Will Disney’s Acquisition of 21st Century Fox Boost Its Stock Price?

Will Disney’s Acquisition of 21st Century Fox Boost Its Stock Price?

  • Case
  • Teaching Notes
Abstract

On March 20, 2019, the Walt Disney Company purchased 21st Century Fox. The acquisition includes 21st Century Fox’s film production divisions such as Twentieth Century Fox, Fox Searchlight Pictures, Fox 2000 Pictures, Fox Family, and Fox Animation as well as Fox’s interests in streaming services like Hulu. The acquisition is part of Disney’s strategic initiatives to provide more appealing high-quality content and entertainment options to meet growing consumer demand; increase its international footprint; and expand its direct-to-consumer offerings, which include ESPN+ for sports fans and the highly anticipated Disney+ streaming video-on-demand service launching in late 2019. In this case, students will analyze Disney’s value using a variety of methods as well as determine the risks and opportunities of the acquisition.

Case
Learning Objectives

By the end of the case study, students will be able to:

  • describe the main strategy of Disney in the future, and analyze and predict the future development of Disney from different perspectives;
  • describe the primary driver of Disney’s acquisition, and analyze its potential risk;
  • understand the process of intrinsic valuation; specifically, students should understand how to use the DCF model, including the calculation of CAPM, WACC, and terminal growth rate;
  • understand the valuation methodology weighting—students should understand how to develop the best weighting for specific cases.
The Disney Corporation

Walt and Roy O. Disney founded the original Disney Company as the Disney Brothers Cartoon Studio on October 16, 1923. The company established itself as a leader in the U.S. animation industry with films like Snow White and the Seven Dwarves before diversifying into live-action film production, television, and theme parks. Since the 1980s Disney has created a more mature and diversified brand than is associated with its family-oriented brand.

The Walt Disney Company’s headquarters are located in Burbank, California and the company operates 340 stores throughout the United States, Japan, and all through Europe. Disney has five major segments: Walt Disney Studios, Parks and Resorts, Disney Consumer Products, Media Networks, and Disney Interactive (Figure 1). Disney generates more than 50% of its revenue from cable networks and its domestic theme parks (Walt Disney, 2018, p. 32).

Percentage values from the pie chart are listed below:

  • Consumer Products & Interactive Media, 8%
  • Studio Entertainment, 17%
  • Media Networks, 41%
  • Parks and Resorts, 34%
Figure 1. Walt Disney’s 2018 Revenue by Segment
A pie chart shows the percentage of revenues from each segment in Walt Disney Company for the year 2018.

Source: Walt Disney (2018, p. 32)

Governance

The Board of Directors are responsible for ensuring that Walt Disney represents the best interests of the shareholders. To assist them in this task, the Board of Directors create committees, the most important of which are: the Audit Committee, the Compensation Committee, and the Governance and Nominating Committee (Figure 2). These committees are comprised entirely of independent directors (Walt Disney, 2018, p. 54).

All text in the image is within rectangular boxes. The organizational structure is listed below:

  • Board of Directors
    • Current CEO Robert A. Iger
    • CIO
    • CFO
    • HR
    • Operations
      • Media Networks
      • Parks and Resorts
        • Walt Disney Studios
        • Business Development and Technology
        • Walt Disney International
          • North America
            • Florida
            • California
          • Paris
          • Tokyo
          • Hong Kong
      • Studio Entertainment
      • Consumer Products
    • Security
Figure 2. Walt Disney Corporate Structure
An image shows the hierarchy of members in Walt Disney Company.

Source: Walt Disney (2018, pp. 55–57)

Industry Overview

Walt Disney is one of the best-known companies in the world of entertainment. The entertainment media business consists of corporations that own content and license intellectual property. They also distribute media through television, movies, and film. To prevail in this competitive industry, firms need to adapt continually to consumers’ taste in both content and distribution.

The industry has seen a shift over the past few years where buyers are changing from cable programming to on-demand streaming services. To adapt to this change and the loss of subscribers, corporations must create innovation solutions to grow their distribution channels. Companies that grow significant content increase globally and innovate for coming online trends are best positioned for long-term success.

Outlook

In the United States, the media and entertainment (M&E) industry represents markets of approximately USD 700 billion. Businesses within the M&E industry produce and distribute television shows, commercials, streaming content, music, and supplementary services (Nead, 2018). The United States represents 33% of the global M&E industry and is the largest M&E market in the world. The U.S. M&E industry is expected to reach USD 804 billion by 2021, according to the Global Entertainment & Media Outlook by Pricewaterhouse Coopers (Nead, 2018).

Competitive Positioning

Disney competes with a number of media conglomerates such as Comcast, Time Warner, 21st Century Fox (before acquisition), CBS Corp, and Discovery across a number of different products ranging from movies to news and sports to television programming (Walt Disney, 2018, p. 17). Disney’s long-term objective is to be the market leader in the media industry, with the biggest market portion by revenue of all rivals before 2030 (Walt Disney, 2018, p. 55). In 2018, Disney reported USD 52.465 billion in revenue, which is close to 31.82% of the total revenue generated by its ten nearest rivals combined (Walt Disney, 2018, pp. 15–22). Walt Disney Parks and Resorts had an operating profit of USD 4.5 billion, an increase of more than 100% in 2018 from five years earlier (Walt Disney, 2018, pp. 32–37). For comparison, Disney Media Networks, home to ESPN and ABC, had a profit of USD 6.6 billion, a 3% decline (Walt Disney, 2018, pp. 32–37; Table 1).

Table 1. Walt Disney’s Top Five Competitors

Company

Gross revenue (USD million)

New Corp. (top competitor)

33,405

Time Warner (top competitor)

26,888

NBCUniversal (top competitor)

1,270.8

CBS Corp.

14,059.8

Viacom

13,619

Source: Walt Disney (2018, p. 17)

Advantages

One of Disney’s primary advantages is its ability to innovate. ESPN, ABC, and Disney Channels cannot be distributed by other media networks, ensuring that the company continues to have unique value proposition to potential customers (UConn, 2016). The power and exclusive nature of this content enable Disney to make a profit above its rivals through advertising and affiliate fees. The corporation also ties many of its business units together where buyers can engage with the same characters through television, film, buyer products, parks, and video games. For example, one of the most influential brands of Disney is Star Wars. Star Wars began as a movie brand but its influence has expanded to almost every field of entertainment because of its huge success. Moreover, Disney intends to make further investments and develop new Star War movies, TV shows, and video games to reap future profits. Disney has used the strategy with a number of movie brands including the Marvel series.

Environment

Walt Disney is unlike others in the business. Its integrated business models, ability to cross-sell products, and the tendency to recycle fan-favorite movies means that Disney has become a mass media conglomerate that dwarfs its nearest competitors. Disney has rivals in every business segment, but few have recreated the integrated business structure that Disney has mastered. Disney’s market cap of USD 168.55 billion is the biggest when compared to its nearest rivals and more than twice the entertainment business average.

Overall Disney’s network, park, and studio entertainment businesses are either equal to or greater than their closest competitors. ABC has provided several hits such as Scandal, How to Get Away With Murder, and Grey’s Anatomy and ESPN is the most viewed sports network. Star Wars, Pixar, Marvel, and the upcoming Indiana Jones sagas all control the studio entertainment segment. The Disney theme parks are an added attraction and revenue source that the telecom companies do not have in their portfolio. For this reason, Disney stock has exceeded both Time Warner and News Corp. over the past several years (Data 1).

Data 1. Stock Daily High of Disney, News Corp., and Time Warner

Financial Analysis

DIS started relatively stable in fiscal year 2019. According to the 10k from Walt Disney, DIS reported EPS (earning per share) of USD 1.84 billion, and revenue of USD 15.303 billion (Walt Disney, 2018, pp. 25–26). Performance of Disney’s Media Networks, Parks, and Consumer Products divisions led the way and helped the organization rise above expectations. Figure 3 shows the remarkable box office performance of Disney in 2018.

Heading of the graph reads “Disney Remakes: Worldwide Revenue (USD millions).” List of movies is plotted along the x-axis and the revenue is plotted along the y-axis from USD 0.00 to USD 1,400 with a gap of USD 200. Values from the graph are tabulated below:

Movies

Revenue (in USD millions)

Beauty and the Beast

1,263

Alice in Wonderland

1,020

Jungle Book

966

Cinderella

543

101 Dalmatians

320

Mary Poppins Returns

308

Christopher Robin (Winnie the Pooh)

197

Pete’s Dragon

143

Figure 3. Disney Remakes Worldwide Revenue (USD millions)
A vertical bar graph shows the revenue of the Walt Disney Company all over the world generated from its movies.

Source: The Numbers, 2020

Cashflow

The Walt Disney Company’s cash flow for the first quarter of 2019 declined by 6% when compared to the first quarter of 2018; however, overall sales increased (see Data 2; Walt Disney, 2018, p. 28). According to capital IQ data, the company reported cash flow of USD 2.099 billion and free cash flow of USD 904 billion. Free cash flow declined by USD 352 million, around 28% lower compared with the fourth quarter of 2018 (Walt Disney, 2018, p. 28). Specifically, investments in resorts and parks were the main items that drove the fall in cash flow. A Star Wars themed land and other attractions at Disneyland California and Walt Disney World Resort are due to be opened in 2019. These construction projects and other improvements are presumed to be the cause of the decline in free cash flow.

Data 2. Walt Disney Company Total Revenue

Debt Level

According to DIS’s 10k, its debt levels have fallen from USD 25 billion to USD 21 billion over 2018; most of the debts accounted for long-term debt (Walt Disney, 2018, p. 21). DIS currently has USD 4.2 billion remaining in cash and short-term investments for investing into the business, which could contribute toward debt repayment (Walt Disney, 2018, p. 21). Moreover, DIS has produced USD 14 billion in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 68%, indicating that its operating cash is sufficient to cover its debt. In DIS’s case, it is able to generate 0.68x cash from its debt capital (Walt Disney, 2018, pp. 21, 25). According to DIS’s 10k, its level of debt is 39%, which is appropriate relative to its total equity (Walt Disney, 2018, p. 25). DIS is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. For DIS, the ratio of 20.07x suggests that interest is comfortably covered. High interest coverage is seen as a responsible practice, which highlights why most investors believe large-caps such as DIS are a safe investment (Walt Disney, 2018, pp. 21, 25, 27).

Valuation

A buy recommendation is an industry term used by analysts when they want to advise a client to purchase a specific security. In general, analysts will issue a buy recommendation when they believe a stock or security will have strong performance in the near future. When analysts issue a buy recommendation, they will also provide a target price, which is fundamental to the investment recommendation. When analysts study companies’ financial data from their past performance, they may use current development trends to predict the future development of companies, and help investors decide their investment strategy. Normally, analysts will predict target price through different prediction models, such as DCF (Discounted Cash Flow) and DDM (Dividend Discount Model). After weighting those target prices appropriately, analysts will have a final target price, which can help them give a buy or sell recommendation. Of course, the real situation and weighting will be different from firm to firm; investors should read and study companies’ financial performance carefully rather than believe investment recommendations directly. An initial analysis of DIS resulted in a buy recommendation with a target price of USD 124.37, presenting 8.307% upside potential on the closing price of USD 108.23 on March 20, 2019 (Table 1). The valuation came up with a target price of USD 124.37, driven by a 20%/10%/60%/5%/5% blend of a DCF to equity model price of USD 175.02, a DDM price of USD 36.89, P/S multiple (historic) of USD 132.61, TEV/revenue (competitor comparable) of USD 90.16, and P/E multiple (industry) of USD 39.39 (Excel 1).

Image has two segments separated by a horizontal line. Text on the left side and right side of the first segment reads “Valuation Weighting” and “The Walt Disney Company,” respectively.

Text on the left side of the second segment reads “Valuation Methodology Weighting.” A pie chart is in the center of the second segment. Text on the right side of the second segment is listed below:

  • Discounted Cash Flows
  • Dividend Discount Model
  • P/E Multiple (Historic)
  • P/S Multiple (Historic)
  • P/B Multiple (Historic)
  • P/E Multiple (Competitor Comparable
Figure 4. Valuation Weighting of the Walt Disney Company
An image shows the various methodologies involved in the valuation of the Walt Disney Company and its business management.
Table 2. Valuation Weighting of the Walt Disney Company

Methodology

Weight (%)

Model price (USD)

Weighted price (USD)

Discounted Cash Flows

20

175.02

35.00

Dividend Discount Model

10

36.89

3.69

P/E Multiple (Historic)

0

18.24

0.00

P/S Multiple (Historic)

60

132.61

79.56

P/B Multiple (Historic)

0

189.28

0.00

P/E Multiple (Competitor Comparable)

0

10.15

0.00

TEV/EBITDA (Competitor Comparable)

0

90.16

0.00

TEV/Revenue (Competitor Comparable)

5

82.94

4.15

P/E Multiple (Industry)

5

39.39

1.97

TEV/EBITDA (Industry)

0

256.76

0.00

TEV/Revenue (Industry)

0

123.54

0.00

Total Weight

100

Target Price

124.37

Current Price

108.23

Dividend Yield

1.38%

Expected Total Return

16.30%

Recommendation

STRONG BUY

Intrinsic Valuation
Free Cash Flow to Equity (FCFE) and Free Cash Flow to the Firm (FCFF)

The FCFF method utilizes the weighted average cost of capital (WACC), whereas the FCFE method utilizes the cost of equity only. Until 2023, we expect DIS’s FCFF to decrease 2.71% as compared with 2019, and FCFE to decrease 2.93% as compared with 2019. Based on our FCFE and FCFF analysis, the estimated price is USD 175.02.

Cost of Equity

The cost of equity was calculated through the Capital Asset Pricing Model, after being adjusted to market risk premium. The 1-year U.S. government bond rate of 2.44% was used as a proxy for the risk-free rate. A regression analysis was run on 5 years daily DIS stock prices versus the S&P500 index then came to the DIS beta of 0.92, close to the betas of both U.S. movie and enterprise market index of 0.89 (Damodaran NYU data). Specifically, analysts recorded daily stock prices of Disney and S&P 500 index over 5 years (2013–2018), then calculated the daily price change in percentage in this period. Then, analysts used beta form in Excel, which is calculated as the covariance between the return of the stock and the return of the index divided by the variance of the index, to have the final beta of each stock. The market risk premium is expected to be 5.08%, using average 5-year S&P price indexes (8.12%) as expected market return minus the risk-free rate (2.44 %). Therefore, analysts reached the estimated cost of equity of 7.67%.

Terminal Growth Rate

The terminal growth rate was weighted with the long-term GDP growth rates of DIS’s major geographical markets by the current geographical revenue composition. This approach came up with a positive terminal growth rate of 3.5%. Analysts used the formula terminal value = (FCF × [1 + g]) / (WACC – g). Analysts calculated terminal value for both FCFF and FCFE because analysts took both of them as the same weight in the DCF model. After two more calculations, analysts took the average of two growth rates and reached a final terminal growth rate of 3.5%.

Relative Valuation
Peer Analysis

The analyst chose three major movie and enterprise companies with comparably big and mid-cap sizes as the industry peer group of DIS. They have the same characteristics and growth rates within the industry.

Enterprise Value Multiple

Total enterprise value (TEV) to revenue is an appropriate enterprise multiple to compare DIS to its peers because this ratio helps compare a company’s revenues to its enterprise value. The lower TEV/revenue, the higher possibility that a company is undervalued. This results in an EV/EBITDA multiple of 2.13x (industry average 3.13x) and the target price of USD 10.5 for a 1-year horizon.

Equity Multiples

DIS’s P/S and P/E ratios are all good compared to those of its peers except relative ratios. With P/E, DIS is trading at a downside of 27% to the market. Analysts used the P/E peers’ average of 40.5 as the P/E multiple, and multiplied by DIS’s EPS of USD 0.97 in order to get the target price of USD 39.39. DIS’s revenue per share is USD 41.96 until March 2019, which is around 10 % higher than the peer group average. After calculation, the lowest P/S multiple is 2.74x, the highest is P/S multiple 3.49x, and analysts took the average of both, 3.16x, as our P/S multiple. The target price is USD 132.61.

Discussion Questions
  • What are the risks associated with the Walt Disney Company’s decision to purchase 21st Century Fox?
  • Write a fundamental analysis of Walt Disney from the following perspectives: competitive position, past and ongoing acquisitions, future development plan, and financial performance.
  • Create a SWOT analysis to summarize the possible concerns of Disney’s future development.
  • Do you support the valuation methodology weighting in this case? Please explain your reasons for supporting the methodology. If not, please show your own weighting and explain your reasons.
  • This case uses data from 2018 to predict Disney’s performance in 2019 by using a DCF model. If data from the current year is used to predict next year, will the final result be different? If so, please show your new DCF price, and explain the reason for such difference. Students should input their assumptions and financial data first and provide detailed reasons for every assumption.
References
Nead, N. (2018, February 11). Media and entertainment industry overview. https://investmentbank.com/media-and-entertainment-industry-overview/
The Numbers. (2020, October). All time worldwide box office for Walt Disney movies. https://www.the-numbers.com/box-office-records/worldwide/all-movies/theatrical-distributors/walt-disney
UConn. (Fall 2016). Portfolio Report Undergraduate Student Managed Fund. https://smf.business.uconn.edu/wp-content/uploads/sites/818/2016/12/SMF-Portfolio-Report-Final-V3.pdf

This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

2021 SAGE Publications, Ltd. All Rights Reserved

You are not authorized to view Teaching Notes. Please contact your librarian for access or sign in to your existing instructor profile.
locked icon

Sign in to access this content

Get a 30 day FREE TRIAL

  • Watch videos from a variety of sources bringing classroom topics to life
  • Read modern, diverse business cases
  • Explore hundreds of books and reference titles