(This is Part XI 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! Implications, Takeaways and Cautions about Projected Revenue
Part VI: The Television!
Part VII: Licensing (Merchandise, Like Toys, Books, Comics, Video Games and Stuff)
Part VIII: The Theme Parks Make The Rest of the Money
Part IX: Bibbidy-Bobbidy-Boo: Put It Together and What Do You Got?
Part X: You’ve Been Terminated: Terminal Values Explained and The Last Piece of the Model
This series has been the equivalent of an all day trip to Disneyland for me. Arriving when the park gates open, I stayed all day, walking the park and going on every ride. I’m exhausted, and now all I have to do is wait for the fire works. My feet are killing me, but I’m almost there. So yes, today is the fireworks of this process, though the rides (articles) have been great along the way.
I spent Tuesday and Wednesday building our exhaustive models, so let’s “generate insights” from the data, since insights are a hot business term. I’ll start with the big numbers. I’m going to do this as a Q&A.
What is the Bottom Line, Up Front?
Or “Bottom Line, 10 Parts Later”?
Here it is: Disney will NOT lose money on this deal, even discounting for the time value of money. So yes, the people claiming success on behalf of Disney are indeed correct. They crushed it.
To show this, here are the totals for the deal. But, to show what “making money” means, I’ve broken my three scenarios into unadjusted, discounted for cost of capital and discounted for inflation. Again, these totals include my estimates for the last six years, the next ten years, and a terminal value for all future earnings:
(All numbers in millions, by the way.)
Here is how those values relate as a percentage of the initial price ($4.05 billion). (So subtract 100% to get the return.)
If you said, pick one as “the truth”, I’d pick my median scenario—that’s what median is for, right?—and I’d chose the cost of capital line. That really is the best way to look at investing in entertainment properties, and Star Wars is as pure entertainment as you get. (It’s also what the finance text book would tell me to do.) So it is smack dab in the middle of the table.
Using that number, the only conclusion is that Disney crushed it. Disney got a 107% return over the lifetime of the deal. (A 5x deal in unadjusted terms.)
Even looking at the high and low cases, this makes sense. Even the most pessimistic scenario shows a 38% return. (Which is a 3x return in real dollars. Again, huge for a low case.). Bob Iger and Kevin Mayer made a huge bet and it still had a nice return. In the high case, Disney will make an unadjusted 9x on the asking price. That’s a great deal.
Why do you focus on the discounted numbers compared to the totals?
I ignore “unadjusted” numbers—unadjusted is my best term for it—because I can’t help myself. One of my biggest missions with this series is to remind all my readers of this key finance point. A point—leveraging the time value of money—that the New York Times made when writing about President Trump’s taxes (and which he incorrectly criticized). So it needs to be repeated: A dollar today is worth more than a dollar tomorrow. Financial models need to reflect this reality.
To illustrate it, here’s an example. Disney could have take $4 billion dollars (and yes, they paid half in cash, half in stock) and put it in the S&P 500. If they had done that, they’d have earned a 10.5% inflation-adjusted CAGR from 2013-2018. So if Disney had done nothing, they’d earned 10.5% on their money. This is why the “cost of capital” exists. It accounts for the return you should expect for the risks of a given industry. If you make an investment, it isn’t just good enough to make some money, you need to beat the industry costs of investing in said industry.
Well, why did you also include inflation?
It’s easier for many folks to understand. The cost of capital is what we should judge the deal on, but “cost of capital” is a finance term that most of us don’t deal with on a daily basis. Inflation is easier to understand. It is the everyday reality that the things around us get more expensive over time. Inflation is the cost if you don’t do anything with your cash. It’s just another way to look at it. (And while it fluctuates, it’s hovered around 2% for so long that I’m using that as a placeholder.)
How does the cash flow look by time period?
Glad you asked, because I want to answer this question to keep this Q&A flowing. Essentially, this question asks how earnings flow in by our three major periods: what has happened (2013-2018), the near future (2019-2028) and the far future (the terminal value). Here are 3 tables showing this by model:
To make it easier to read, here’s that breakdown in percentage terms of the total for each line.
A key way to explain this from my EBITDA (as stand in for Free Cash Flow) analysis is that the next ten years are critical to making the money back on this deal. In our median case, Disney has only made back 14% of the total value of the deal. In the next ten years, I expect them to earn another 50%, with the terminal value chipping in 36%. Across the three scenarios, we see how unadjusted numbers are biased towards the terminal values and the low case has the least optimistic future.
Back in June, after you finished the film section, you called this deal already a home run. What happened?
You’re right, this does clash with what I wrote way back in June about the film side of the business. With Disney’s first four Star Wars feature films, my estimates are that 63% of the deal value or $2.5 billion in adjusted ($3.8 billion in unadjusted) earnings had been generated. Add in 6 years of tremendous toy sales and you would expect breakeven already.
But two key lines of business were missing. First, the TV shows will start in the next ten year period. While their upside is low in my model, in a high case they could really boost the bottom line. (I’m estimating $4 billion in revenue with $650 or so in profit margin.) Unlike Netflix, I expect Disney to continue to push alternative revenue streams such as DVDs, TVOD and merchandise. If one of their series is a huge hit, that’s real money.
TV, though, pales in comparison to the other missing line: theme parks. As visitors stream into Disneyland and Disney World, the new Star Wars themed lands will generate huge revenue streams. Moreover, to get those new theme park lands, Disney had to spend a ton of money to make the parks. So theme parks are both extremely expensive (which all landed in the first six years) and extremely profitable revenue streams (which all comes in the next ten years)
Would happen if we excluded theme parks from the analysis?
To get at this, I could just remove the theme parks from the equation. I’d call this model the “Warner Bros equivalent” model meaning, “What would this look like if Disney didn’t own its theme parks?” Notably, Universal does own theme parks, so it could have hypothetically done this, and, yes, Warner sells its IP to Universal Resorts. Specifically with Harry Potter. (That crushes it.)
To answer this, I’m using my “median” model, since I kept theme parks costs and revenues the same across my three scenarios. In that case, the model shows a decline in adjusted revenue of about $750 million dollars. This isn’t as big as you would guess, and is primarily driven by the fact that the likely pay off rate for a new theme park land is decades, and a lot of that value is captured in the terminal value, which is discounted a lot by year 16. (I tried to make a chart to show, but it didn’t look great.)
That still doesn’t quite get at the question. The better question is, “What does the earnings situation look like assuming Disney hadn’t built the park?” In this case, well a table does show it. This table shows the earnings from 2013 to the years 2018, 2019 and 2020 respectively (with percentage of initial price below):
By 2020 Disney will have almost paid off this deal in adjusted terms. That is, in other words, the non-theme-park-expansion break-even year. The best way to put the theme park expansions into context, as a second capital expenditure (CAPEX) decision. In this case, another good one, but a decision that could throw off our model.
Why are your numbers for the first six years different in each model?
The toys. Unlike films, which have box office to ground all our estimates, and theme park costs, that Disney essentially released, we have no idea how much money Disney is making on toy sales (really all licensing). I mean Disney knows and if someone passes me their franchise revenues, I’d summarize them. In the meantime, I had to give my best guess based of analyst estimates. And toy sales have more uncertainty than the other lines of business.
What would the model look like without the terminal values?
I like this question because it gets to the idea of the “payback period”. The finance folks will tell you that things like IRR or Payback Period are technically irrelevant to capital budgeting. Which is true in theory; Net Present Value (NPV) rules all.
But I do like “payback period” as a way to quantify confidence. If I said I was confident on my estimates of the last six years, I’d say I’m guessing on my ten year forecast. And my terminal values are approaching “shots in the dark”. So if you’re confident that you can make most of your money back in 15 years (16 in our case), then the terminal value is the gravy on top and you’re overall that much stronger in your beliefs to do a deal. So here are the “sans terminal values” table:
Some thoughts. In the worst case, Disney breaks even on the deal. So you can be pretty confident they are on track to make money here. In the best case, they can double that. So yeah still a great deal, and this means we can be more confident in that conclusion.
What would you pay for Lucasfilm right now? In other words, ignoring the last six years, what is the next ten years and beyond worth?
Oh, that’s a good question. Essentially the opposite of the previous one. Instead of putting numbers into 2012 terms, we put them in 2018 terms, and assume the previous six years didn’t happen. (mean 2019, my brain is still typing 2018 in February.)
The only tweak I made from the initial model is including the CAPEX for the theme parks in this model. Disney just spent $2 billion on those, so it would inflate the model too much if we pretended they didn’t need to pay those off. Doing that and we see the current value to Disney is $9.4 billion dollars. In other words, Disney has doubled the value they paid for the franchise. That shows the power of Disney licensing, theme parks and film marketing to this point.
The one caution would be the reliance on terminal values now. Instead of being 16 years in the future, it’s a closer ten years. This means that terminal value accounts for more than half of the total value of the franchise. As you can see, this means also that the films need to keep doing well to justify this valuation.
Why didn’t you put the CAPEX on its own line, to judge the “Net Present Value” in dollar terms?
This is a question no one is probably asking, but since I’ve been dipping back into my Corporate Finance text book throughout this process to double check my work (the Berk and DeMarzo textbook for those deep finance nerds), I reminded myself that that’s how they do it. My method in terms of percentages, though, is the same thing. Everything is in 2012 dollar terms anyways. In other words, any percentage value over 100% is NPV positive. It’s half a dozen one way or six in the other.
(Yes, I’ll write an “NPV Explained” article in the future since it is so essential and so often ignored.)
Why didn’t you include ILM & Skywalker Sound?
We’re in the part of the article series where I admit some flaws and weaknesses of my analysis. Frankly, without an income statement showing how much ILM and Skywalker Sound have generated for Lucasfilm over the years, I’d have no clue how to start valuing a VFX house. (And sound effects house.) It’s not something I’ve done.
Moreover, my gut/experience says the production side of entertainment has pretty small margins. Especially VFX/animation houses that compete with programmers, designers and engineers in South Korea, Japan and India, some of whom have much smaller costs. So even though they likely make money, they have small margins and lots of headcount to pay for. As a result, I don’t think these lines of business really drive the bottom line.
You’re almost done. Any last words?
First, I can’t promise these are my last words. In fact, I know I’ll write another article next week thinking about this whole process and drawing other conclusions. I have learned a lot about Disney’s business, Lucasfilm’s performance, strategy, decision-making, modeling and trying to package all that into a comprehensible (and enjoyable?) series. So I may write future articles or use these models, but I’ll consider those appendices to this series.
Second, I am almost assuredly wrong. Imagine what it would mean if I could accurately forecast all the past revenue of one line item of a company I don’t even work for. There are hundreds of variables in the calculation of and accounting for revenues, profits and costs that I couldn’t hope to get them all right. As for the future? No one can predict that.
The true question is, “How wrong am I?” Am I so far off that none of this should be read or even considered? That’s much too extreme. But am I close, say within 1%? Probably not. Instead, I’ll just say this is the most accurate range of estimates you’ll find on the internet. I mean, no one else has produced one that I’ve found. Not only that, if you’ve never tried to value a business line-by-line, you’ll probably learn more from these 32K words than any other source. (Not to toot my own horn, but I’m pretty damn proud of this.)
Third, I can’t promise there are no crippling spreadsheet mistakes in my models. I think I found all the big ones, but in my last read I found one table that was off by 60%. With just one link to the wrong page in the Excel, one of the most important tables was wrong. If I find any other mistakes, I’ll update them. (Proofread your models is the lesson.)
Fourth, let me know what you think. I’m a huge believer in “crowd sourcing” and this is my entry into the business world. But I don’t know it all. Far from it. If you think I’m wrong or too aggressive or too conservative, send me a note. I can easily update the model to reflect those thoughts.
Fifth, and last, please share on email, Twitter, Reddit and any other social platforms for people you think will find it interesting. If you want to support my writing—know that I’m currently doing this for free, by living off savings—sharing is the best way to help out. So I haven’t asked for much from my audience—besides following me on Twitter and Linked-In—so consider this my first ask. If you found this useful, insightful or fun, spread the word. (And thanks for reading this far!)