There is turmoil in the Magic Kingdom. The home of Mickey, Minnie, Goofy, Ant-Man and Chewbacca is under siege. Activist hedge fund managers who have seen the world’s second-largest entertainment firm’s stock plummet 50%, from the height of the pandemic in March 2021 to US$100 ($131.25) currently, smell blood and are raring to pounce. The intruders want the keys to the door of the Magic Kingdom so they can “unlock” value.
Clearly, there is a lot of value in the House of Mouse. Its Avatar: The Way of Water recently topped US$2 billion at the global box office. Disney owns resorts and theme parks in Shanghai, Hong Kong, Tokyo, Paris as well as Florida and California, a fleet of luxury cruise liners which each cost more than half a billion US dollars to build, two of the world’s highest-grossing movie studios, broadcasting network ABC, the world’s biggest sports network ESPN, a growing consumer products division that sells Baby Yoda toys, food, books and console games, one of the most sought after archives of filmed entertainment, and the world’s No. 2 video streaming platform, Disney+.
Two years ago, the market was valuing Walt Disney Co at nearly US$370 billion, or more than Walmart Inc, the world’s top retailer, and JPMorgan Chase, the most valuable bank on earth. Now, Disney is valued at less than half of that. Despite all its great legacy assets, the Kingdom is no longer seen as magical by investors. Disney, which turns 100 in October, looks like a stodgy old media firm that is struggling to pivot to streaming as viewers cut the cord on expensive cable TV bundles and shun movie theatres for home viewing shows on streaming pioneer Netflix.
Disney is no stranger to loudmouth antagonists. Last August, activist hedge fund manager Dan Loeb of Third Point pushed Disney to spin off ESPN and integrate streaming subsidiary Hulu into its direct-to-consumer platform, Disney+. “ESPN would have greater flexibility to pursue business initiatives that may be more difficult as part of Disney, such as sports betting,” he argued. A month later, he backed away from his demands. “We have a better understanding of ESPN’s potential as a standalone business and another vertical for Disney to reach a global audience to generate ad and subscriber revenues,” Loeb said.
But just as Loeb was turning friendly, another activist investor, Nelson Peltz built a 0.6% stake in Disney worth US$ 940 million. In October, Peltz, 80, a former junk bond salesman who runs Trian Group, threw down the gauntlet and asked for a board seat. Three weeks later, CEO Bob Chapek was gone. Disney decided it needed a stronger leader to fight off Peltz, who has a track record of successfully winning board seats and forcing managements to do things his way. Trian built a stake in the beleaguered conglomerate General Electric, which is now being broken up into separate healthcare, jet engine manufacturing and power firms. Peltz also bought stakes in consumer goods maker Procter & Gamble and its London-based rival Unilever plc and won seats on their boards.
Media behemoth losing its way
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Now he wants to be on Disney’s board and dictate his terms to the keepers of the Magic Kingdom. Why? In recent years, “Disney lost its way resulting in a rapid deterioration in its financial performance from a consistent dividend-paying, high free cash flow generative business into a highly leveraged enterprise with reduced earnings power and weak free cash flow conversion,” the hedge fund manager claims.
The way Peltz sees it, “Disney is one of the most advantaged consumer entertainment companies in the world, with unrivalled global scale, irreplaceable brands and opportunities to monetise its intellectual property better than its peers by leveraging the Disney ‘flywheel’ (networks, theme parks and consumer products).” If it does that, Trian boss argued, “Disney should be well positioned to navigate the ongoing transition from legacy content distribution channels to streaming.”
In early 2020, at the start of the global Covid-19 pandemic, Disney’s long-serving CEO Bob Iger stepped down, passing over its streaming chief Kevin Mayer and picking Chapek, who ran the theme parks business, as the CEO. Mayer quit to become TikTok’s CEO and Chapek was forced to shut lucrative theme parks, resorts and cruise segments as Covid restrictions took hold. Meanwhile, Netflix expanded its huge lead in video streaming as people confined to their homes binged on its shows.
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Chapek made a few missteps. He eliminated the dividend that Disney had paid shareholders for 57 years as he beefed up its annual budget for new content. Disney set aside US$8 billion on new content to make Disney+ a more compelling streaming service. That was small compared with what some of its rivals were splurging. Netflix spent US$18 billion on new content last year while Amazon Prime spent US$15 billion. Indeed, even Apple TV+, a streaming minnow, spent US$8 billion on new content last year. Clearly, Disney was being outgunned and outspent on new content by its main tech rivals.
Disney also got into a fight with Florida governor Ron DeSantis, currently the leading contender for Republican nominee for president in 2024. The state’s 50-year-old special district allows Disney to operate as its own local government in Orlando where its theme park and resort are located. As Chapek and DeSantis locked horns, the governor said he would withdraw Disney’s privileges in the area. There was also the battle with Scarlett Johansson, Disney’s highest-grossing star. The Avengers star crossed swords with Disney over a breach in contract regarding Black Widow’s release. Johansson claimed that Disney dishonoured its commitment to release the film exclusively in theatres by simultaneously making it available on Disney+. War with their top talent on contractual issues is often a dangerous minefield. When a studio fights with its top star, other stars are hesitant to work with it or move to rival studios. Eventually, Disney buckled and settled its legal problems with Johansson.
Last November, the Disney board suddenly fired CEO Chapek, just weeks after giving him a new three-year contract, and brought back former CEO Iger to reawaken the magic. Iger had served as Disney’s CEO for 15 years, succeeding another long-serving CEO Michael Eisner, who had the keys to the Magic Kingdom for 21 years. Disney had foundered following the death of its founder Walt Disney in late 1966. His successors did not have a vision to grow the entertainment firm. Indeed, long after the founder’s death, Disney’s senior executives wondered aloud: “What would Walt do?” Eisner, who was hired by the founder’s nephew Roy Disney, grew the company into a media and entertainment giant by hiring top talents like Jeffrey Katzenberg as the boss of Disney Studios.
Iger built on that success by buying top-notch franchises — animation studio Pixar, Star Wars creator Lucas Films and Marvel, the Avengers creator. In 2019, Iger brought Disney kicking and screaming to the streaming business, launching Disney+ to compete directly with pioneer Netflix. In his 15 years at the helm, Disney stock surged more than sixfold, or nearly double the performance of the benchmark S&P500.
His biggest deal was the purchase of Fox’s entertainment assets, including the studio that made The Simpsons and X-Men, from billionaire mogul Rupert Murdoch for US$71.3 billion. Disney needed compelling TV shows and movies to persuade viewers to pay for its streaming service. It has since combined classic Disney and Pixar cartoons, the Star Wars franchise and the Muppets with Marvel’s X-Men and Deadpool.
The Fox assets acquisition was finally consummated in March 2019 and months later, Iger launched Disney+. With his work done, Iger, then 68, stepped down, paving the way for Chapek to lead Disney into the digital era.
Streaming growth slowing down
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Unfortunately, video streaming is no longer the high-growth business that it once was. Netflix, the only pure-play listed streaming firm, saw its revenues grow just 6% last year. Analysts are projecting 7% growth for Netflix this year. That’s in an inflationary environment. The average S&P 500 firm grew revenues by more than 11% last year.
That’s taking a toll on the stock prices of entertainment firms such as Disney, which are being forced to beat on streaming. Disney’s underperforming stock, Peltz noted, “reflects the hard truth that it is a company in crisis.” Though he concedes Disney is undergoing a challenging pivot to streaming, he argues that the behemoth benefits from owning best-in-class intellectual property (IP), a diversified business mix and a lucrative theme parks business. Disney’s problems, Peltz argues, are primarily self-inflicted, including failed succession planning by Iger, “over-the-top compensation practices” like hefty severance packages for top executives, a flawed direct-to-consumer strategy, and a struggle with profitability despite similar revenues as Netflix and a significant IP advantage.
Peltz blames all that on a lack of overall cost discipline. He argues that Disney was “over-earning in its parks business to subsidise the streaming losses.” Moreover, he notes, Disney’s earnings per share have been cut in half since 2018 despite US$162 billion spent on mergers and acquisitions, capital expenditure and content — or almost as much as its entire current market capitalisation of US$180 billion. “Management has shown poor judgement on recent M&A efforts including overpaying for Fox assets,” he noted.
While he wants a seat on the board of Disney, the Trian boss is not looking to get rid of Iger, who took over as CEO just nine weeks ago. Peltz wants to ensure a smooth succession at Disney within two years. He also wants orderly deleveraging at the entertainment behemoth, reinvigoration of its “flywheel” to help drive efficiencies and higher profits. Peltz also wants to reinstate dividends.
On Jan 17, the Disney board unanimously rejected Peltz’s request to join the board because he did not suggest any specific strategic ideas and lacked media expertise. That’s disingenuous since most of Disney’s directors had no media experience when they joined the board while Peltz served on the board of MSG Networks for years and is still on the board of its parent, Madison Square Gardens.
The battle for Disney is far from over. Peltz is likely to bide his time and wait for Iger or the board to make missteps. Disney owns about two-thirds of the streaming TV service Hulu, with media conglomerate Comcast Corp controlling the rest. Disney either has to buy out Comcast and integrate Hulu, or sell its controlling stake in Hulu. Disney values 33% of Hulu at US$27.5 billion while Comcast wants up to US$50 billion. Over the next year or two, there is likely to be more consolidation in the industry as streaming players falter. Roku Inc, Paramount Global, and Warner Bros. Discovery (WBD) are losing money on their streaming and are unlikely to make much headway with free advertising tiers.
Rising interest rates, a sluggish economy and a softening Ad market are weighing on media firms. WBD, laden with US$50 billion in debts, is reeling under media mogul, David Zaslav. Comcast, the giant cable TV operator which owns content creator NBCUniversal, is better poised but as more customers cut the cord even as its Peacock streaming service lost US$2.5 billion last year. It is forecast to lose US$3 billion this year. A Comcast-WBD merger will create a formidable rival to Disney. There are also developers of immersive interactive games and software firms looking for their knights in shining armour. In normal times, Disney might acquire a gaming software developer like Roblox or a movie studio owner like WBD. Yet, these are turbulent times with activist investors lurking. Disney needs to tread cautiously to avoid being dismantled and seeing its pieces sold off.
Assif Shameen is a technology and business writer based in North America
