It's Getting Goofy at Disney

An overview
Walt Disney's nephew Roy is a former Disney (NYSE: DIS  ) board member. So is Stanley Gold. During the March 2004 Disney annual shareholders' meeting, Roy Disney and Gold posed some hard questions, such as why operating income grew from $3.1 billion in 1994 to just $3.2 billion in 2003 -- after roughly $25 billion in capital investments over those 10 years.

At the center of the 2004 storm was Disney Chairman (at the time) and Chief Executive Officer Michael Eisner. The debate revolved around whether investors should keep Eisner or follow the lead of large shareholders like Roy Disney and the California Public Employees' Retirement System and pull their support. Get this: 45.4% of Disney shareholders withheld their vote for Eisner's re-election to the board -- a giant no-confidence vote.

Was the board listening?
Instead of seeing a rebuke by shareholders, the board viewed the vote as a referendum on separating the combined positions of CEO and chairman. That perspective ignored the months of campaigning from the dissident board members who had called into question the company's performance under Eisner's leadership. In the end, Eisner lost his chairman title but was retained as the CEO.

The board's rationale for the proxy voting pales when you consider that its choice for chairman was former U.S. Sen. George Mitchell, who had 25.7% of those voting withholding their vote for his board re-election. Mitchell's lack of popularity with shareholders didn't stop the board from making him chairman. Now, how goofy was that?

What might shareholders have expected? A year before, America Online founder Steve Case had 22% of shareholders withhold their votes for his election to the board of Motley Fool Stock Advisor recommendation Time Warner (NYSE: TWX  ) . He stepped down. The big difference there was that the board strongly questioned his running of the company.

For many shareholders, the dissidents' pre-meeting press release -- titled "Don't Underestimate the Power of Your Vote!" -- became the post-meeting joke. Roy Disney's summary that the board's arrogance was almost unbelievable didn't soothe the pain felt by those wanting a change in Disney management.

Fast forward one year
Once again, the dissidents ask shareholders at this year's annual meeting to withhold their votes for the board. The primary issue is CEO selection -- or, more specifically, the fact that it had not occurred yet.

While the dissidents questioned why Eisner was given a $7.2 million bonus when the company had only met 1997 financial levels (a great question), the fact was that Walt Disney's operating results had improved. At least 92.2% of the shares voted in favor of all board members -- a clear sign that the dissidents had lost momentum and that Eisner and Mitchell's popularity was on an upswing along with the earnings.

The war rekindled
In mid-March, Disney announced that Bob Iger, currently the Disney president and chief operating officer, will replace to Eisner as CEO. Immediately, the dissidents advised shareholders to "seriously consider replacing this board and starting anew."

Last week, the dissidents filed a lawsuit. The charges are ugly -- false statements to shareholders, fraud, and breach of duty. Because there was not a full disclosure on the search for a CEO, the dissidents are looking to overturn the most recently elected board and hold another election. The suit also seeks to stop the company from changing the compensation contracts for Eisner and Iger.

The surprise claim from the dissidents is that they decided not to run an alternative slate of directors based on statements the board had made regarding the CEO search. Also surprising is that Roy Disney has refused to permit scrutiny of the board's decision to appoint Iger as CEO.

The Associated Press is reporting that all 10 independent members of the 12-member Disney board are calling the dissidents' charges "baseless and inaccurate." Iger used the company's earnings conference call to say that the suit would not be a distraction -- a pledge that sounds good until you think through what might happen if this matter does move into the courts.

What will happen?
Regardless of what happens on the legal front, Disney's 129,000 employees will continue working. The most it will do to them is provide fodder for water-cooler conversations.

But consider this. If the dissidents can stir up the pixie dust once more, acquisition offers could surface. All of the turmoil before the 2004 annual meeting emboldened Comcast (Nasdaq: CMCSA  ) to launch -- and subsequently fail at -- a $66 billion ($26.46 a share plus debt) takeover attempt.

Disney is a premier brand name, and the stock trades for only 2.1% more than Comcast offered more than a year ago. If that company and the dissidents are successful in showing a clear vision with the potential to maximize asset values, deep-pocket buyers just might be persuaded to make an offer -- without being asked!

What might also get entangled are the on-again, off-again talks with animation powerhouse and Motley Fool Stock Advisor recommendation Pixar (Nasdaq: PIXR  ) . Although Pixar Chairman and CEO Steve Jobs is talking to Iger, they are not negotiating business. With the CEO of Disney being contested, Pixar might decide to leave Disney for more certain waters.

What if the dissidents win?
One thing is clear. The dissidents want a different CEO, and they probably want one from outside the company. Without knowing who that might be, it is impossible to judge what special skills a new CEO would bring.

If the dissidents elect their own board, their objectives are clear: Disney would take a stronger creative turn in animation. Playing it safe -- the path to sequel after sequel -- is what the dissidents label as the path to killing growth and creativity. The company would take the financial and creative risks in animation that have made Pixar and DreamWorks Animation (NYSE: DWA  ) what they are today.

What's more, Walt Disney's namesake focused on reaching "the child in each of us," and that focus would prevail with a dissident board. The dissidents bemoan the modest investment in the existing theme parks and the creation of two parks -- Animal Kingdom and Disney's California Adventure -- where there just isn't enough to do for a full day. Expect a dissident board to start reinvesting more heavily in the theme parks, which have seen operating margins fall from 18.1% in 2002 to 14.5% for the last completed fiscal year.

Overall, the dissidents want the company to start focusing on returns. They acknowledge that taking risks and producing a smooth flow of earnings is hard, but they also want to look at the large base of assets the company has added and examine why they are not producing historic returns. Given Disney's large capital additions over the past 10 years, any operating improvement (or asset sales to reduce debt and tighten focus) should be viewed as extremely positive for the stakeholders.

The bottom line
The dissidents are just making noise at this point. Disney, its current leadership, and the board are in charge. Period. The dissidents' focus on results and leadership, though, should be viewed as a positive. They are holding a lot of people's feet to the fire in a very public display of business warfare.

Call it goofy -- and where else would the word "Goofy" bring up such a clear character image? -- but the war at Disney comes at a time when earnings are finally rising strongly.

Earnings for this fiscal year, which ends in September, are expected to increase by 21.1% to $1.32 a share -- a reasonable 20.5 times forward earnings. Disney's stock is up by 16.2% over the past 52 weeks, and the company has produced almost $3 billion in trailing annual free cash flow.

Is Disney a golden opportunity? The bottom line, to this observer, is this: To see Iger as a cookie-cutter image of Eisner is unfair to both men. Iger will soon be in charge, and his approach will be refreshingly different. If he fails to perform, the dissidents will have their slate ready, and a broad, sweeping change could happen. But the most likely outcome will be that Iger will bring needed change and just might take a few of the dissidents' results-focused ideas to heart and make them his own.

Are you looking for great companies with great opportunities? Why not try a subscription to the Motley Fool Stock Advisornewsletter?

Fool contributor W.D. Crotty owns shares in Disney and Pixar. Clickhereto see the Motley Fool's disclosure policy.


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