(This is Part I of a multi-part series answering the question: “How Much Money Did Disney Make on the Lucasfilm deal?” Previous sections are here:
Part I: Introduction & “The Time Value of Money Explained”
Appendix: Feature Film Finances Explained!
Part II: Star Wars Movie Revenue So Far
Part III: The Economics of Blockbusters
Part IV: Movie Revenue – Modeling the Scenarios
Part V: The Analysis! Performance, Implications, and Cautions)
Let me take you into the mind of a business school student. While in school, you’re taught to be super critical of any business presented to you in the form of a Harvard case study. Even if things look super rosy, there are some bad numbers hidden in the appendix you need to find.
At the same time, you’re taught to be super positive for any business that is doing well on the stock market at the moment. You don’t have appendices to go searching through to find flaws. It’s a weird dichotomy of simultaneous criticism and optimism.
The company that was flying high when I was at business school—and has been a darling of Harvard case studies since the 1990s—was The Walt Disney Company. During my first year as an MBA student, Disney acquired Lucasfilm, the maker of Star Wars and Indiana Jones (if somehow you didn’t know that). I was so enthused by the deal that I used it as my topic for our speech class. To call me “enthusiastic” would undersell my opinion: I thought it was a guaranteed home run.
So when I came up with my first “analysis” article for this website: “How Much Money Has Disney Made on the Lucasfilm deal?” I remembered I’d already tried to answer that question. In that presentation above.
So I pulled out the presentation. I searched for my numbers to see what I said. I only found one slide with any numbers on it. I laid out the challenge for The Walt Disney Company: to make a good return on its investment, Disney would need to earn nearly $550 million per year to make up its money.
That’s a huge number. So did my speech predict how much money Disney would eventually make on the deal?
If I could make one change to the entertainment business press—and I’d make a few—it would probably be to enforce this rule: You don’t have a strategy if you don’t have any numbers. Looking back on that presentation in speech class, I didn’t obey my own rule! My presentation didn’t have any numbers. Well that’s not quite true, I had some tables showing that Disney does well at the box office and international growth is important, but I didn’t project how much money I thought Disney would make or lose by that deal. I just said I loved it and listed some general strategic points.
That’s what most of us do day in and day out in business, and I want to change that.
Strategy is numbers, and today I want to look back at that deal. It feels like a good time to update our thoughts on the Lucasfilm acquisition. While the last film was a box office smash (the number one movie in 2017), it had the worst customer feedback since The Phantom Menace. Worse, Solo had a troubled production, worrying fans on the Twitter/Reddit. And when Disney announced a new trilogy with Benioff and Weiss, it was met with a giant “Eh” and articles worrying about “saturation”.
Today, as a business analyst who loves Disney’s model and a Star Wars fan who loves the franchise, I want to combine these two things and answer a question I haven’t seen anywhere else: How much money will Disney make on the Lucasfilm deal?
Blink and Gut Analysis
When I write an “analysis” article, I’m going to try out an approach different from most other analysts. I laid out my rationale here, but to summarize, too often when we think about complex questions (like the one I laid out above) we don’t clearly own up to our initial reactions and gut thinking, even though that inevitably informs our final analysis. To combat that, I’m putting my “blink” and “gut” reactions right up front, then seeing how they change as I run the numbers.
I’m going to keep my initial gut from 2012 and say this deal is a blockbuster. And with the $2 billion worldwide box office gross of The Force Awakens, I’ll hold to that opinion. Disney will likely make a lot of money on this deal.
So I’m writing this article for a reason, which has to mean something. While my blink was super positive, my gut has a nagging feeling, and I want to put it to paper. What bothers me about this deal?
Well, a few stray strands of information. The last movie, Star Wars: The Last Jedi encountered the first negative reaction of the franchise. And the initial speculation on the next standalone movie—Solo: A Star Wars Story—is also negative. More importantly, The Last Jedi had a lower box office than The Force Awakens. Rogue One: A Star Wars Story was lower than both. Two is a line, three is a trend. So if Solo does poorly at the box office, you’ll have a negative trend. I’ve also heard that while Star Wars is the best selling merchandise in the world, it isn’t as high as you’d guess
Those are the negative pieces. But even in my gut they go up against the monster that is the “numbered movies” (Episode VII, VIII, IX, etc) performance at the box office. And knowing that most other revenue streams flow from there, you have to assume Disney can and has generated quite a bit of revenue from the series, and hence cash.
And then you have theme parks. Even though they’ll require their own huge cash investment, it’s the piece de resistance that most other traditional or nontraditional movie studio have. If Disney can break even on everything else, with new Star Wars lands in the theme parks, they’ll have a cash cow to milk for the next 20 years.
So overall, my gut says Disney will make some money on this franchise. Possibly a lot of money. But I’ll throw a caution in that it may not be as much as you would guess. If my initial speculation (blink) sounded like generating 20-50% returns, discounted for the time value of money, I’d currently say, before running the numbers, that Disney’s returns will be more like 15% to 25% over a ten year time horizon, and then they would have this asset paid off. So overall, my gut thinking says this is still a great deal.
Summary & Plan of Attack
The terms as I understand it are that Disney bought the rights to Lucasfilm for $4.05 billion dollars. They bought George Lucas out with half cash and half stock, but as my accounting professor told me, stock or cash end up being the same thing when it comes to shareholder equity.
Disney owns all the rights to all Lucasfilm unencumbered. That includes the rights to the intellectual property Star Wars and Indiana Jones, and the company LucasArts (which Disney closed after the deal, except for video game licensing) and Lucas’ various special effects companies. I am not including the special effects companies in my analysis because this deal was about Star Wars and Indiana Jones, not the other companies.
Also, George Lucas gave up his back end participation in the sale and that the original distributor of Star Wars—20th Century Fox—still has rights to the initial Star Wars: A New Hope in perpetuity and other home entertainment rights for other films through 2020. This of course would go away if the Fox and Disney merger goes through.
When it comes to Disney, we know that Disney has a film studio, multiple kids focused TV networks, the largest licensed merchandise division of major film studios and very successful theme parks. It also already owns some of the most important intellectual property in the world, starting with Mickey Mouse, going through its princesses, and continuing through Spider-man/Marvel. That last piece of IP was acquired as a part of Bob Iger’s content buying binge, which started with Steve Jobs and Pixar and continued through George Lucas and Lucasfilm. Along with Star Wars, Marvel gave Disney a firm entry into the boy’s IP world.
Plan of Attack
Disney can make money of the Lucasfilm deal in a variety of ways. It can release blockbuster movies, make new TV shows, put those shows on an SVOD platform, license those blockbuster movies to TV networks, sell the video game rights, sell books, release DVDs, and put the characters in the park. So how should we break this all down?
The easiest way is to just break it down by the lines of business that Disney uses in their annual reports: Movie studio, TV, licensing & merchandise (including interactive), and theme parks. Some of the business models are easy, with a lot of assumptions (movies), some are harder (TV), some easy to understand, but not publicly available (merchandise) and the last one is the most challenging (theme parks).
I’m going to review each line of business, making projections for how much money I think they’ll make. At the end, I’ll add it all up and make a projection for the future. Then I’ll analyze some other pieces that are still strategic and evaluate what the model tells us about the business. That said, before I get there, I feel like I need to make a caveat and a reminder about the most important—and hardly ever mentioned—factor in deal making: the time value of money.
Caveat – These are my assumptions and numbers
Let me try to answer a critique of this article before it comes out. The big critique of this analysis could be, “Wow, guy, you’re making a lot of assumptions in this analysis.”
And I will be.
I’m going to search the internet for any data I can find, but guess what? I won’t find a lot of it. So where I can’t find it, I’ll have to guess. Off the top of my head, I’ll have to guess at kids L&M sales, along with the revenue Disney will actually generate. The other huge one is global marketing spend for the movies and how Disney’s revenue compares. I’ll have to make up a lot of it.
But—and this is my counter—isn’t the entertainment journalism press already making a lot of assumptions about this very deal? I’ve read tons of articles calling it a blockbuster deal, using only scattered numbers like box office as a stand-in for profitability. I’ve been at panels where people called this a grand slam for Disney. It may be, but those people are making way more assumptions than I am.
The difference between me and them is I’m putting down my thoughts on paper. I’m clearly laying out my assumptions to try to estimate/predict how well this deal is doing. I don’t blame them entirely; they aren’t making a final call cause it’s hard. All I’m asking is that you don’t criticize this analysis if you don’t have a better one to point to.
I could refine the critique above even further: I think the implicit assumption of the critique three paragraphs up is that I’m making a lot of assumptions compared to what The Walt Disney Company knows. And that’s totally true. Former head of strategy and current Disney SVOD head Kevin Mayer could choose to release a summary of the deal that has all the actual numbers and details. He knows if this deal is good or bad. But he won’t because he has nothing to gain by doing that.
The lesson here is really for competitors of Disney. They have to make a lot of the same assumptions I will make. In some cases they’ll have better data than I do. But in most cases they won’t have done this analysis. But they’re still making decisions based of the Disney acquisition and what they believe it implies about the future of competition in entertainment.
I’d also add, that putting these numbers out there is a pretty good service to get for free. In the case of Disney or it’s competitors, they won’t release their analyses. There may be some pay-for news services that have done this analysis, but I haven’t seen it. So if there were a hypothetical line chart of “who knows what” I’d put myself above “most journalists” and “casual observers” but below “other studios” who are below “The Walt Disney Company”. I made a chart to lay this out.
But since everything above me is behind a paywall or proprietary, and everything below me doesn’t have this analysis, I’m providing a pretty good service for free, right?
Reminder: Time Value of Money
Originally I was going to launch my website with an article on the Disney-Fox acquisition. (I’m Disney obsessed apparently.) Yet, that deal is so complex I found myself having to explain a lot of pieces of the business that other articles (like this one) could explain better. Like the economics of movies. So I decided to hold that analysis to build a foundation of other articles for that one to sit on top.
One key piece of the foundation isn’t entertainment specific. And it’s this reminder:
Always remember the time value of money!
If Finance 101 has a rule—or even Economics 101—it’s this reminder: money has different values at different time periods. The simple, yet supremely powerful, time value of money. And honestly, you can’t discuss “deal making” without acknowledging it, though many “deal makers” definitely get by without acknowledging it, to their decision-making detriment.
And if deal-makers may not know it, then the articles in the business press probably don’t know it, even though it is literally fundamental. The last and first time I heard it in a media piece was by Jason Furman from the Kennedy School of Government in the “Left, Right and Center” from February 9th. (Though NPR’s Planet Money has mentioned it and Kevin Drum leads the charge for ensuring all charts use inflation-adjusted numbers.)
So let’s have a quick lesson on this extremely powerful rule. My hope is that I can use the Lucasfilm acquisition as a cool example to show how the rule works. It will also serve a great secondary purpose in that it puts the size of the deal into context. Though, in full disclosure, this lesson will be quick. They teach classes on this at business school so I obviously can’t do the topic justice in one post. (Or pick up The Cartoon Guide to Economics for a great illustrated explainer. Seriously)
(If you’re a finance whiz who knows this like the back of your hand, you can skip to the next section, but you still might find it an interesting way to look at deals.)
Basically, in a sentence, the time value of money says a dollar today is worth more than a dollar in the future. That’s because due to inflation and other factors, it is more valuable to have a dollar now then in the future. (Just imagine if I offered you a dollar now or a dollar in one year. You would take it right now, right? I’d have to offer you more money to wait a year.)
How does this impact Disney? Well, in December 2012, Disney completed it’s acquisition of Lucasfilm for a reported $4.05 billion dollars. We know that money is worth more in the present, and worth less in the future, we understand that Disney doesn’t just need to make back that $4 billion, it needs to make back that four billion accounting for the time value of money.
To illustrate, imagine a straight-line chart where Disney makes $400 million dollars (after all costs) over the next ten years. On paper, you could look at this and say, “Hey, Disney made their money back!” But I just said that money now is worth more now than money in ten years. That money—the four billion over ten years—isn’t actually worth four billion. If we discount the money just for inflation, how much would they make? Look at the chart below:The quick analysis shows that far from earning their money back, even if Disney makes $400 million in profit each year, for ten years, it would only make back $3.66 billion. Now let me clarify a few big assumptions. I’m using big, round numbers where possible. Cutting off $50 million from the total acquisition price for one (To be clear, $50 million is is still a large amount of money.) For inflation, I’m just using a flat 2%, since it has been around that rate for however long and that seems good enough to me.
The timing of those cash flows can really matter, and in my first timeline, I had the money start coming in 2013. The money really didn’t start coming in until Disney released its first new Star Wars movie, which wasn’t until the very end of December 2015. So let’s give Disney 10 years of $400 million in cash starting in 2016. How much do they make now? $3.44 billion. So even with a huge amount of revenue in $400 million per year in cash, at the inflation rate, to make their money back in 13 years, they’d need to make $462 million per year in the future to earn $4 billion in current terms.)
But wait again! We shouldn’t even use the inflation rate. There are investments out there like government bonds that return a 2% return, but have hardly any risk. This deal (deterministic history aside, which I’ll get to) has tons of risk. You need to account for the risk of the industry you are investing in, usually abbreviated as the “cost of capital”. The cost of capital is basically an industry measure for the return you should expect given your risk. You can look this up. For media-entertainment, it is 8%. (Technically NYU has it at 8.2%, but round numbers, right?)
So with an 8% discount rate, starting in 2016, man the amount of cash Disney needs to earn gets high. Even earning $400 million per year (which man a lot of business would kill to say “we earn $400 million every year”), Disney will only make $2.2 billion dollars. If Disney wanted to get to break even in ten years—and this is what makes Excel so great—then Disney would need to make about $689 million per year.
Here’s another way to think about it. What if Disney took the $4 billion dollars and just put it in the stock market? Or a basket of entertainment stocks? Well, if it earned 8% per year, it would increase to $10 billion dollars (roughly) over 12 years. So we need Disney to do better than that with our cash (I’m a shareholder) in the Lucasfilm deal to justify this purchase.
Now some caveats to this back of the envelope analysis. And some of these caveats can really swing the numbers. First, the return will never be this even. Especially with a blockbuster franchise, some of the numbers will spike when “Episode” films are released versus spin-off films (or no films). (Essentially, that’s why I moved the starting point to 2016.) Second, some of the costs of a movie are front-loaded (like production, then marketing), while the revenues trickle in over time. This model doesn’t factor that in, but it would make the numbers go down because you’re paying a higher amount for the cash earlier than the revenue, which comes later.
Third, most models of ongoing business use a “terminal value” after a certain point. After all, there is no reason why Disney has to make all the money back in the first ten years, or first 13 years or even first 16 years. Those are arbitrary numbers I picked to make the math round and easy for this explainer.
That said, forecasting out past ten years is, well, tough. Better word: impossible. If someone tells you they can forecast revenue accurately past ten years, well, they are lying. So instead, you make some assumptions of the value of the business at the end, and add that to the total, again, discounted for the time value of money. Another way to look at this is this sort of the “ongoing value” Disney would have for owning Star Wars outright. We’ll do that in our final analysis.
As the 8% cost of capital discount rate shows, money that far in the future is worth much, much less than today. The next chart shows the “multiplier” which is basically how much a dollar today is worth at an 8% discount rate in the future or discounted for inflation. In other words, in 2028, for every $1 you earn, that’s worth $0.32 in today’s terms. Or for a $100 million dollars, that’s worth $32 million today.
With our caveat and reminder out of the way, let’s get to the analysis. Unfortunately, by my count, I’ve already run for 3,800 words and five charts just to introduce the topic, lay down my initial biases, and explain the time value of money. So next Tuesday, I’ll hop into the economics of Star Wars films, feature film accounting and forecast how much money Disney has made from films alone. Oh, and TV for adults. We’ll do that too.