How Disney’s Financial Wizardry Boosted Its Return On Investment

It has emerged that Disney used unconventional financial terminology to calculate its performance in a flattering business presentation designed to convince stockholders to vote in its favor at its annual meeting today.

The vote has been driven by Blackwells Capital and Trian Fund Management – two hedge funds which have amassed large stakes in Disney and are seeking board seats. Blackwells has asked for three whilst Trian wants two – one for its co-founder Nelson Peltz and another for Jay Rasulo, who was Disney’s chief financial officer from 2010 to 2015. It is a highly personal and bitter battle.

Broadly speaking, both funds claim that Disney hasn’t delivered for stockholders in recent years and, testimony to this, its stock price has declined by almost 40% since its peak of $201.91 in March 2021. There is good reason for this.

The global cost of living crisis has cast a dark spell on all of Disney’s key divisions since the coronavirus pandemic receded. Many people can no longer afford to visit Disney’s theme parks or go to the theater whilst others have had to cancel their subscriptions to its Disney+ streaming platform and ESPN sports network, a process known as cord-cutting.

Compounding the problem, the economic downturn coincided with heavy investment by Disney in streaming content to try and draw subscribers away from its chief rival Netflix. It has left the streaming unit with losses of more than $11.3 billion since it launched in 2019 with profitability only forecast by the end of this year.

As we have revealed, over the past few years Disney also placed massive bets on movies for the big screen which were anything but dream tickets. Indeed, in just the past few days it has come to light that Disney lost $130 million alone on last year’s theatrical run of Indiana Jones and the Dial of Destiny.

The movie was given the green light in 2016 by Disney’s chief executive Bob Iger who also presided over the skyrocketing price of its theme park tickets and hotels. Likewise, cord-cutting was also a worry under his watch and in 2019 he launched Disney+ before he stepped down the following year.

Iger handed the reins to Bob Chapek, then-head of Disney’s parks division, who got the blame when Disney’s stock price went into freefall in 2022. It lost 31.5% of its value in the first 11 months of the year and in a bid to bring back the magic, Disney tempted Iger take the top job at the media giant again.

Since then, Iger has cut $7.5 billion of costs and costly content which was in production. Disney is also planning an ESPN streaming service, has launched a cut-price, advertising-supported Disney+ package and has offered free water park access to on-site hotel guests at its sprawling Walt Disney World theme park complex in Orlando, Florida.

Blackwells doesn’t believe that is enough to give Disney a happy ending and has suggested breaking it up into three separate public companies which would each have their own specialist management team. Disney has resisted this, arguing that it would spell the end of its synergy and the conglomerate that Walt Disney founded in 1923.

Remarkably, Trian’s request for board seats is even more controversial than this. In February 2015, Rasulo was passed over for Disney’s Number Two job and left the Mouse three months later after a total of 29 years with the company. He isn’t the only former Disney staffer involved with Trian.

Another of Peltz’s partners is Israeli-American billionaire Ike Perlmutter who was chairman of Disney’s Marvel Entertainment super hero division. He famously butted heads with Iger and in March last year was sacked as part of the cost cuts.

Against this backdrop, Disney recently released a presentation entitled ‘The Right Board, The Right Strategy: Disney’s Plan For Shareholder Value Creation’. The 67-page screed gushes over Disney’s achievements to try and convince stockholders to back Iger’s vision for the company and vote in favor of his preferred directors. It even goes as far as to claim that between 2020 and 2022 the Disney “management and board deftly handled severe impacts from the global pandemic.” If that was actually the case then it raises the question of why Disney needed to fire Chapek.

Peltz and Rasulo are the focus of the attention in the presentation and, strangely for a company which is usually cautious with its wording, the descriptions of them are replete with unverifiable opinionated statements.

Apparently written with a crystal ball in hand, the presentation claims that “Jay Rasulo will harm Disney” and, suggesting that the authors are also mind-readers, it adds that “Peltz knows nothing about managing creativity.”

Indeed, the presentation goes to such great lengths to show that Disney is always in the right that it ends up contradicting itself. It claims that “neither Peltz, who does not understand media, nor Rasulo, who has not managed through the industry’s disruption, have the skills to help Disney.” If this is true and not just a petty snipe, then why does the presentation later claim that Disney “already have in motion the vast majority of Peltz’s ‘suggestions'”?

It doesn’t just suggest that Disney is clutching at straws but also that its argument is circular. By objecting so strongly to Trian’s directors, Disney comes across as being closed-minded which is the very thing that Trian and Blackwells are complaining about. They say that Disney is badly in need of a fresh perspective and its presentation simply serves to make it look desperate to demonstrate that this isn’t the case. It goes to astonishing lengths to do so.

Thanks to the history between Iger and Perlmutter, the presentation heaps as much praise on Disney’s CEO as the company itself. The acrimony between the two men is so great that business network CNBC has even suggested that Iger could resign if Trian gets its way with its bid for board representation.

There is little doubt that whenever Iger leaves, his largest legacy will be four landmark acquisitions. They started less than a year after he first became Disney’s big cheese when he approved the $7.4 billion buyout of computer-animated movie producer Pixar, owners of the Toy Story franchise, in January 2006.

He followed it up three years later by paying $4 billion for Marvel Entertainment, home of the beloved Avengers franchise. It helped Disney to appeal more to young boys and gave the company a counterpart to its successful franchise of princesses. Iger didn’t stop there and in 2012 Disney bought Lucasfilm, owner of the rights to Star Wars and Indiana Jones. That too cost a cool $4 billion but this was nothing compared to what was yet to come.

Iger saved his biggest deal for last when Disney bought 21st Century Fox for a staggering $71 billion in 2019. Fox gave Disney the movie rights to super hero squads the X-Men and the Fantastic Four as well as adult-focused content for its streaming platform which has yet to pay off.

Iger has become almost synonymous with these four deals so it’s perhaps no surprise that they loom large in the presentation. It devotes a full page to the fruits of them under the title: ‘Enduring franchises highlight our powerful IP and unique monetization capabilities’. This too comes across as being desperate.

The purpose of the page is to show the financial benefit that Iger’s iconic transactions have brought to Disney. The logos of franchises linked to these deals are presented next to a chronology of the key developments such as the opening of theme park attractions based on them and the debut of new movies in the series. At the side of the timeline is a figure showing the alleged Return On Investment (ROI) that they have generated.

According to the document, Star Wars has generated a 2.9x ROI for Disney, whilst the Avengers has made 3.3x and Toy Story is even higher at 5.5x due to the lower costs of making computer-animated movies. This too is why the list is crowned by the wildly-popular computer-animated franchise Frozen which has supposedly yielded a return of 9.9 times Disney’s investment. It all sounds sensible on the face of it but looking a little deeper soon reveals that Disney has used every trick in its spell book to arrive at these conclusions.

The smoking gun is Frozen as it was not part of one of Iger’s four landmark deals. In fact, it was actually adapted from Hans Christian Andersen’s story The Snow Queen. This immediately raises the question of how the ROI was calculated if there was no investment to acquire it. Surprisingly, the fine print at the bottom of the page doesn’t answer this question but it does contain a blockbuster revelation.

The fine print states that the ROI calculation is based on “titles released following Disney’s acquisition of the IP.” This doesn’t solve the Frozen conundrum as it was not an established franchise which was acquired by Disney like the other three on the page. However, the presentation goes on to make it clear how the investment was calculated.

The fine print states that “investment reflects film production costs and print & advertising associated with the theatrical release of the titles, and in the case of animated titles it also includes production overhead.” In short, the ‘I’ in ROI covers the movie’s production expenses and marketing costs. There is no indication that the ROI calculation factors in Disney’s acquisition cost of the companies which own the franchises and this isn’t actually as significant an omission as it may seem.

Despite initial appearances, the page is not intended to show the ROI of Disney’s acquisition of Lucasfilm, Pixar and Marvel but just the Star Wars, Toy Story and Avengers franchises within them. Lucasfilm, Pixar and Marvel all own a multitude of other franchises and assets so it wouldn’t be logical to attribute the entire purchase price of those companies when calculating the ROI of Star Wars, Toy Story and Avengers. There is no doubt that this is what Disney intended to do as the fine print even lists the movies in those franchises which the ROI calculation is based on.

Accordingly, there is no question about the logic behind the calculation of the costs of the four franchises on the presentation page. However, the ‘R’ in ROI is a completely different story. The fine print is very clear about what the return doesn’t include and this too is entirely logical.

It states that the return “does not include derivative revenue streams, such as park attractions, nor does it include DTC originals associated with those franchises or pre-established franchise consumer products revenue.”

Starting at the end of this list, the pre-established franchise consumer products revenue refers to cashflow which was in place prior to Disney’s acquisition of the franchises so it is perfectly reasonable to exclude that. Likewise, DTC, or Direct To Consumer, refers to streaming shows and the reason they too should be excluded is that subscribers pay to access Disney’s entire library of content, not just specific shows. As a result, it isn’t possible to attribute subscriber fees to specific franchises and the same goes for theme park attractions as guests get access to all of them for the entry price.

So far so good but then comes a disturbance in the force.

The fine print adds that the return is based on “directly associated theatrical releases, including theatrical, home entertainment, TV (pay and free), and consumer products” which, again makes perfect sense. However, it adds that the calculation is based on a 10-year period of “generated and expected” results. In other words, the ROI figure is partly based on a forecast which may not even prove to be accurate. Remarkably that is far from the most contrived aspect of the calculation.

Sitting there in plain sight in the fine print is the definition of ‘return on investment’ which is described as “the ratio between revenue and investment.” Except that’s not what return on investment is.

As the following definition shows, “ROI is expressed as a percentage and is calculated by dividing an investment’s net profit (or loss) by its initial cost or outlay.” Ditto from Harvard Business School, Pepperdine, and pretty much every major business school and financial institution.

The clue is in the word ‘return’. Revenue is not a return for the owner as a cut of it has to be paid out in costs, unless there are none which certainly doesn’t apply in Disney’s case. Calculating ROI on revenue rather than profit ignores the costs so artificially inflates the result.

Take for example a movie which grosses $1 billion in ticket sales. The studio typically gets 50% of the box office giving it revenue of $500 million. Let’s say the amount the studio actually invested in the picture (after any reimbursements or incentives for filming in particular jurisdictions) comes to $300 million, that gives it a $200 million profit.

Calculating the ROI by using a ratio of the $500 million revenue and the $300 million investment gives a 0.7x multiple. In contrast, using the actual ROI method involves dividing the $200 million profit by the $300 million investment which yields a loss for the studio.

Taking another example, if a movie generates $850 million in ticket sales, giving the studio revenue of $425 million, on an investment of $110 million, it makes a $315 million profit. Disney’s definition of the ratio between revenue and investment yields a 2.9x ROI as the movie generated $315 million in revenue after it had returned the owner’s $110 million investment. However, using the actual definition of the ratio between profit and investment yields an ROI multiple of 1.9x as the movie made $205 million of profits once the studio had got its $110 million investment back.

Try as many figures as you like and the result always comes out the same – using the ratio between revenue and investment will yield a higher result than the ratio between profit and investment which is the usual definition of ROI. The only exception is if the costs are zero which is not applicable in the case of Disney movies or consumer products.

This applies to any industry. Take for example a real estate owner who buys a hotel for $200 million. That cost isn’t factored into Disney’s examples so we should ignore it here too. The owner then makes a $25 million investment to renovate the hotel and it generates $100 million in revenue over 10 years. Its costs over that period come to $50 million leaving a $50 million profit for the owner.

Using Disney’s definition of the ratio between revenue and investment yields a 3x ROI. This is because the hotel generated $75 million in revenue beyond the owner’s $25 million investment. However, using the actual definition of ROI – the ratio between profit and investment – yields a 1x multiple as the hotel only generated $25 million in profit once it had returned the owner’s investment of $25 million.

Again, try as many numbers as you like and the result will always be the same – Disney’s definition inflates the ROI result unless the costs come to zero which isn’t the case here. We have reached out to Disney to ask why it used this definition of ROI but have not received a reply.

It is understood that Disney hasn’t misled investors as the methodology is in the fine print of the presentation. That said, using such a contrived definition makes the media giant look even more desperate and it is such an extraordinary decision that it calls into question the credibility of the entire presentation.

That doesn’t just make Trian look sparkling but Blackwells too and this can be seen through its call to break up Disney. The media giant’s current leisure strategy is to have a small number of theme parks scattered around the globe so that many tourists have to travel far to get to them which makes the experience a special occasion. As a result, they are prepared to pay more for it which raises the profit margins.

That’s an admirable aim but it has also left Disney chronically under-exposed in major markets such as India, South Africa, Australia and the United Arab Emirates (UAE) which all lack a Disney park. The UAE in particular is one of the world’s wealthiest nations and has tremendous pent-up demand for Disney. Not only are 88.5% of the population expats (including many Americans) but the remaining 11.5% are immensely wealthy and already spend big bucks at Disney parks elsewhere in the world.

The Disney vacuum in the UAE has led to the theme park sector in its key cities of Dubai and Abu Dhabi being dominated by Dreamworks, SeaWorld and Warner Bros. Iger shouldn’t have a problem with the UAE as it is a more progressive country on almost all fronts than China which is home to two Disney parks.

There isn’t even a Disney store in the UAE despite it being home to one of the world’s biggest malls and a tremendous number of other American retail chains including OshKosh B’gosh, Williams Sonoma, Payless ShoeSource, Bath & Body Works, Pottery Barn, ACE and The Children’s Place which, ironically, once held the Disney Store license. The absence of Disney Stores isn’t due to the shift away from bricks and mortar as nearby Qatar has one as we have reported.

If Disney’s parks were run by a real estate company it may take the alternative strategy of wider distribution and lower entry prices which would greatly boost distribution and revenue. It would also ensure that Disney isn’t left behind by its main rival NBCUniversal which is planning smaller parks in Frisco, Texas, and the United Kingdom as well as smaller attractions in major cities to capitalize on the booming trend for Location Based Entertainment.

It all contributes to the conclusion that Disney’s presentation appears to be counter-productive. After all, if Trian and Blackwells are such insignificant adversaries then why was there a need to produce the presentation in the first place? Given some of the claims made in the document it could end up casting a dark spell over Disney even if it wins the board vote today.