Wednesday, October 31, 2012

Disney Buys Lucas Film: Good Deal, Dilutive Until 2015.

The purchase of LucasFilm, which includes Copyrights for Stars Wars, some (modest) producer share for the Indiana Jones series and the CGI, post production service businesses created by Lucas is a classic and sound strategic move in the media and entertainment world. Under the $2.0 billion in cash and 40 million shares deal, (currently$49.05 per share intraday), "Disney will acquire ownership of Lucasfilm, a leader in entertainment, innovation and technology, including its massively popular and "evergreen" Star Wars franchise and its operating businesses in live action film production, consumer products, animation, visual effects, and audio post production. Disney will also acquire the substantial portfolio of cutting-edge entertainment technologies. Lucasfilm, operates under the names Lucasfilm Ltd., LucasArts, Industrial Light & Magic, and Skywalker Sound." Why now? Frankly, Lucas Film is something that deal makers in the media world have had on their to do lists for decades. Presumably, there were two buyers for this property, Fox because it owns distribution for the Stars Wars franchise and Disney for its strong and increasing commitment to CGI production, and so-called Fantasy Films. For decades Lucas has kept the business under the tightest possible control, but presumably access to capital and estate planning concerns were best resolved by a sale to Disney now. Does the deal make sense? Did Disney over pay? Should Fox have stepped up. The usual investor questions right? Yes, yes and yes. Why did Disney walk away with the prize? Disney is a great company; management is highly regarded in the media and entertainment world; perhaps, only Comcast is as highly regarded these days as both Time Warner and Fox have had missteps. Time Warner's long term agony (AOL) would have certainly been an issue if there were strategic elements to support the sale to Time Warner. But, there were none. Fox has a strategic relationship with Lucas Film as distributor of the existing Stars Wars Films, but presumably, nothing else to warrant a deeper involvement. And, for someone like Lucas who wished to hand off his life work to a new generation of filmmakers the wiretapping scandal and criminal investigations in the UK was an additional negative. Disney also has the lowest cost of capital in the entertainment business--assuring Lucas that future films would get made. Disney was also prepared to create the most tax efficient structure for Lucas and to allow him to participate in some of the future upside of his new partnership with Disney. Is this an exciting acquisition for Disney? Yes, but long term. The good news is that Lucas Film is the real deal with properties which will produce income either in the form of (highly predictable) cash flow from existing properties (virtually existing Star Wars) or from (only slightly less predictable) new Star Wars productions. And seriously, New Stars Wars Films? These are going to be huge as long as the franchise is both managed and energized. At the same time income from merchandising is going to be bigger than from Disney's most Pixar and Marvel Acquisitions because they skew older and more male. Is there bad news: no, just less good news, according to the company's press release the acquisition will not be additive to earnings until 2015--meaning it will be dilutive to earnings until 2015-- when a new Star Wars is released. Does that mean that Disney overpaid for the property? Yes and no. It means that Disney paid more than anybody else was willing to pay--one must presumably. Is the purchase price of $4 billion too much compared to Marvel and Pixar? Hell, no! On a cash on cash return, the purchase price probably reflects some $300 million annual return to Disney before the benefits of new productions. That is just our guess but figure Lucas expects Disney to earn potential future profitability from the franchise. But those future pictures could each return what--$300 to $500 million in future cash proceeds? Maybe more, right? At the same time, the existing distribution deal with Fox is likely to be strained and to be less lucrative than it might have been without the sale as Fox has less incentive to spend money on marketing the films in existing distribution windows. We certainly expect Fox to window dress its ongoing relationship with Lucas Film but to leave most of the franchise building to the future beneficiary--Disney. One final point, does the acquisition of Lucas Film change the management balance at the company? Maybe. Kathleen Kennedy who is joining the company, is a very strong producer and could be a candidate for a wider role at the company as Iger is leaving in 2015, even though there is plenty of management depth at the company--in the Parks Division, Espn, ABC and so on. All in all an interesting, sound acquisition. I do not have a current position in Disney (DIS), but have had in the past and will likely do so in the future. I have no plans to acquire shares until the big macro questions--like the direction of monetary and fiscal policy--are resolved.

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