Disney Pixar Case

UPVEEN TAMERI

PG – MARKETING

ROLL NO - 156

THE WALT DISNEY COMPANY AND PIXAR INC.: TO ACQUIRE OR NOT TO ACQUIRE?

Q1) Outline the relevant trends in the entertainment industry in US for November 2005, which would impact the operations of Walt Disney, Pixar and their relationship. A1) The US entertainment industry in 2005 was seeing many new trends emerging which completely changed the future of the entertainment industry. Some of them are as follows:  The largest of the revenue streams by 2005 was home video which contributed around 59% as compared to 23% contributed by box office release. This 59% constituted home video, CDs, pay-per-view, apparel, books, toys etc.  Also sequels to successful movies was another of the important revenue sources as there existed a built-in audience for established characters which reduced the marketing costs, increased the lifetime of the original movies and mostly generated more box office revenue than the original movies.  The popularity of Animation as a media was fast spreading worldwide due to the increase in number of satellite TV channels and internet. Moreover, the target market for the animation industry was evolving to include customers of all ages and not just their original target i.e. kids.  The trend of the industry has changed from handmade drawings, which is labourintensive, to using computer technology in order to create the realistic and higher quality pictures. The new Computer Graphics technology was rapidly supplanting hand-drawn animation.  Also the competition in the animation industry was increasing with many players emerging like Walt Disney, Pixar, Fox, Sony, Lucasfilm, DreamWorks, MGM, Universal, Paramount, etc. The fierce rise in competition in the CG space can be attributed to the fact that animated films generated the highest returns of all movie genres, also barriers to entering the industry decreased as the access to CG technology grew.

Q2) Using the relevant strategic framework, explain in detail, the points in favour and against the Pixar’s acquisition by Disney as of November 2005. A2) One of the key reasons for the success that Disney and Pixar could enjoy by Disney-Pixar acquisition is due to how related the business is before the takeover which leads to more synergies when merged. The joining would boost Pixar’s creativity leading to higher quality cinematic output than before. Disney can open the door to a huge distribution network for Pixar’s releases. Many experts said that it would be a “near perfect strategic fit”. This friendly takeover would allow both companies to avoid future competition and increased market power. Two of the major players in the creation and production of animated movies industry joining forces would seem like a key play to any competitor or onlooker. The premium that Disney paid for the Pixar acquisition was without a doubt evaluated in light of the nature of the animation content that Pixar harvests and the distribution opportunities it offers through innovative technologies. As animated, family-focused content, Pixar movies are also known to maintain comedy, action and music features, sections of which can be repurposed into short-form programming which, like music, is easily downloadable and attractive for a number of consumer portable devices, including Apple’s iPods and iPhones. If the accomplishment of the iPod with music is an indication what it will be like for video, Disney’s acquisition of Pixar bids wonderful commercial opportunities for Disney in future media and entertainment markets. Better off test The value of synergy is greater when Pixar and Disney form an exclusive relationship because it benefits to both parties. For example, after the merger, both of them could maintain their two separated animation facilities which mean that they can keep their employees. Also, Pixar which is very good at producing computer animated featured movie will keep working on its core competency while Disney would be responsible for the marketing and distribution. If Disney after acquiring Pixar does not dilute Pixar’s competency then that would be a great choice. Disney should try to utilize Pixar’s strengths to enhance its creative capability. For example, Disney should try to leverage Pixar’s brand and capability such as it should chose to keep “Pixar” brand by using “Disney-Pixar” for marketing its new movie called “Cars”. In this collaboration, both Disney and Pixar can form more stronger and powerful team where more talented human resource will be provided. They can exchange the knowledge by work sharing or experience sharing. Also, the most critical element would be decreased the competition between Disney and Pixar because Pixar was the largest player in the movie industry in terms of producing computer animation movie. Therefore, Disney could strongly increase the market share resulted from this collaboration. Thus it passes the better-off test.

Best Alternative test The various alternatives for Disney are common ownership, acquisition of Pixar, having strategic alliances or long-term contracts and so on. In case of common ownership, it would be very risky and can have other implications like changing focus of company from core business or the huge investment requirement etc. Long term contracts or strategic alliances doesn’t seem to be feasible either as Disney and Pixar were already in such contract and renewal of this contract didn’t look possible due to reasons like the personal conflicts between Eisner and Jobs. Also Warner Brothers showed interest in negotiating with Pixar which shows that there was a great possibility that once the contract between Disney and Pixar gets ended, there would be negotiations of Pixar with others. In such case acquisition seems to be a good option. It is because:  Animation was integral to Disney’s corporate strategy as they drove retail in its theme parks and consumer product divisions.  Pixar’s track record for producing smash hits was unmatched.  Steve Jobs on the Disney board would probably be good for Disney shareholders.  Disney needed an animation company to have the competitive edge for their films in the market and Pixar was the best option they had in place. Few factors in acquisition that could lead to problems are: 

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Culture clash - Pixar’s culture is based on creativity and innovations. Its employees are treated more generously than Disney employees. Employees are very important factor in the success of Pixar, so Bob Iger should keep employees satisfaction after the acquisition. Also he should make a smooth integration of Pixar’s and Disney’s culture. He should found which norms from which organization are necessary for continuing growth and should develop them. This means he should create new organization’s culture based on best norms from both companies. Most important reasons for acquisitions are resources, knowledge and knowhow. Bob Iger will have the challenge to make two organizations to communicate and share their knowledge. Therefore he should create environment for development of learning organization. This will allow company to achieve high growth, do successful business and meet all upcoming challenges. Vision - Challenge for post-acquisition process is generating new joint company vision that will be leading vision for both companies and employees. New vision will give shared goals and objectives for companies and give directions for achieving those goals. It is necessary to create new vision for the company and avoid following double visions and objectives of Disney and Pixar. New management team - Challenges for Bob Iger would be to form a successful management team that will be real leader for all company employees. Management team should change its attitude towards new company vision and objectives. Management team should provide clear leadership toward new objectives and visions.

Q3) Analyse the following Based on the relevant information in case, quantify in USD, the potential benefits and likely disadvantages of the acquisition. Analyse the risk in the acquisition. A3) BENEFITSThe Walt Disney has to pay in a range of $6.5 billion and $7.4 billion to purchase Pixar, giving Pixar market cap of $5.9 billion The transaction will make Steve Jobs, who is the majority shareholder of Pixar with 50.1%, to Disney's largest individual shareholder with 7% and a new seat on its board of directors should he accept a stock swap. Jobs' new Disney holdings will exceed holdings belonging to exCEO Michael Eisner, the previous top shareholder, who still held 1.7%; and Disney Director Emeritus Roy E. Disney, who held almost 1% of the corporation's shares. The deal is good to be done as an exchange of stock which at price of $7.5 billion will take place at 2.3:1 Disney: Pixar which is a high value for stock exchange ratio for this industry and also it eliminate the transaction cost. DisadvantagesOverall it is seen as a very costly deal for Disney. There are many reasons to support this belief:  Projected P/E ratio for Pixar is 46 which is much more than the closet competitor DreamWorks which has P/E value of 30. More the P/E ratio shows investor is paying more than the actual value of a firm.  Disney has a very low P/E ratio (17) as compared to the Pixar (46) making Disney heavily dilutive.  Resulting in dilution of shareholders’ equity, the result may even make the original shareholders lose control. Risk associated with the dealFinancial Stock Dilution  Change original ownership structure of the firm  Arbitrage selling pressure caused by the arbitrage group as well as diluted earnings per share is expected to be incurred by the acquirer's share price decline.

 It is likely that Pixar is to gain from this deal and Disney has to take wait for time to increase its stock price after the acquisition. Cultural difference between Pixar and Disney  Disney is a big company with 125,000 employee in 2005 whereas Pixar a small firm  Hierarchical structure: distant upper management in Disney whereas Pixar has a highly individualized structure  Micromanagement ->low morale, “brain drain” of creative talent in Disney. In Pixar full time and resources were given to employees for some new ideas  Disney focuses on profitability than quality and Pixar motivate its employee on choosing a particular idea and working on it until it works in best way.

Q4) Based on the strategic analysis in questions 1, 2 and 3 clearly mention whether you would recommend the acquisition. Give your rationale for the same. A4) In the wake of a stagnating share price, Walt Disney Corporation (Disney) has to revive its animation capabilities as investors are flocking to more successful animation studios such as Pixar Animation Studios (Pixar) and DreamWorks Inc. Disney’s efforts in animated films in years prior to 2006 have been disappointing. In an industry in which creative talent rules, Disney had simply not been able to assemble the right combination of talent in an environment conducive to creating blockbuster animation films. Disney and Pixar had been in a joint venture involving three pictures since 1991, in which Disney shared the production costs and profits. Disney benefited from Pixar’s success by co-financing and distributing Pixar films. Talks to extend this arrangement disintegrated in 2004 due to the failure of Pixar CEO Steve Jobs and Disney CEO Michael Eisner to reach agreement on allowing Pixar to own films it produces in the future. With the current distribution agreement set to expire in June 2006, Robert Iger, Eisner’s replacement, has to repair the relationship with Pixar. The move will reflect Disney’s desire to infuse the firm’s internal animation resources with those from a proven animation company. A key Disney strategy is to use popular Disney movie characters across different venues (i.e., theme parks, merchandise, and television). Disney also has to prevent Pixar’s acquisition by a competitor. Despite near-term dilution of Disney’s earnings per share, investors seem focused on the longterm impact to growth in Disney’s shares. The risk associated with the transaction can be measured in terms of what Disney could have done with cash raised by issuing the same number of new shares to the public. At $6.5 billion - $7.4 billion, Disney could make 64 sequels at approximately $100 million each. Moreover, Disney may have to pay top dollar for Pixar, as the

filmmaker was coming off a string of six consecutive movie blockbusters. Finally, revenue from DVD sales might have been maturing. The long-term success of the combination hinges on the ability of the two firms to meld their corporate cultures without losing Pixar’s creative capabilities. Pixar president, Ed Catmull & John Lasseter, Pixar’s creative director, can help to design attractions for the theme parks and advising Disney’s Imagineering division. In an effort to insulate the Pixar culture from the Disney culture, Pixar should remain based in Emeryville, California, far from Disney’s Burbank, California, headquarters. (Best alternative test) Having Pixar chairman and chief executive Steve Jobs as a member of Disney’s board of directors can be of immense help. Jobs’s advice may rejuvenate the Disney board at a time when the entertainment industry was scrambling to reinvent itself in the digital age. Jobs, who is also the chairman and CEO of Apple Computer Inc. (Apple), is in a position to apply Apple’s substantial technical skills to Disney’s animation efforts.

Q5) If Walt Disney Corporation choose to go ahead with the acquisition What pitfalls does Disney need to avoid? What actions would you recommend to Disney to simultaneously start with its due diligence? A5) Pixar was in terms of employee size at least, a small and well knit organization and fairly independent in terms of working. In contrast, Disney was a very huge company with a very vast employee base. One of the major problems that experts were hinting might happen was the possibility of a culture clash. Because of such differences in the working and culture of the two companies, people might never get used to the huge change and won’t be able to work at their best which would lead to a major loss in productivity and quality of work. Another problem could be that majority of the talent could leave Pixar after the acquisition and Pixar will be nothing without its animators. The possibility of the attrition happening is further heightened by the culture shock mentioned above. If Pixar workers are not able to adjust to the less independent style of working at Disney, they might not feel at ease and hence decide to ultimately resign leaving Pixar just a vast number of computers without any talent. Also, both the divisions should stick to its core competencies, that is Pixar is good with making computer generated animation at a low budget within a short duration of time and Disney is good at marketing, distribution and leveraging the movie success to generate revenue streams from other sources, so both the divisions should stick to what they do best and do minimum interference and not restrict or hamper the other divisions working.

To avoid all the above, Disney needs to start working on a number of things to make the acquisition a success. They are as follows: 

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Appropriate valuation – The correct monetary value for the acquisition need to be calculated keeping in mind that the value should be high enough so that Pixar accepts it and reasonable enough for Disney to make profits out of it. The losses incurred by Pixar in 2005 also need to be taken into account. Lessen culture shock – Disney needs to formulate a strategy and certain guidelines for its employees so that the affect of culture shock is as less as possible and the employee’s productivity is not affected by it Independent environment to lessen attrition – Disney needs to make a very hospitable environment for Pixar employees before they arrive so that they feel at home and do not think about leaving the company post the acquisition as the main resource of Pixar is the talent of its animators. A new branding outlook for the new company – Before the merger, Disney needs to think as to how the two brands which are equally well known will co-exist in the company and will not cannibalize each other. Creating new set of objectives – Disney needs to rethink its objectives along with the ones it plans to keep for Pixar so that not only do both of them work efficiently but also not interfere with the working of the other.

Q6) As of November 2005, what were Pixar’s strategic options? Analyse qualitatively each of these options for Pixar. A6) Pixar being a leader in computer generated animations and having an impeccable track record of producing mega hits had a lot of potential suitors in the form of Warner Bros., an AOL Time Warner Inc. unit, and Fox, a News Corp. unit. Sony Corp.'s Sony Pictures Entertainment which had launched computer animation unit in 2002 was also another potential suitor as it would be related horizontal integration for Sony. Any studio that makes a deal with Pixar may instantly move to the front of the lucrative animation market. Thus we see that the competitive advantage of Pixar in the domain of computer generated animation gave them with numerous option and multiple suitors to be team up with. Constraints of Pixar However there existed multiple constrains holding back Pixar from breaking away from Disney which included the following

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Pixar still owed Disney three films under its present arrangement, which will run at least through 2005. Disney had an extensive distribution and marketing capabilities given its status as the premier family brand, with far-reaching marketing, distribution and licensing power The hold over sequels of films made by Disney-Pixar would suffer as per contractual agreement

As of November 2005, Pixar’s strategic options were as follows: 1. Being acquired by Disney Being acquired by Disney would provide Pixar with better positioning vis-a-vis their competitors like Lucasfilm, DreamWorks, MGM, Universal, Paramount etc. Disney has been one of the very few companies to have grown with the animation industry and it has a unique collection of assets like theme parks which Pixar could leverage. Also acquisition by Disney would increase the P/E ratio of Pixar which would be welcomed by the investors. Pixar shareholders will receive 2.3 Disney shares for every Pixar share they own. The most profitable company would be Apple. The deal would give Apple iTunes more video content to offer. 2. Renegotiating the previous deal with Disney Another option would be renegotiating the deal with Disney. This would reduce Disney to be just the distributor, something which Disney has already rejected. But given the success history of Pixar and Disney’s not so successful results when making films alone, Disney would want to get associated with a successful animation company like Pixar, something which Pixar would like to leverage. 3. Negotiating a new deal with a rival company of Disney/Strategic Outsourcing In that deal, Pixar would strike a deal with larger companies like Lucasfilm has with Twentieth Century Fox, in which the larger studio gets only the distribution fees. Pixar was ready to take charge of 100% production pay for only the distribution fees. Although the option is attractive for Pixar as they are in a commanding position to achieve the deal following its success history, but it would mean two different companies with two different sets of shareholders and hence, two different agendas. 4. Vertical Integration: Though through vertical integration Pixar might deviate from its core business, implementing a tapered, forward vertical integration would enable greater control to Pixar to distribute its mega hit pictures and pave the way for further leveraging capabilities of the acquired company. 5. Joint Ventures: Joint ventures would reduce cost as well as risk associated with forward vertical integration. Also this is useful for cross border reach. Though the risk of dissipating industry know how exists, given the proprietary nature and highly skilled

resources of Pixar in computer generated animation, such spill over can be easily contained. If the industry in which the acquired company participates has the potential to remain profitable, then the target passes the industry attractiveness test. Disney & Pixar are two major and time tested players in the animated movie industry. Their synergy has produced smashing hits in the box office. Disney has a deep pocket and Pixar has a huge talent base. Pixar is a large player in the industry in terms of developing and producing computer animation and Disney has positioned itself strongly as a family entertainment company .The combination of these two companies will be very difficult to imitate. Thus the combination of Disney and Pixar will result in a little stabilization where competitors will not like to target them . Hence it would reduce the rivalry. Bargaining power of the Buyer is low in this industry. Due to the advent of so many ways to watch a movie it is almost certain that the interested viewer will watch the movie. Also because of Disney theme parks etc, there will be constant exposure towards the movie. Threat of Substitutes will be low. Substitute products can be theatre or other forms of entertainment. But these forms cannot match up to the appeal it creates in the general mass. Threat of new entrant is low in animation industry due to cheaper technological products. But when the acquisition takes place finding the talent will be tough because as a strong brand, the Disney-Pixar combination will attract more talent. Hence, the merger will increase the attractiveness in the industry.