Case Analysis - The Walt Disney Company and Pixar Incorporated: To Acquire or Not to Acquire

Walt Disney along with Pixar impacted the entertainment industry in a revolutionary manner when they escalated the use of three dimensional computer generated (3D CG) technology. This greatly enhanced viewer experience at a time when animated movies were growing in popularity. These movies, in particular, attracted the attention of children primarily due to the concept of sequels, which had extended the lifespan of hit movies. However, owing to the increasing success of animated movies as a result of the Disney-Pixar partnership, competition in this space became fierce as barriers to entry reduced and several production houses like DreamWorks and Paramount Pictures entered the industry. This prompted Disney to consider the future of their relationship with Pixar and take a critical strategic decision to ensure that they stayed on the pedestal.

Business Model

While ‘creative people’ were one of the crucial elements that both Pixar and Disney had in common, the innovative culture of Pixar helped maintain their technical superiority. Their proprietary computer animation technology gave Pixar a distinct advantage in the software development industry. The production of animated commercials was an additional source of revenue. Steve Jobs was also a valuable intellectual asset who significantly contributed to Pixar’s success. Pixar created a flat and flexible organization that gave more autonomy to the firm’s artists. Walt Disney was the frontrunner of animated children’s movies. They employed the most talented story writers in the business and owned the most advanced production studios. Although box office sales were a major source of revenue and a triggering signal for success, Disney’s actual financial success derived from alternate revenue streams such as the sale of toys, apparel, books, television showings, home video sales and video games.

Disney and Pixar joined hands to produce five animated movies in a partnership lasted a decade. Disney focused on marketing and distribution, while Pixar predominantly provided technical support. Disney received 60% of the movie revenue and held the right to produce sequels, schedule the release dates, and select the locations.

Principal Issue

The principal issue in this case is a decision. Robert Iger, the newly appointed CEO of Disney must decide whether Disney should acquire Pixar in an effort to cement its position as the leading producer of animated children’s movies, being the largest media conglomerate in the world.

Subsidiary Issues

·   As a result of technological advancement and the growing propagation of talent in the CG space, competition became fierce with several new players entering the industry. The impending contractual expiration of the Disney-Pixar partnership was piling increasing pressure on Disney to make a decision regarding the future of this relationship under these circumstances.

·   Owing to varying cultures at Disney and Pixar, this might repel existing employees of Pixar as they might think they would lose freedom and flexibility of work as well as other essentials that they were enjoying under Pixar.

·   Given that Pixar’s enterprise value was $5.9 billion, Disney would have to pay an additional premium of $6.5 - 7.4 billion, in addition to stocks with a 2.3:1 exchange ratio that could be very costly and could diminish stockholders value.

·   This acquisition will also be heavily dilutive as Disney’s price-to-earning (P/E) ratio was 17 while Pixar’s was 46; this would repel investors and reduce shareholder value.

Performance

The decade long Disney-Pixar partnership had been regarded by many as one of the most successful in the industry’s history, grossing over $350 million in their first three movies between 1995 and 1998. Between 98’ and 04’, Pixar contributed to 10% of Disney’s revenue and over 60% of its total operating income. Many of the great animated hits that represented the new generation of 3D movies, were an outcome of this co-production. This fruitful performance prompted Disney to purchase 5% of Pixar for $15 million in 97’, soon after its IPO was issued. It was also the largest IPO of the year, raising $140 million.

In 2004, amid reports that the relationship between Pixar CEO Steve Jobs and his counterpart Michael Eisner had broken down, potentially threatening contract renewal negotiations, Disney resolved to replace Eisner with Robert Iger in an effort to preserve the relationship - A clear indication that Disney valued Pixar’s contributions. This five movie deal which took these two titans through the release of ‘Cars’ in 2006 was also estimated to add over $1.5 billion in operating income and $0.44 in EPS to Disney’s bottom line. By far, the performance of the Disney-Pixar partnership paved the way for a new era of animated movies, using the jointly developed 3D CG technology. It also outlined the most significant part of Pixar’s history with both companies enjoying a great exchange of talent, resources and learning.

Alternative Decisions

Robert Iger must reflect on which of the following three alternatives are best for Disney’s future.

·  Re-engineering Disney Animation to better complete with Pixar, effectively striking a distribution deal with another animation studio. This would mean that Disney would have to forfeit their long, successful relationship with Pixar and all the investments they put into it. They would then have to broker a contract with another studio to fill Pixar’s void, assuming all the uncertainties that would come with it and starting from scratch with their new partners. This would also mean that Pixar could now become one of Disney’s biggest competitors - A problem that Disney would be creating for itself.        

·   If Iger decided to stick with Pixar, he will have to negotiate a new distribution deal and give into some of Steve Job’s demands which included 100% ownership of all films and a lower, fixed distribution fee for Disney.

·  The last option available to Iger is for Disney to acquire Pixar and integrate it into their organizational structure.

Criteria for Choice

·    Importance of animation to Disney’s corporate strategy since Disney-Pixar joint movies have achieved the highest revenues and have contributed the most to Disney’s operating income. Thus, continued strong financial performance for Disney by improving its average revenue growth and EBIT margin as well as maintaining healthy cash flows is crucial.

·    Maintaining an alliance with Pixar since it is better for Disney to collaborate with Pixar than compete with them. Pixar could easily become a major competitor and can take over a good part of Disney's market share after the partnership dissolves.

·  Comparatively lower risk option: The purchase acquisition estimation should not be overpriced, and should be compared to benchmarking acquisitions in the market. Disney must also retain the ownership of movies and the right to produce sequels.

·   Least alteration to the current successful operation, and retention of the creative and technical mix of talents that was produced by the partnership. Disney’s decision should not ruin the stellar performance Pixar has been achieving for them.

Recommendation

Based on the analysis of these alternatives and in light of the stated issues, we recommend that Disney go ahead with the acquisition of Pixar primarily because of the proven success that their partnership had displayed and secondly, on account of the strong strategic fit which was evident. In addition, Disney would gain a major asset in Steve Jobs who, at the time, was accredited with the highly successful launch of the Apple iPod and was regarded as the greatest modern day visionary leader and inventor. The prospect of pairing Jobs and Lasseter with Disney’s talented executive team was also very lucrative. Jobs was also at the help of Apple computers at the time and an affiliation with Disney would be mutually beneficial for all the three brands from an image standpoint. Moreover, the projected PE ratio of Pixar was 46, while that of DreamWorks, its closest competitor, was 30, making Pixar the undisputed leader in the CG technology space. Also, as things stand, Disney is a saturated company with average revenue growth of only 5.3% and Earnings before interest and tax (EBIT) as a percentage of revenue of 9.6%, while Pixar is a prosperous and promising company with an average revenue growth of 39% and 53% EBIT margin.

However, the decision to acquire Pixar also has significant drawbacks. First of all, Pixar and Disney were very different owing to varying cultures that could result in a clash. Disney would be poised with the daunting task of either integrating Pixar into its organizational culture or allowing Pixar to operate independently. The former would suggest that Disney would have to disregard Pixar’s unique culture, which would not go down too well with the Pixar faithful, while the latter option could result in isolating Pixar from Disney’s operations to an extent. This could alienate the smaller subsidiary and create a significant disconnect. Also, the prospect of working with Steve Jobs and accommodating his forceful personality was very intimidating for many Disney executives. Keeping Pixar’s employees committed to Disney’s vision would be challenging since many of them had contemplated resigning if Pixar were to be acquired. This uniquely blended talent pool is Pixar’s core value and Disney would be risking a mass exodus of talent.

Plan of Action

·   Disney should allow Pixar a fair deal of autonomy and protect its work culture as it is the main success factor of Pixar. This can also be achieved structurally by treating Pixar as a separate subsidiary of Disney.

·   Disney must also retain the Pixar brand in order to protect its distinct identity and to create a sense of association.

·  Disney must accept a gradual organizational shift to being more collaborative in order to foster smoother integration with Pixar’s work environment. This will retain Pixar’s talented employees and incentivize them to believe in the firm’s vision.