The Walt Disney Company. Christina Russell FIN 6406 Strategic Financial Management Dr. Frye

Transcription

1 The Walt Disney Company Christina Russell FIN 6406 Strategic Financial Management Dr. Frye

2 Table of Contents Part 1: The Company Page: 2-5 Part 2: Financial Planning and Analysis Page: 6-10 Part 3: Dividend Growth Model Page: 11 Part 4: Capital Asset Pricing Model (CAPM) Page: 12 Part 5: Weight Average Cost of Capital (WACC) Page: Part 6: Estimating Walt Disney Company s Value Page: References Page: 18 Appendices: A: Income Statement for Disney and Time Warner Page: B: Balance Sheet for Disney and Time Warner Page: C: Cash Flow for Disney and Time Warner Page: D: Ratios for Disney and Time Warner Page: E: Value Line for Disney and Time Warner Page: F: The Walt Disney Company 10-K Page: 44 *Appendices A, B, and C were derived from Google Finance *Appendix D was derived from Reuters.com *Appendix E was derived from Valueline.com 1

3 The Company It all started with a mouse Mission: The Walt Disney Company's objective is to be one of the world's leading producers and providers of entertainment and information, using its portfolio of brands to differentiate its content, services and consumer products. The company's primary financial goals are to maximize earnings and cash flow, and to allocate capital profitability toward growth initiatives that will drive long-term shareholder value. The Walt Disney Company is the world s largest media and entertainment conglomerate with assets encompassing media networks, studio entertainment, parks and resorts, and consumer products. The Walt Disney Company s television and media network assets include the ABC television network, and ten broadcast stations. In addition, Walt Disney s portfolio of cable networks include: ABC Family, Disney Channel, Toon Disney, and ESPN (80% ownership). The Walt Disney Studios produces films through lines such as Walt Disney Pictures, Touchstone, and Pixar. With the recent acquisition of Marvel Entertainment, the Walt Disney Company enters as a top comic book publisher and film producer. Studio entertainment produces and acquires live-action and animated motion pictures for distribution to the theatrical, home video and television markets. Theme parks and resorts include the operations of the Walt Disney World Resort in Florida, Disneyland Park, the Disneyland Hotel and the Disneyland Pacific Hotel in California. Consumer products segment includes merchandise licensing, publishing. The Walt Disney Company has a prestigious history in the entertainment industry, stretching over 75 years. Since its inception in 1923, the Walt Disney Company and additional affiliated businesses have remained committed to produce supreme entertainment experiences based upon the rich legacy of quality creative content and incomparable storytelling. Within the past few decades, Disney has moved into a wider market, beginning the Disney Channel on cable and establishing subdivisions such as Touchstone Pictures to produce films other than the usual family-oriented fare, gaining a firmer footing on a broader range. Starting in 1984, Disney enjoyed an enormous creative and financial renaissance, in part to the leadership of CEO Michael Eisner, the success of all its subsidiaries, sales through the Disney Stores, and a 2

4 recommitment to excellence in developing original feature-length animated films. Under Eisner s guidance, Disney acquired Capital Cities/ABC in 1996, a $19 billion deal that increased the company s stature immensely (Sander, 1). Adding to the theme parks, cruise ships, professional sports teams, and dozens of other businesses owned by the company, the acquisition of Capital Cities/ABC gave Disney the power of broadcasting and the ability to meld entertainment content with programming. During the late 1990s, the company was aggressively building a presence on the Internet and adopting a concentrated approach to international expansion. Disney has traditionally relied on its existing creative components to continually produce new original properties to fuel the consumer products sales however in 2009 the media giant purchased Marvel for $4.3 billion in cash and stock. The deal expanded Disney s stable of intellectual property with the addition of such characters as Iron Man, Spider- Man, and the X-Men. Which have all been turned into successful Hollywood blockbusters and licensed for other purposes (Hoovers, 1). Strengths: I knew if this business was ever to get anywhere, if this business was ever to grow, it could never do it by having to answer to someone unsympathetic to its possibilities, by having to answer to someone with only one thought or interest, namely profits. For my idea of how to make profits has differed greatly from those who generally control businesses such as ours. I have blind faith in the policy that quality, tempered with good judgment and showmanship, will win against all odds. Walt Disney When the Walt Disney Company initially began, it was under the control of Walt himself. Throughout his reign, he developed a culture to create experiences and magical moments for all his guests this philosophy from the beginning has created a long-lasting brand name known for producing a quality product or experience. This Disney culture has succeeded through tight control over how the brand and image is perceived. Disney has become one of the most recognized and renowned brand names throughout all industries. In addition to its well-known brand name, Disney has developed famous characters to add to its image (ex. Mickey, Minnie, Goofy, Donald, Pluto, etc.). These characters have aided in Walt Disney s ability to capitalize and have a definitive grasp upon their target consumers of children. 3

5 However, Disney s largest asset is their ability to stay diversified. Disney is a well-established conglomerate firm with a solid domination within the theme park and entertainment industry. Disney already operates through four different business segments which include media networks, parks and resorts, studio entertainment, and consumer products. Disney s monumental deal with Apple creating a partnership between Disney and itunes should provide an excellent resource to further push the brand and provide a reputable channel to push product distribution. Overall, Disney s desire to strive for excellence, ability to adapt to change, and continuing to keep the consumers as the driving force behind the enterprise make Disney an empire within the media industry. Weaknesses: Being a conglomerate of this capacity, the Walt Disney Company holds exceptionally high sunk costs which could hinder Disney s future financial abilities. In addition to sunk costs, there is the continual cost of updating all the parks, resorts, hotels, cruise ships, etc. Disney s brand of quality must be maintained nonetheless it continues to escalate the costs. Although merchandise aimed at the children segment is a huge market, such a public image can have a kiddie-stigma attached to the Disney brand name which could deter the young adult segment. Although Disney is attempting to increase its Internet presence, it cannot compete with the popularity of properties such as Google.com, Youtube.com, and Facebook.com, which are either owned or have lucrative deals with Disney s top competitors Time Warner, CBS Corporation, and News Corporation (Hoover s). Opportunities: Disney has many opportunities to continue the firm s growth within the industry. Currently the markets are much more versatile to outsourcing and globalization. The Walt Disney Company is working towards this global localization through expansion into Europe and Asia. Approximately twenty-five percent of Disney s operating income comes from outside the United States and Canada, making continued growth internationally a major competitive advantage. Disney has invested tremendously in their Research and Development department, which projects progressive new attractions to pull in consumers. Disney s ability to re-invent 4

6 and create limited edition products allows multiple opportunities for sales with new or improved merchandise. Threats: Disney has multiple threats that could negatively impact its profitability in the future. Disney s major threat comes from its competitors on national, regional, and global platforms. The high competition and growth of other industry giants pose multiple problems to Disney s ability to sustain as a leader within the industry. With the recent acquisition of Marvel and other businesses, Disney s hasty acquisitions could post low or unprofitable sales, resulting in not only a loss, but a negative impact for the conglomerate s brand name. Another threat is Disney s high pressure and demand in terms of sales, creativity, and innovation while maintaining its quality status. Finally, due to the recent economic state, employee retention can pose a threat if employees are let go and work for competitors within the industry. Competitors: Disney would fall under the Entertainment Diversified industry category as a service sector. News Corp., Time Warner Inc., Liberty Media Interactive, Liberty Capital Group, and Liberty Starz Group are the Walt Disney Company s main competitors within this industry. Even though the Walt Disney Company is a market leader, these other competitors can pose definitive difficulties because they are all diversified conglomerates with a solid presence within the global market. Growth Potential: Overall, the Walt Disney Company is poised very well for the future. The successful leadership of Bob Iger is particularly important to the continued success of the firm. As the leader, Iger does not assume autonomous control, but puts a great deal of trust in his associates and top level executives, creating an extraordinary working atmosphere. Iger s deal with Apple s Steven Jobs should provide a huge opportunity for growth with this significant partnership. Disney has a long successful history while still being able to adapt with the changes within the industry. Under the current leadership, Disney is already a growing part of the new environment of digital media. 5

7 Financial Planning and Analysis Liquidity Ratios The Walt Disney Company Time Warner Inc. Industry Current Ratio (MRQ) Quick Ratio (MRQ) (Data for the liquidity ratios was taken from Reuters.com) The current ratio measures the company s ability to pay its short-term obligations. The ratio is mostly used to give an idea of how well a company can pay back its short-term liabilities with its short-term assets. The Walt Disney Company current ratio of 1.11 is greater than 1, which means their assets can cover their liabilities. However, the Walt Disney Company is below both the Industry and its competitor, Time Warner Inc. The quick ratio (acid test ratio) measures a company s ability to meet its short-term obligations with its most liquid assets. The quick ratio is a more conservation method to measure liquidity over the current ratio because it excludes the inventory from the current assets. If a firm needed had to pay off its short-term obligations immediately, there are occurrences where the current ratio would overestimate a company s short-term financial strength. The Walt Disney Company quick ratio is 1.01 versus Time Warner s This shows that Disney actually holds less inventory than Time Warner (9% versus 13%), and Disney s quick ratio is actually less than the industry average as well. Leverage Ratios The Walt Disney Company Time Warner Industry Total Debt to Equity (MRQ) 38.23% 46.18% 61.61% Times Interest Earned (Interest Coverage) (Data for the leverage ratios was taken from Reuters.com) The debt to equity ratio indicates what proportion of equity and debt the company is using to finance its assets. The Walt Disney Company has a low total debt to equity with only 38.23% of their assets are financed with their liabilities. Disney s total debt to equity is lower than both Time Warner and the Industry average. This implies, relative to the industry, the Walt Disney Company takes a less aggressive method to finance its growth with its debt, reducing its risk as a company. 6

8 Times Interest Earned is a measure of the firm s ability to meet its debt obligations through interest payments. Time Warner s negative time interest earned implies that they cannot cover their debt; whereas Disney does not have a time interest earned ratio was missing. After calculating Disney s time interest earned from their 10K, they have a substantially higher ratio indicting it can meet its debt obligations seven times over. Assets Management Ratios The Walt Disney Company Time Warner Industry Inventory Turnover (TTM) Receivable Turnover (TTM) Average Collection Period days days days Total Asset Turnover (TTM) (Data for the leverage ratios was taken from Reuters.com) The inventory turnover illustrates how often a firm s inventory is sold and replaced over a period. Since inventory is typically the least liquid form of an asset, a high ratio implies strong sales and effective buying. The Walt Disney Company dominates in terms of inventory turnover with a higher turnover than both the industry average as well as Time Warner. The receivable turnover ratio and the average collection period are used to calculate a company s effectiveness in extending credit as well as collecting debts. The receivables turnover ratio measures how efficiently a firm uses its assets. The average collection period is stated in terms of the number of days that credit sales remain in the accounts receivable before they are collected. Disney has both a better receivable turnover and average collection period, implying that Disney is working efficiently at collecting their accounts receivables as well as effectively using their assets. The total asset turnover is the amount of sales generated for every dollar s worth of assets, the higher the number the better. Although Disney is doing better than Time Warner, it is still slightly under the industry average, this implies that Disney can do more to enhance Disney s ability to efficiently use its assets to produce sales or revenue. Profitability Ratios The Walt Disney Company Time Warner Industry Return on Assets (TTM) 5.37% 2.32% 5.76% Return On Equity (TTM) 9.61% 5.47% 13.87% Net Profit Margin (TTM) 9.93% 8.10% 10.36% (Data for the leverage ratios was taken from Reuters.com) 7

9 The Walt Disney Company has average to below average profitability ratios. The return on assets (ROA) indicates how profitable a firm is relative to its total assets. The ROA aids in determining how efficient management is at using the assets it has to generate additional earnings. The return on equity (ROE) measures a company s profitability by showing how much profit a firm makes with the money the actual shareholders have invested. Although Disney s ROA and ROE is better than Time Warner, it is still slightly below the industry average s ROA and ROE. The net profit margin indicates how much of every dollar of sales the company keeps in earnings. Disney s 9.93% means that the company has a net income of approximately $0.10 for each dollar of sales. Disney s profit margin is greater than Time Warner s, indicating that they have a higher level of earnings compare to its competitor. Market Value Ratios The Walt Disney Company Time Warner Industry P/E Ratio (TTM) Price to Book Ratio (MRQ) (Data for the leverage ratios was taken from Reuters.com) The price earnings ratio indicated the company s current share price compared to its per-share earnings. Since Disney s P/E ratio is higher than both Time Warner and the industry, this implies that shareholders are expecting higher earnings growth in the future. The price to book ratio compares a stock s market value to its book value. Disney is very close to the industry s average so this seems to be valued correctly, however one must be aware that this could vary by industry. 8

10 DuPont Identity The breakdown of the DuPont identity is meant to show the effects of operating efficiency (PM), asset use efficiency (TATO), and financial leverage (EM). If ROE is unsatisfactory, the DuPont identity helps locate the part of the business that is underperforming. Therefore, Disney 2009 =.0915*.5727*1.87 = 9.80% Disney 2008 =.1171*.6050*1.93 = 13.70% Disney 2007 =.1320*.5828*1.98 = 15.24% Time Warner 2009 =.0946*.3923*1.97 = 7.30% Time Warner 2008 = *.2237*2.70 = % Time Warner 2007 =.1583*.1959*2.29 = 7.10% These ROE s will differs from the one listed previously from Reuters.com due to the site using TTM (trailing twelve months), which is more upto-date and accurate. The table is calculated out is derived from the balance sheet and income statement from Google Finance. Company Comparison: DuPont Identity Year Walt Disney Company Time Warner 2009 ROE 9.80 % 7.30% 2008 ROE 13.70% % 2007 ROE 15.24% 7.10% The table is calculated out and derived from the balance sheet and income statement for The Walt Disney Company and Time Warner from Google Finance. The return on equity shows how well a firm uses investment funds to generate earnings growth. The Walt Disney Company s return on equity and net income has steadily decreased since 2007, whereas the profit margin has steadily increased. With Time Warner s ROE s lower values against Disney it could imply that it is slightly a more conservative firm. Disney s decreasing profit margin could mean it is not controlling costs as well as it previously was, its profit margin has decreased due to Disney s net income decline. In terms of total asset turnover, Disney is also better than Time Warner which means Disney manages its assets in a more efficient manner against Time Warner. In 2008, Time Warner s net income was in the 9

11 negative which lead to a negative return on equity; this is due to a seven billion dollar unusual expense and a backlash from consumers which lead to damaging publicity. Growth Rates 2009 Internal Sustainable The internal growth rate is the highest level of growth achievable for a firm without obtaining outside financing. The growth rate calculated for the Walt Disney Company is 4.44%. Historically, the Walt Disney Company saw internal growth rates of 6.14% and 7.36% for 2008 and 2007 respectively. This continuing decline could be a result of the dismal economy. However, with the acquisition of Marvel Entertainment, along with new and profitable feature films, the Walt Disney Company can still attain a positive internal growth rate. The sustainable growth rate is how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio. The Walt Disney Company s sustainable growth rate is 8.42%. Historically, the Walt Disney Company saw sustainable growth rates of 12.57% and 15.66% for 2008 and 2007 respectively. Again, a depressed economy is probably the main culprit notwithstanding, the Walt Disney Company strong management team can expect to see sustainable growth. Additionally, analysts on Value Line have forecasted double-digit growth during the next fiscal year. 10

12 Dividend Growth Model Estimated Growth Rate in Earnings and Dividends/Required Rate of Return Dividend Discount Model (Data from Value Line Publishing) r = 11.92% The data from Value Line Publishing listed a historical dividend growth rate of 10.0% for the Walt Disney Company and estimated the firm s dividend growth rate to be 11.5% until I chose to take the average between these two growth rates to give a more accurate depiction of the potential growth rate which is why 10.75% was used in the above equation. The final calculation shows that the required rate of return is 11.92%. This number is rational because 11.92% is larger than the 10.75% estimated divided growth rate, and actually closer to the 11.5% estimated dividend growth rate. According to Value Line Publishing s data given according to historical rates and calculating the required rate of return, it is safe to believe the Walt Disney Company has a stable constant growth. This stability is because Walt Disney has been growing at a stable rate for over five years. 11

13 Capital Asset Pricing Model (CAPM) Estimates of Beta Google Finance: 1.17 Value Line: 1.00 Reuters: 1.15 S&P: 1.10 Average: The table above lists the beta estimates from four sites along with the average beta between Google, Value Line, Reuters, and S&P. The beta of a stock is a number that describes the relation of returns with that of the financial markets as a whole. Since the Walt Disney Company s beta is almost exactly 1, the company has about as much systematic risk as expected against the overall market. Beta is pivotal in the capital asset pricing model because it measures the part of the asset s statistical variance that cannot be diminished by the diversification of the firm, since it is correlated with the return of the other assets within the firm. Expected Return Using CAPM CAPM = = 9.397% The current risk free interest rate for three-month Treasury bills is.115% as of April 1 st, According to Chapter 9 in the textbook, the historical risk premium rate relative to the Treasury bills for large-company stocks is 8.4%. Using these two figures, along with the average beta calculated above, the calculated expected return is 9.397% using CAPM. The required rate of return that was calculated using the dividend discount model was 11.92% which is approximately 2.5% higher than the CAPM rate calculated. This is due to a difference with how beta is estimated which could be smaller than the actual beta. With the currently weak economy, the low interest yield for Treasury bills may have made the estimate appear lower. CAPM is a more accurate measure of return due to the fact that the 11.92% return was still higher than both the historical and future rates given on Value Line. CAPM is also more accurate because it uses actual current market numbers decreasing the use of estimates used within the dividend discount model approach. 12

14 Weighted Average Cost of Capital (WACC) The weighted average cost of capital formula is: The Walt Disney Company s capital structure is as follows: Debt (B) Book Value (Long Term Debt): $ 11, Equity (S) Stock Price: $ Shares: $ 1, Market Value: $ 54, Total Value of the Firm (B+S): $ 66, Weights Debt 17.41% Equity 82.59% The remaining components of the WACC equation come from the following: Tax Rate (2009) ( Tax Expense $ 2,049 Net Income before Taxes $ 5,658 Tax Expense/Net Income before Taxes 36.21% Cost of Debt 2.416% Cost of Equity ( ) (CAPM) 9.397% 5.22% After collecting all the information above, the Walt Disney Company s weight in bonds is 17.41% (11,495/66, ) and their weight in stocks is 82.59% (54, /66, ). According to marketwatch.com, the Walt Disney Company has multiple different bonds with yield to maturities of 0.537, 1.224, 1.257, 1.723, 2.405, 2.860, 3.607, 4.125, and I averaged all nine yield to maturities to find the average of 2.416%. The tax rate for the Walt Disney Company was calculated using Google Finance s Income Statements. After estimating the tax rate, using the CAPM as the cost of equity, and determining the cost of debt I calculated that the weighted average cost of capital (WACC) to be 5.22%. WACC may not be a sensible discount rate for all of the Walt Disney Company s capital budgeting projects since the Walt Disney Company is so diversified with multiple companies within the conglomerate. The Walt 13

15 Disney Company generates revenues through five main segments: Media Networks (44.8%), Parks and Resorts (29.5%), Studio Entertainment (17.0%), Consumer Products (6.7%), and Interactive Media (2.0%). The media networks division may be able to take on greater risks due to the constant need for research and development required in this industry. The parks and resorts division also requires more capital due to constant updates with operating expenses and research and development. For all these reasons, the Walt Disney Company may need different discount rate for each division to more accurately determine the breakdown of debt and equity. 14

16 Estimating Walt Disney Company s Value Estimated Free Cash Flows Investment in Net Working Capital Year PPE Current Assets Current Liabilities NWC (CA-CL) 2009 $34,992 $11,889 $8,934 $2, $33,842 $11,666 $11,591 $ $32,578 $11,314 $11,391 $ (77) 2006 $30,948 $9,562 $10,210 $ (648) 2005 $29,573 $8,845 $9,168 $(323) (All dollar amounts in Millions of USD taken from Google Finance) Year Profit Depreciation Investment in Fixed Investment in Free Cash after Tax Assets Working Capital Flows 2009 $3,307 $1,631 $1,150 $2,880 $ $4,427 $1,582 $1,264 $152 $4, $4,687 $1,491 $1,630 $571 $3, $3,374 $1,446 $1,375 $(325) $3,770 (All dollar amounts in Millions of USD taken from Google Finance) Profit after tax and depreciation were taken directly from the Google finance statement of cash flows. The investment in fixed assets was calculated using the difference between the PPE previous year and current year. The investment in working capital was calculated by taking the difference between the net working capital of the previous year and current year. Finally the free cash flows column was calculated using the formula listed between the tables. 15

17 Estimated Growth in Free Cash Flows Year Free Cash Flows Δ Free Cash Flows Growth Rate in Free Cash Flows 2009 $908 $(3685) % 2008 $4,593 $ % 2007 $3,977 $ % 2006 $3, The free cash flows was taken from the table listed above. The change in free cash flows is derived from calculating the previous year s free cash flows from the current free cash flows. The growth in free cash flows is calculated by dividing the current year s change in free cash flows over the previous year s free cash flows. According to the data above, the Walt Disney Company s growth rates have steadily decreased since In 2009 the growth rate dropped dramatically most likely due to the acquisition of the Marvel Company. It is probable that the growth rate should begin to increase as the Walt Disney Company begins to experience profits from the investments and development from the purchase of Marvel. With the vast differences in these three growth rates in free cash flows, it is not practicable to calculated rates or even an average of the growth rates. The use of Value Line s estimated cash flow rate of 10.5% is better because it uses more historical data which will give a more practical growth expectation for the Walt Disney Company. Estimated Value per Share As stated above, my initial plan was to use Value Line s estimate cash flow rate of 10.5% and the Weighted Average Cost of Capital of 5.22%. Unfortunately the growth rate is larger than my WACC so the rate is not applicable. I will use the two-step approach, where the longterm growth rate at the horizon is smaller than the calculated weighted average cost of capital. Through analysis of the growth rates of the free cash flow s that were previously calculated, I expect that the Walt Disney Company s acquisition of Marvel Entertainment will return to a standard rate in four to five years. I will assume that at the start of the fourth year the growth rate will drop to 5.0% from 10.5%, I chose this rate because it is slightly less than half the growth rate from the previous Value Line estimate, and is still twice as high as the inflation rate. I derived the inflation rate from the US Inflation Calculate which determined that the average 16

18 rate for 2010 was 2.35% (2.6 in January and 2.1 in February). The Walt Disney Company is a strong and consistent conglomerate so I believe it will be growing by more than the inflation rate. Forecasted Free Cash 5.0% Growth Rate PV of Cash Flow 3(Horizon Value) = = 1, * (1.05)/( ) $501, Present Value of Business CF0 = FCF 0 $ CF 1= FCF 1 = FCF0*(1.05) = $ CF 2 = FCF 2 = FCF1*(1.05) = $1, FCF 3 = FCF2*(1.05) = $1, CF 3 = FCF 3 +Horizon Value = $502, r = 5.22% NPV = $434, Value per Share (VPS) = = $434, Long Term Debt = $11, Preferred Stock = 0 # of Shares Outstanding = 1, VPS = $ My estimated stock price of $ is $ more than the stock price of $29.98 which was listed on Value Line. This inconsistency in prices could have been caused for a number of reasons. The estimates for the FCF growth rates were difficult to estimate because of the Walt Disney Company s varied free cash flows. Also throughout this project, multiple estimates were made to complete calculations, including estimates for the Weighted Average Cost of Capital. These figures are rather arbitrary; however I would still invest in the Walt Disney Company. There are numerous reasons to consider when determining whether a stock is a good investment, not just whether the free cash flows are positive. The Walt Disney Company continues to build shareholder s wealth through making intelligent acquisitions and sustaining a competitive advantage within the industry. The Walt Disney Company is a wellestablished conglomerate which continues to be an industry leader; I would invest in the Walt Disney Company because it has proven that it will continue to be successful and profitable in the ever-changing industry. 17

19 References Sanders, Adrien-Luc. The Walt Disney Company. About.com Guide. 30 March Hoovers Inc. The Walt Disney Company. 30 March