Category: The Disney-Lucasfilm Deal

Disney-Lucasfilm Deal Part XI: Disney Will Make A 107% Return on Lucasfilm Acquisition (And Other Conclusions)

(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:

Table 1 Totals(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.)

Table 2 PercentagesIf 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:

Table 3 Totals by Period

To make it easier to read, here’s that breakdown in percentage terms of the total for each line.

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Disney-Lucasfilm Deal Part X: You’ve Been Terminated: Terminal Values Explained and The Last Piece of the Model

Disney-Lucasfilm Deal Part X: You’ve Been Terminated: “Terminal Values Explained” and The Last Piece of the Model

(This is Part X 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?

Yesterday’s article was pretty audacious, trying to estimate 6 years of past revenue and 10 years of future revenue. But the eagle-eyed among you may have noticed I left out a crucial detail:

What about the future? 2029 and beyond? Surely Lucasfilm is worth something then too?

Yes, it is. But predicting the far future is the toughest part. Which ties into one of my biggest pet peeves in valuation. I loathe business models that project near term middling performance (or even losses), but a far future of wild success. 

Usually, this wild success is summarized in an outsized “terminal value”, one of the most crucial concepts in equity valuation. It can be hyper-dependent on the growth rate. If the growth rate raises by a point, then the model’s value can shoot through the roof. (And yes, many tech valuations follow this model.)

Yet, terminal values are the best tool we have to solve this problem. If we use them properly. Today I’m adding that last piece to the model, but explaining how I got there and what it is.

Terminal Values…Explained

What is the terminal value? Well, the last number on the spreadsheet that captures all “future” earnings. Look at my model (this is the median scenario), with the new lines added:

Table 1 - Empty ProForma wTerminal Values

In a word, the “terminal value” tries to capture the value of all future earnings after your model stops. Say you feel confident you can predict revenue out five years. Okay good enough. (I mean no one can really predict revenue, costs and hence earnings, though we still try.) But what about 10 years? 15 years? There are too many variables.

You can see the need for this in the Lucasfilm acquisition. Can I really predict what will happen with release dates of films, even two years out? I already had to remove Indiana Jones 5 from my models. Take another line of business, licensing. If you used the toy sales of 2015 to forecast the future, well you’d be much, much too high. (2015 was probably the peak of Star Wars toy sales.) Back when this deal was signed, Disney didn’t know if they were going to launch a streaming service (I assume) but they still could have sold Star Wars TV series. Possibly for even more money. Not selling to others changes the model.

Here is where the science of modeling has come back to the art. (Which isn’t a bad thing, despite current connotation. Good art is really, really hard to make. Great art even harder.) The traditional way to model a terminal value is to use the future cash flows of the last year of the model, and assume those hold steady into the future. In other words, you make a “perpetuity”, a cash flow stream that continues forever. Alternatively, if your company has a large variance in cash flows year to year, you can use a three or five year average to get the base number. To be even more conservative, you can assume instead of a perpetuity, it is an annuity, where the future revenues only last for a given period of time, say 10 or 20 years. (If you need a refresher on “time value of money”, go here.)

The Specific Terminal Value Calculations

How long will Star Wars be valuable? Davy Crockett was the Star Wars of the 1950s, and it isn’t worth $4 billion dollars. Mickey Mouse has been Mickey Mouse since the 1920s, and he’s worth well more than $4 billion dollars. Which way will Star Wars go? I’m going to assume for a long time. Essentially for decades, but with one scenario where it shrinks over time. Which I’ll control for by tweaking the discount rate. (Either having it grow or shrink.)

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Disney-Lucasfilm Deal Part IX: Bibbidy-Bobbidy-Boo: Put It Together and What Do You Got?

(This is Part IX 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)

Many of you are interested in knowing how much money Disney made when it bought Lucasfilm for $4.05 billion dollars. How do I know? Well, one of the Google search terms that directs to my site is, “disney profit lucasfilm”. (And really I should be higher in that search ranking!)

This interest comes from that fact that very few people know the answer. Disney CEO Bob Iger does. Kevin Mayer (Iger’s chief dealmaker) does. Christine M. McCarthy (Iger’s CFO) does. And likely many other Disney employees. 

As for the public, though, we haven’t the foggiest. 

Few other news websites have tried to answer this question. It’s too speculative. Instead, they usually rely on some version of, “Disney has grossed more at the box office than the acquisition cost of Lucasfilm” type articles. These are so obviously wrong—a studio doesn’t collect all of box office for one; it doesn’t account for other revenue streams for two; it doesn’t discount for the time value of money for three—that many of the Disney & Star Wars super-fans want something more. So I did a bottom’s up analysis. (I’m the strategy guy and a super-fan.)

Yet, I’ve left you all wanting. I never finished the damn thing.

Today, it all comes together. Totaling over 66 pages and 30 thousand words with dozens and dozens of charts, tables and financial statements, this article series is my Ulysses. I’ve calculated all the revenues and costs to finally answer the question that started this:

How much money did Disney earn on the Lucasfilm acquisition?

Today, I’m going to walk through building my final model. I will include the final numbers for my three scenarios (through 2028), but today is really about adding in the final estimates to the model. Like a final Harry Potter film—or uncompleted ASOIAF book—this dramatic conclusion will need multiple parts. I’ll explain the model today, tomorrow I’ll calculate the terminal values and then on Thursday, I’ll draw tons of fun conclusions. That’s right, it’s a Lucasfilm week!

Calculating the Final Piece

At first, I was going to make just one model, call it the “average” and be done with it.

But that didn’t make any sense. I’ve been using scenario modeling through out, building best and worst case options where appropriate. In one case—film—I made 8 different scenarios. Scenarios are great because they account for the inherent uncertainty in predicting the future.

To add everything up, I built three versions, the traditional “best case / worst case / average case”. I’m a big fan of using three versions of a model, if they are all realistic. (If you want to goose your numbers with three scenarios, make the worst case very nearly break even.) I treat the high and low case as the equivalent of our 80% confidence interval. The average then acts as my best guess of what will happen. The final summary model looks like this:

Table 1 Empty Proforma

The shaded green cells are what we need to fill in, based on our past calculations. Sure, it looks like a lot of cells, but it is really just 11 lines. A lot of time, we act like high finance is really hard. It isn’t. All you do is add and subtract. We don’t even have to do the math ourselves since Excel does that for us.

As I was building this, I realized that in some lines of business, I forecast revenues out to 2027 and 2028 in others. Don’t ask me why I didn’t keep things uniform. For consistency, all these models will go to 2028, the next ten year estimate. Building this final summary was a good proof read of the Excel models as well.

The Final Calendar

To help build the models, early on I built a calendar that represented my best guess for the future of Lucasfilm under Disney. Remember, this deal was signed in December 2012, so I started the calculations in 2013. This calendar didn’t make sense for any individual article, so I’m putting it here, so that everyone can understand the scale of what Disney is rolling out here:

Table 2 CALENDAR of Lucasfilm

The Three Scenarios

Let’s walk through what I put in each model.

The “Average”: Status Quo Continues

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The Economics Behind Not Releasing Star Wars Films Exclusively on Disney Plus – Part II

(If you missed yesterday’s post, click here.)

Let’s continue with where we left off yesterday. The risk for eliminating theaters and associated early windows (home entertainment and pay-per-view) is in the hundreds of millions of dollar range. So can Disney make that up by releasing new Star Wars films directly and exclusively on Disney Plus?

Part II: Calculate the value of “exclusivity” and “day and date”

Running your own streaming service could be worth all the revenue per film you exchange in box office, pay-per-view, EST and DVD sales. Maybe. The bulls like me would say, “So Disney should exchange making money in theatrical sales for losing billions like Netflix or Hulu?” Hmm. The bears would say, “Look at Netflix’s market capitalization.”

But we’re not looking at the whole platform. We’re looking at individual films. The problem is most of the ways people calculate the value for an individual title on a streaming platform are more wrong than they are right. Or let’s say “suboptimal”. Let’s review how NOT to calculate this number. (With the caution that I can/will write a bunch of articles on this)

Suboptimal Method 1: “Multiply number of people by price per month”

Let’s say 50 million people watch a Star Wars film when it releases on Netflix. (Yes, I think that’s a pretty good estimate. Call it “one Bird Box”.) So the math is:

suboptimal 1

Bingo! $550 million! We should skip the theatrical window.

Hold on. I see some problems with the math. Actually, that method is simultaneously both too high and too low.

(And I bring this up because I hear this discussion of streaming economics all the time on podcasts. I don’t know why podcasts in particular do this math, but it happens.)

First, on the, “this math is too high side”, how do we account for a customer who subscribed to the Disney platform, binges 12 “tent pole” movies, then unsubscribes? Do we have to divide by the number of films? Or what about the new Star Wars series, if a customer watched both? This is why you factor in the total value of the catalogue. So it’s too high.

On the converse side, I could be shortchanging the film. What if it acquired customers? Attracting new customers has to be more valuable, right? They aren’t just worth one month, they’re worth their “lifetime value”. A good model should account for that. And that happens to be…

Suboptimal Method 2: “Multiply number of people by CLV” (even higher)

To start this analysis, we need to estimate a “customer lifetime value”. Note, when Disney launches their service, they won’t have a clue what this is. They’ll have estimates—which aren’t much better than guesses—but they won’t know. If you have no subscribers, you lack the best data to judge retention rate. Sure, you can use Hulu’s data, but there are a host of variables you would need to account for. (Say how their price fluctuates wildly to bring in customers.)

So back of the envelope, let’s assume a new customer stays for on average two years. They pay $11 per month, and you paid $30 to acquire them through partnership bounties and direct marketing. Here’s the math:

sub optimal 2

So if Disney releases a film, and 50 million people watch, that’s worth nearly $12 billion dollars! Release 12 movies like that and then it can make 144 billion dollars!

Do you see the flaw in this logic? 

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The Economics Behind Not Releasing Star Wars Films Exclusively on Disney Plus: Part I

Last week, Bob Iger said in an interview with Barron’s that Disney had no plans to start releasing new Star Wars films—by which he means the ones that will come after Episode 9, releasing later this year—on Disney Plus, their soon-to-be streaming service.

I agreed with this move. Some didn’t. Here’s a tweet that Rich Greenfield of BTIG and prominent Netflix bull, retweeted:

There were others and I got into a debate with Jason Hirschorn of MediaREDEF fame on Twitter:

Twitter is a great medium for some things (getting me exposure to a lot of people for one thing) but bad at others (like the racism and and sexism). I’d also add its bad at discussing things that revolve around numbers. Hard to pull out a spreadsheet on Twitter, you know?

So my case for keeping Star Wars films in theatrical releases is here instead. As I look at it, theaters represent a huge proportion of potential revenue for feature films. For any company that wants to maximize shareholder value, capturing that revenue by releasing in theaters makes sense. To ask Disney to release its blockbuster tent pole films day & date, exclusively on its streaming service is to ask it to forgo billions in potential revenue. 

That just doesn’t make sense for shareholders of Disney.

I often rely on an aphorism that “strategy is numbers”. (I stole it from a professor in business school.) When you skip putting numbers to a business strategy, well, you’re at risk of cutting corners. In other words, you’re still talking numbers, but you just don’t have to hold yourself accountable to them. By not calculating the numbers, it makes qualitative or narrative points much sexier.

Fear not, today, we’ll put numbers to this debate. The goal won’t be for me to “decide” the debate, as this is the type of strategic decision that is impossible to decide with numbers alone. Instead, the numbers will help define how big a leap our qualitative judgments need to make. In other words, it will define how “strategically valuable” skipping theaters to support streaming needs to be. We’ll go in three parts: the Disney numbers, the streaming numbers and the qualitative arguments.

Part I: Weigh the specific economic risk for Disney

This is fortunately really easy. I spent a large part of 2018 writing a novella on the Disney acquisition of Lucasfilm. As a part of that series, I created individual film accounting models per Star Wars film to “show my work”, partly to help the audience learn about feature film accounting and partly to run the numbers myself. 

First, here’s my assumptions on the current distribution for revenue for the lifetime of a feature film (emphasis on lifetime):

film revenue model

As you can see, I currently project that 30% of a feature films value come from theatrical rentals, which is how much a film actually collect on box office results. (Roughly half of the box office, but less overseas, particularly in China. Read the whole series for more.) Taking that  with some estimates on production budgets and marketing budgets, here are my estimates for various types of Star Wars films:

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Disney-Lucasfilm Deal Part VIII: The Theme Parks Make The Rest of the Money

(This is Part VII 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: Disney-Lucasfilm Deal – Television
Part VII: Licensing (Merchandise, Like Books and Comics and Video Games and Stuff))

If you’ve been reading along after 47 pages and six months of writing, you know that Disney more than made its money back on its purchase of Lucasfilm through releasing wildly successful Star Wars sequels, and then making another $1.7 billion in licensing revenue. So they made their money back.

But to truly get a great return on investment—as I wrote in the introduction in my “gut” section and again when referring the licensing & merchandise—theme parks are the whipped cream and cherry on top. In 2019, if it stays on track, in Disneyland and in Disney’s Hollywood Studios, Disney will open Star Wars: Galaxy’s Edge, which have been under construction since 2016.

And they could be huge money makers.

Theme parks allow The Walt Disney Company to make more off its IP than any other studio. (That’s its competitive advantage.) So let’s figure out how to quantify that benefit. Then, we’ll figure out the costs.

The Challenge: Disentangling the Marginal Benefit of new Theme Parks

With movies, calculating the revenue is messy, but we have lots of data. With toys, forecasting the revenue is easy, but we have way less data. What about for theme parks? In this case, the toughest part of the process is assigning the value.

Think of it like this. We know that putting in a Star Wars: Galaxy’s Edge at Disneyland will drive attendance and revenue. The problem with theme parks is untangling how much revenue they will drive.

In other words, the “marginal benefits”.

Some day I’m going to write “Marginal Benefits Explained!” because it’s a core economic principle—the core principle?—and I’ve seen 7-figure-earning business execs screw it up. Marginal benefits are the additional revenue a business generates by changing an input. So if you’re making a million dollars a year and raise prices, and it goes up to $1.2 million, your “marginal benefit” for the price raise is $200K, the additional revenue you generated.

(You want to know my biggest frustration/pleasure with this website? Every time I write a new article, I think of two more posts to write inspired by it. The “hydra problem” of the Entertainment Strategy Guy.)

This idea is what stymies the analysis with theme parks. Let’s visualize it with an example.

Next year, I’ll walk into Disneyland in the off-season (probably September-ish). I’ll be wearing a Star Wars shirt. My brother will probably rock a Marvel shirt. That said, I’ll also have a three year old wearing, if current trends hold, either an Elsa (Frozen) or Belle (Beauty and the Beast) dress.

So how much of that trip do you allocate to the opening of ? (Punctuation side note: do you italicize theme park lands? I did, but should I?) My family already averages one trip to Disneyland every year, and my daughter knows that Mickey lives at Disneyland. So she’d go anyways. But what about me? I’ll definitely go to see the new park at some point. We could make an analogy of a theme park to a content library on a streaming platform. People pay for the whole thing, not the parts. With content libraries—which is essentially what a theme park is—untangling and clarifying the value offered by each piece can be tough.

The Economics for Theme Parks

When in doubt, I like to boil things down to a simple formula. So let’s do the rough “business model” for a theme park. I came up with this:

Slide63

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Disney-Lucasfilm Deal Part VII – Licensing (Merchandise, Like Toys, Books, Comics, Video Games and Stuff)

(This is Part VII 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: Disney-Lucasfilm Deal – The Television!)

In business school, as I said in my first article in this series, I was super bullish The Walt Disney Company. The Lucasfilm acquisition followed on the heels of the Pixar and Marvel acquisitions—which were already doing well—and at the time ESPN was a cash juggernaut. Strategically, they’d made a series of great decisions.

Still, those moves, while good, weren’t the core reason why Disney has succeeded so much over the last forty or so years. I believed then, and still do now, that Disney is one of the few movie studios that has a business model derived from a distinct competitive advantage. As others have written about, this competitive advantage goes back to drawings by Walt Disney in the 1950s.

Slide57

Basically, while having a great content is at the center of the plan, they develop and reinforce their relationship with customers through everything else. Or, to be cynical they make their money off everything else. Walt Disney created an iconic character in Mickey, then another in Snow White, then another in Cinderella, and so on to start. Then Walt Disney (the person and the company) would monetize the characters through music and books and comics and eventually television. Then they pioneered the concept of theme parks. Michael Eisner took this approach and applied it to home entertainment and acquiring TV networks.

When I was in b-school, I took the famous chart and summarized it in economic terms thusly:

Slide58

This is the simplest description of supply and demand in the marketplace, the core model at the heart of economics. Basically, along any curve, you maximize your price and quantity sold to yield the highest profit. I’ll cover this more when I write an article on “Transaction Business Models Explained!” (the sequel to my two articles on subscriptions) but for movies you basically can only charge the same price per movie ticket, regardless of movie. As a result, to maximize revenue you need to maximize customers, and hence Hollywood makes blockbusters.

Most studios stop there. But not Disney. They aren’t just selling movie tickets, they’re selling merchandise on top of that. And then, for the piece de resistance, they sell theme park admissions (and in park up-sales) in an experience they own outright. Other studios do this, but nobody does it as well as consistently as Disney.

In my adventures after business school, I’ve only become more convinced that Disney knows its business model, knows its competitive advantage and makes moves to sustain that model. They may be the only movie studio, er, “giant media conglomerate” that has a competitive advantage. To continue our series on Lucasfilm, I’m going to add in the rest of those boxes going up, starting with merchandise.

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