Today’s menu

• Deal heat

• Disney’s acquisition spree

• How did the market take it?

• How can Disney fix this?

• Conclusion

Deal heat

Deal heat is a term that the late Jack Welch popularised. Jack was the CEO of General Electric between 1981 and 2001. He was considered one of the best leaders in corporate America.

Deal heat rears its head when one company is trying to buy another company. In business jargon, this is called Mergers and Acquisitions (or M&A). Two companies joining together is a merger; one company buying another is an acquisition.

I’ve been involved in acquisitions, they are emotionally charged situations. The buyer is trying to woo the seller. The seller is trying to start a bidding war amongst multiple buyers, to drive the price up. Investment bankers or corporate financiers are involved and they want to earn their high fees. Lawyers are involved.

In this situation, pressure develops to get the deal done. The likely result is that the buyer pays too much and in the process, destroys value for their shareholders. This is called the Winner’s Curse. This is no secret, it has been studied extensively in finance and it is well known that companies which acquire, tend to underperform in future.

Disney’s acquisition spree

Disney has been on acquisition spree, here’s a few notable acquisitions:

• Pixar was acquired for $7.4 billion in 2006.

• Marvel Entertainment was acquired for $4 billion in 2009.

• Lucas Film was acquired for $4 billion in 2012.

• 21st Century Fox was acquired for $71 billion in 2019.

There were many more acquisitions, but I thought these ones might interest you.

Now you know why there have been so many Marvel superhero movies - Disney had bills to pay. You also know why Star Wars (made by Lucas Film), which we all thought was done in 1983, then we thought it was really done in 2005, got more movies and series from 2015 onward.

But the real doozy was the 21st Century Fox acquisition. At the time Disney had a market capitalisation of $169 billion, then they paid $71 billion for 21st Century Fox. This acquisition caused quite the kerfuffle because competitors also wanted to acquire 21st Century Fox. So Disney had to up their bid. But they didn’t want the news to leak, so they secretly flew on company jets to Ireland, then chartered a local jet to take them to London, where they could steal the deal.

There should be an adage in finance like “decoy jet in the morning, acquisition take warning”. When we hear in the news that you’re doing crazy stuff like that, we know you’re about to overpay for an acquisition and we can avoid your company.

Bob Iger was the CEO of Disney from 2005 to 2020 and you can read all about Disney in his book - The ride of a lifetime. The book is quite entertaining if you want to read it.

By the way, Bob Iger’s successor as CEO was Bob Chapek, but things didn’t go well, so Chapek got fired in 2022 and Iger became the CEO again.

That’s right - a guy named Bob was replaced by a guy named Bob, who was then replaced by a guy named Bob.

Enough bobbing around, back to business.

In the graph below you can see that from 2019 to 2020, Disney’s assets increased from $98 billion to $194 billion. Most of that increase was from the 21st Century Fox acquisition.

With that massive jump, surely Disney became a better company.

Nope. Not really.

The graph below shows Disney’s return on invested capital (ROIC). We usually talk about return on capital employed (ROCE). Both are very similar. We discussed the differences in a previous newsletter here. Worry not - they tell you the same thing.

As a rule of thumb, ROCE (or ROIC) above 15% is very good. In the range of 10% to 15% is okay, but below 10% is usually bad.

In 2019, Disney had ROIC of 18% and immediately after the 21st Century Fox acquisition it dropped to 8% and then down to 2%. I think we can see why Bob Chapek got fired.

In 2024, ROIC was 6.6%, which is still below the 20-year average of 8.9% and way below 10% - which we consider adequate.

ROCE (or ROIC) is important. You can think of it like the interest rate you get on your savings account. The higher the interest rate, the better. In this case Disney’s return was devastated by the acquisition. Basically they paid too much - as always happens with acquisitions.

Take note that in years before the acquisition, Disney was doing okay. ROIC was above 10% and growing. In other words, they messed it up by themselves.

How did the market take it?

Not so well.

Disney’s stock price has fallen 18.25% in the past 6 years. Today, Disney’s market capitalisation is $167 billion. That is $2 billion lower than in 2019, before the acquisition.

That is classic value destruction through acquisition. You spend $71 billion dollars and end up making your company worth less.

Here’s a summary of the financial numbers for completeness:

• ROCE is very low at 7.6%.

• Revenue growth hasn’t been great at 2.4% in 2024.

• The share price has been swinging wildly.

• The company looks expensive with a P/E of 40.

How can Disney fix this?

They cannot fix it.

When a company makes a bad acquisition, they have three choices:

1. Live with the consequences - as Disney is doing.

2. Admit defeat and sell what you bought at a big loss - very costly to shareholders.

3. Pray for a miracle that dramatically increases profitability.

Unfortunately, option 3 never happens, so you’re stuck with 1 and 2.

Actually, there is a fourth option.

You can sneak your way out of trouble by separating the troublesome company into an independent company and listing it on a stock exchange. This is called a demerger or a spinoff.

If you do this, you can tell everyone that you did it to create shareholder value, because the two entities are worth more separately. Basically, you kick the problem child out of the house.

Conclusion

Lets end by clarifying this newsletter’s title.

I like Disney’s products, I don’t like their stock.

Similar to many of you, I grew up with Disney movies and cartoons. Disney meant fun and adventure. When I was a kid, I had a Donald Duck night lamp - I think I still have it. (No, it's not at my bedside).

The biggest lesson is to beware when you hear about companies doing big acquisitions. It is usually reported very positively in the news, but in most cases it turns out very badly for the acquirer (buyer).

However, if you own the company that is being sold, you’re in luck because you’re probably going to get overpaid for your stock.

I would like to hear what you’re up to.

DM me on social media or email me.