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Business of Magic
A look at the business of Disney
|Alex Stroup, Editor|
Hello again! I know it’s been awhile since my last column, but what with finishing up my summer job, moving back down to L.A., and starting up my graduate school classes... and then some genius decided to take an extra course this term. (What was I thinking?!) Well, let’s just say that now that I’m settled in, hopefully you should be reading new stuff from me here on MousePlanet a little more often.
Today I’m going to start looking into The Walt Disney Company’s most recently announced quarterly business results, and eventually get to a preview of the next set of numbers.
Now, yes, the 3rd quarter’s results were announced quite a while back - August 3rd, to be exact – but how much did you really learn about how Disney’s businesses are doing from that? If you read anything at all about this in the media, it was probably a quick blurb like this:
But what does this really mean? What does "21 cents vs. 18 cents last year" tell us about how the different parts of the business units?
Stick around while I poke a bit deeper into how The Mouse did over the last few months and years, and I’ll also give a little preview of what the upcoming results may be like.
Before we get started, let’s clarify a few things. What I’m trying to do here is to gauge just how each of Disney’s business units (don’t worry – I’ll explain what that means in a moment) is doing, and what the trend in each of those units seems to be. This is not the same as "Earnings per Share" and other things that stock investors are worried about. On the other hand, I’ll argue that without understanding what’s going on in the businesses over the long-term, the financial figures really don’t mean much by themselves.
Next, let me explain a few of the terms I’ll being using. If you know a little about the stock market, you probably already know a few of these terms. But this may be new to many readers, so let’s go through it.
"3rd Quarter" – Pretty much what it sounds like. Businesses break the year down into four quarters (of course, 3 months each) and report on what their company does for each and every quarter. Disney’s 3rd Quarter ("Q3") starts on April 1st and ends on June 30th.
But "Wait," you say – "that isn’t really the third quarter of calendar year." True, but this is pretty normal – many companies have a "fiscal year" that differs from the calendar year, and it’s not a big deal. After all, the "fiscal year" is still 12 months long, and as long as you keep the same fiscal year, one year’s results can be compared easily to previous ones.
Now the most interesting thing about quarters is that in many businesses you can’t make judgments by comparing this quarter’s performance to last quarter’s. That’s because a good many businesses are seasonal - and, in fact, as we will soon see - most of Disney’s business is seasonal as well. For example, the theme parks get most of their business in the summer (really no surprise, right?). So because of this you need to compare quarters on a year-to-year basis: this year’s Q3 results to last year’s Q3. Which is exactly what we’ll do here.
"Business Unit" – Disney is a big company with lots of different things going on. Looking at everything lumped together (the "aggregate results") won’t give you much detail. Looking at every individual business inside Disney could be too much information. The trick is to lump together all the businesses that have a lot in common, business-wise.
The Walt Disney Company has already done this, because they too need an easier way to keep track of and manage what’s going on. They've lumped everything into 5 groups, which are called "Business Units". (Don’t worry, I’ll explain what each one is in a little bit.) The five business units within The Walt Disney Company are:
"Revenues" – This is one of the key measures we’re going to look at, and it’s relatively simple. Revenues is the amount of money coming in, or how much stuff has been sold. Now there are a bunch of arcane accounting principles on when the company can count sales as "revenues", but we’re not going to worry about that here. What we care about is how much money they’re taking in, not precisely when they do that.
"Operating Income" - This is the other key measure. Again, to try to simplify here, "Income" is basically profit. "Operating Income" is the profit from on-going operations, that is, profits from goods or services that are sold over the long-term. In other words, one-time events (oh, say, profits from sales of part of the company like a radio or TV station or perhaps some real estate) don’t count towards Operating Income. Nor do taxes, investment gains, or depreciation (a fairly complicated concept that we’ll try to avoid discussing altogether here). The idea is that Operating Income is the profit made from the main, on-going units of the business.
And finally here’s some things we’re not going to be looking at: Net Income, Earnings, or Earnings per Share. These all deal with the total profit – what’s left from the Operating Profit after all other things (taxes, investments, etc.) have been added or subtracted. While total profit is important, it doesn’t tell us much about the conditions or trends that Operating Income doesn’t tell us already. Additionally, while the "per share" measures are important for stock investors, they may not be consistent from year-to-year as the number of shares of stock outstanding change.
So here’s what we’re going to be doing: Looking at how much each business unit sells and how much profit each one makes, and seeing how that has been changing over time. This should tell us a lot about how the unit is doing – and how it can be expected to do in the near future.
3rd Quarter 2000 Summary
Here’s what The Walt Disney Company reported to its shareholders about the 3rd Quarter results:
Or, in the terms were looking at: Revenues in the 3rd Quarter were actually $5.964 billion, up 9.4% from the 3rd quarter of 1999, and Operating Income was $1.174 billion, up 19.9% from $979 million in Q3 of 1999.
Notice in this that profits grew at a faster rate than revenues. This is a good thing – it means that either Disney cut their costs (which is good for a business) or they are selling things for a higher price (also good, if the customers will still buy the products) – or maybe both. It should be noted that Michael Eisner’s previously stated goal for the company is 20% growth. And although revenue growth didn’t meet that goal, operating income pretty much did.
Now let’s look at the company’s revenue and income over the longer-term. The dotted lines show the simple straight-line trend, and the vertical lines show the break between Disney’s fiscal years:
Notice how the revenue and income lines follow a yearly pattern, with a peak usually in the first quarter? This high point is the Oct.- Dec. quarter – the three months up to and including Christmas, which shouldn’t really be too surprising. See, this is why we compare quarters on a year-to-year basis rather than just looking at consecutive quarters – Disney’s second quarter is always lower than the first, for example. But comparing the year-to-year differences for a given quarter tells us more about how things have changed over the last twelve months.
Another interesting feature of the above graph is the trend over the last six years (shown by the dotted lines). Revenues have been increasing fairly steadily, at an average of exactly 20% per on a quarterly basis – which is part one of Eisner’s stated goal (a 20% annual increase in revenue). But operating profits have increased an average of 13.6% yearly on a quarter-to-quarter basis, which doesn’t meet Eisner’s second goal – a 20% increase in profits as well.
Even worse, most of the gains in profit occurred in the period 1995 through 1997 while over the last three fiscal years quarterly profit has on average dropped 5% yearly. As you can see on the graph, this makes the operating income trend pretty much flat – and that’s not what you want to see, from a business standpoint. You would expect to see profits rise at about the same rate as revenues or, if the company is doing really well, profits rising even faster than revenues.
So why are Disney’s profits not growing as fast as the revenues? There are a lot of possible reasons. If we dig a little deeper, we may find some clues in all those numbers as to what’s been going on.
And that’s what we’ll do next time – we’ll start looking at the performance of the individual business units.