Mickey buys Luxo Jr.

by Mark Goldhaber, staff writer

And everybody thought that Disney's big new thrill ride of the week would be Expedition Everest.

Instead, the purchase of Pixar by the Walt Disney Company seized all of the headlines. Yesterday, Disney reached an agreement to buy Pixar for $7.4 billion in an all-stock transaction. The deal, expected to close this summer, will give Pixar shareholders 2.3 shares of Disney stock for each share of Pixar that they hold.

A look at some of the financials

Many industry analysts and Disney shareholders, including former Disney head honcho Michael Eisner, complained that the price that Disney is paying is much too high for the value that Pixar will add. Of course, a high price was the reason that Eisner refused to buy Pixar many years ago, when it would have have cost around $1 billion.

When valuing the deal, don't overlook that Pixar should not be valued based on its recent income. For each of the seven movies Pixar has made so far, the company has been paying distribution fees and production costs to Disney and then splitting whatever was left over 50-50. Over recent years, more than 90 percent of Pixar's revenues have first come through Disney. With that purchase (and assuming similar performance in the future), that is about $250 million that Disney will keep rather than passing along to Pixar. Compared to a future in which Disney was not involved at all in distribution of new Pixar films, it is actually more like $450 million a year in gained revenue. Further reducing the blow is that while Disney is giving out $7.4 billion in stock, they are also getting their hands on Pixar's stash of over $1 billion in cash, making the net cost of the deal closer to $6.3 billion (and also looming is the sale of ABC Radio, which could be worth $3.5 billion easing investor concerns even further as Disney trades a fringe business for a core business).

Some of the more intangible benefits of the deal for Disney include a reduced barrier to exploitation of Pixar films and characters, since there will no longer be two companies involved in every decision (whether a reduced barrier is a good thing will take a while to know). Also avoided is the publicity nightmare of releasing sequels without Pixar's participation and with their derision. Being completely in-house also means that competition between Pixar's animated movies and live-action movies from Touchstone and Walt Disney Pictures will be avoided.

Otherwise, the only significant assets owned by Pixar are its campus in Emeryville, California, a computer animation software product called Renderman (licensed to other companies for about $10 million per year in additional revenue), and some office space in Seattle, Washington.

The deal, which was approved by the boards of both Disney and Pixar, is contingent on the approval of various regulatory bodies and a vote by Pixar shareholders. Jobs, who owns 50.6 percent of Pixar's outstanding stock, has agreed to vote the equivalent of 40 percent of the outstanding shares in favor of the deal. This means that just over one-fifth of the other shares must be voted in favor of the deal for it to be approved.

Despite almost 300 million shares being issued to Pixar's shareholders, Disney's board approved a plan to avoid diluting shareholder equity. At the same time that the purchase was approved, the board also approved a buyback of an additional 225 million shares, bringing the total authorization to 400 million shares. The board expects the equivalent of the approximately 290 million shares being given to Pixar shareholders to be repurchased by the end of 2007.

It's the talent, stupid

Another asset coming to Disney in this deal are the top people at Pixar. Dr. Ed Catmull, Pixar's president, will become president of the new Pixar and Disney animation studios, reporting to Disney CEO Robert Iger and Walt Disney Studios chairman Dick Cook. Even more exciting to many Disney fans is the fact that Pixar's creative leader, John Lasseter, will become chief creative officer of the animation studios and principal creative adviser at Walt Disney Imagineering, focusing on ride development. This should inject some new enthusiasm into both of these areas.

And then there's the Steve Jobs factor. Pixar Chairman and CEO Steve Jobs will be appointed to Disney's board of directors as a non-independent member, bringing the board's complement to 14, 11 of whom will be independent. The addition of Jobs gives Iger another tech-savvy member on the board with whom to champion new markets in new technology. But Jobs' marketing wizardry might prove even more valuable.

Those who are already members of the so-called "cult of Steve" know first-hand how Jobs' infectious enthusiasm and marketing savvy can inspire intense loyalty to Apple products, whether it be for computers or MP3 players. Even when he announced that Apple was changing the core processor inside its computers to the rival—almost hated—Intel chipset, Jobs got his followers to come along for the ride, with very few protests.

If Jobs can help Disney to once again inspire that kind of loyalty among its less-ardent fans, that could prove a tremendous boost to the company's income.

In a way, having Jobs, Catmull and Lasseter come on board in the deal is similar to one of the major benefits expected from the original plans to acquire the Jim Henson Company back in the late 1980s. While Disney really wanted the Muppets and other assets from the company, the real gem was to be having Jim Henson come up with all sorts of new ways to tell stories. When Henson died, the value of the company dropped tremendously, because Henson's genius was no longer part of the deal. The deal then dried up very quickly.

Keeping the top three Pixar executives (as well as all of the directing talent behind them, including Pete Docter, Brad Bird, and Andrew Stanton) on board bodes well for helping Disney keep its focus on telling good stories, regardless of the venue or medium.

No culture clash expected

Fears that a purchase by Disney will put a damper on the creative atmosphere at Pixar appear to be ill-founded, as both Disney and Pixar animation units will retain their current operations and locations. What this means is that it should be business as usual in Emeryville, home of Pixar, with no major interference from Disney corporate.

Iger confirmed that commitment in a conference call to discuss the deal, saying, "One of the things that's really important to us in doing this is that Pixar's culture be protected and allowed to essentially continue because it is such an incredibly important ingredient to the success of making these movies, not only in the environment right to work in, but it's a magnet for attracting talent."

He also added, "Having been part of companies that have been taken over twice, I'm very sensitive to what can happen when a company is bought in terms of the impact on the level of productivity on morale, on the ability to retain and attract people. So we spent a lot of time talking about that when we negotiated this deal, and I have really deeply committed to seeing to it that Pixar is allowed to exist in the form that is has existed, because that in my opinion is the single greatest thing that we can do to ensure that Pixar continues to be successful."

If both Pixar and Walt Disney Feature Animation survive as separate independent business units, perhaps some friendly intra-company competition will help keep creativity at a high level.

In a statement, Jobs noted, "Disney and Pixar can now collaborate without the barriers that come from two different companies with two different sets of shareholders. Now, everyone can focus on what is most important, creating innovative stories, characters and films that delight millions of people around the world."

The deal also received the blessing of Roy E. Disney, who said in a separate statement, "Animation has always been the heart and soul of the Walt Disney Company and it is wonderful to see Bob Iger and the company embrace that heritage by bringing the outstanding animation talent of the Pixar team back into the fold. This clearly solidifies the Walt Disney Company's position as the dominant leader in motion picture animation and we applaud and support Bob Iger's vision."

Anatomy of a deal

Just a year ago, a Pixar-Disney marriage would have been unthinkable. Steve Jobs and former CEO Michael Eisner were verbally attacking each other, and the enmity appeared to doom any possibility of a new distribution contract between the companies. With the retirement of Eisner last September and the announcement of Iger's succession, the courtship dance began.

Iger immediately reached out to Jobs to try to reestablish the relationship. By the time that Eisner's retirement became official, things were coming together well. In October, Iger and Jobs announced a deal making Disney the first provider of video content through Apple's iTunes store. Taken as a sign that Disney's relationship with Steve Jobs was warming, rumors about the negotiations between Pixar and Disney began to gain steam. Pixar's demands for a new distribution agreement required that Pixar finance its own films, with Disney (or another studio) just receiving a small fee for distributing the pictures. Ancillary rights for sequels, character merchandising, use of film elements and characters in theme parks were also subject to negotiation. Jobs had earlier discussed the notion of retrieving some of those rights for earlier films back from Disney as part of a deal. In other words, any new deal would leave Disney with only a small fraction of the financial benefit enjoyed on the first seven films, and quite possibly a reduction in the power it already had. All of those issues became moot with the deal combining the two companies.

Moving forward

The new deal means that Pixar will be able to exert control over additional sequels to their original films. While not coming out and saying it directly, Iger intimated that the long-awaited Toy Story 3 will be created by (and follow the original storyline devised by) the staff at Pixar. Of course, that would likely spell doom for Circle 7 Studios, the group assembled by Disney for the purpose of creating sequels to the original Pixar films (things also don't bode well for the relationship between Disney and Britain's Vanguard Studios, producers of the animated film Valiant).

After the highly-anticipated Cars, next year will likely see the release of Pixar's Ratatouille as it continues to target one movie release per year. Disney's animation studio will also continue toward its goal of one film per year, with Meet the Robinsons scheduled for December, followed next year by American Dog and Rapunzel. Pixar's decision to move its films from the holiday season to the summer season beginning with Cars will probably stand with Walt Disney Feature Animation getting to release its films during the holidays.

How the film slates may change is unknown, but it is reasonable to assume that sequels will make their way into Pixar's schedule. Towards this end, in 2005 Pixar had begun efforts to create the necessary infrastructure to develop movies in parallel, allowing more frequent releases.

The deal really helps to put Iger's stamp onto the company, indicating how much of a bridge-builder he is, making a deal with Pixar despite the original animosity between the companies. In fact, when asked on the conference call why Pixar chose to stay with Disney, Jobs said, "Disney is the only company with animation in their DNA, and the only company that we think has this incredible collection of unique assets like the theme parks that are very attractive to us as well, and they're the only company that has Bob Iger, who we've grown to like a lot, and to trust."

Another benefit to Iger is that fact that Jobs will now be the largest individual shareholder (approximately 138 million shares) in the Walt Disney Company. Until the deal goes through, that title will continue to be held by Michael Eisner (approximately 14 million shares). In lessening the leverage of his old boss by gaining an ally with more than three times the leverage, Iger can insulate himself somewhat from criticism by Eisner.

An additional benefit for Jobs is that he can now concentrate less on Pixar and more on Apple, which needs his attention much more than the studio does. Jobs will doubtless be a force on the Disney board, pushing Disney into trying all sorts of new media distribution channels, but freed of his CEO duties at Pixar, he will be able to spend more time with his first love—Apple.

So the hands have been dealt and the marriage bargain has been done. All that's left to do now is to sit back and see how it all plays out. It should be quite entertaining.

Alex Stroup contributed to this article.