull off.

Q: Would Michael Eisner have a role in the new company?

A: It is unlikely, and almost certainly not a management position. The top management tier of takeover targets rarely does very well in the new company, especially if that management had actively resisted the takeover.

To convert this into a friendly merger, it is possible Eisner might be assured a position on the board of the new company, but it seems unlikely. In the investment community, Eisner would be more of a hindrance than an asset, and after 20 years in charge, nobody is likely to trust that he can just sit and offer advice at quarterly board meetings.

Personally, I think that if he had the financial responsibility removed from his shoulders and was given the movie studios (not that either side would ever go for this), it might rekindle the shrewdly creative role he played at Paramount and his first decade at Disney.

Q: How do we contact the Disney board and let them know they shouldn't consider this offer?

A: Any time you want to communicate directly to the Disney board of directors, you can send your mail to:

Board of Directors
The Walt Disney Company
500 S. Buena Vista St.
Burbank, CA 91521-9722

FAX: 818-560-1930

I've received a couple e-mail comments from people asking how they can contact the board, and who to protest that they are even considering this offer. And therein lies the maneuvering in Comcast going public with an offer to purchase.

Ideally, Comcast would prefer to have discussed this behind closed doors with Michael Eisner and the board. Then some equitable agreement would be found and Comcast and Disney management would provide a united front in selling the deal to the shareholders.

Apparently, Eisner didn't even want to start discussions. So Comcast developed terms on its own and presented them, thus triggering one of the fiduciary responsibilities of a board of directors. The board is required to seriously consider any offer of purchase. Comcast offered, and the board immediately said, “All right, we'll look at it.” They had no choice in the matter; after consideration, they can then say no. Doing so without consideration, however, would open the Disney board to all kinds of trouble.

Q: What about the sports teams?

A: The Walt Disney Company owns the Mighty Ducks of Anaheim and Comcast owns the Philadelphia Flyers, both in the National Hockey League.

Ownership rules prevent a single owner from owning more than one team, so one of the two teams would have to be sold.

According to audit numbers released last week, NHL teams lost a combined $273 million last season, with only two out of 30 teams making a profit in the $10 million range. A breakdown by individual teams was not released, but the Philadelphia Flyers are considered a more financially stable team than the Mighty Ducks. Also, the NHL is facing a possible strike or lockout of players next season over contract negotiations, which could further weaken Anaheim's interest in hockey, where the Ducks already play second fiddle to the nearby Los Angeles Kings.

According to Forbes annual list of NHL team valuations, the Flyers are currently the fourth most valuable hockey team, worth $252 million while the Mighty Ducks are not so mighty. Despite a good season last year, they're worth only $112 million, 24th in a league of 30 teams. The Flyers had 2002-2003 revenues 66 percent over those of the Ducks ($101 million vs. $59 million).

Add to all that arena ownership in Philadelphia and the tight integration between the Flyers and several regional sports networks owned by Comcast, and it is pretty obvious which of the teams would be cut.


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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