<THE RULE MAKER PORTFOLIO>
Trouble in the Kingdom
by Tom Gardner
ALEXANDRIA, VA (May 10, 1999) -- This week, your writers will review five large companies that we believe fall short of being Rule Makers. Tonight, I'll begin with Walt Disney (NYSE: DIS).
Just a year ago, Walt Disney Co. was riding high. The ESPN division of its Capital Cities/ABC subsidiary was on a rampage. Earlier in the year, ESPN had dealt out $4.8 billion to lock-in the rights to broadcast NFL games on Sunday night. Its partner network, ABC, bid and won Monday Night Football for the NFL for $4.4 billion. Beyond television, the company's theme parks were a go-go. Tomorrowland was renovated. Animal Kingdom Park was released with great fanfare. And summer movies were just around the corner: He Got Game, Toy Story II, Armageddon, and Mulan.
Additionally, Disney was cleaning up its house and preparing for the future.
Michael Ovitz had departed, with a controversial severance package. Jeffrey Katzenberg was gone on what appeared to be decent terms. And Disney's entertainment business was gradually being reengineered toward the Internet. Disney purchased the remaining stake in Starwave and was heading toward making a major investment in search engine, Infoseek (Nasdaq: SEEK).
To top it all off, in April of 1998, Chairman Michael Eisner declared that, owing to the stock's recent strong performance, the Board would complete a 3-for-1 split in July. Disney shares rose 10% on the announcement. You might be wondering what a "Hey, I Bought at the Top!" post to our message folders looks like. Here's a link to a note posted on April 27, 1998 when Disney stock was trading just prior to its all-time high.
When the stock split in July 1998, Disney shares were still dancing around $40 per stub. During the year since then, though, it's fair to say that the company has, in most ways, not modeled the behavior of a Rule Maker. It's been all downhill for this $61 billion entertainment giant. Disney has suffered through the loss of top management, the jet-fast adoption of the Internet, the accompanying slowdown in viewership for its network television programming, a tragic lawsuit, and a heap of interest payments tied to its mountain of debt.
And the stock has fallen from its all-time high of $42 per share (5/4/98) down to $29 3/4 today -- during a period that the S&P 500 has risen 19.4%
The fact is, though, that well prior to this difficult period, Disney was not making the grade. It was not operating with an understanding that cash is king -- that the game of public-market business is won by those who generate cash early and often, forever. Its $19 billion acquisition of Capital Cities/ABC (bringing with it the assumption of $10 billion in long-term debt) meant that the market would keep a very close eye on its performance. And even with ESPN rolling, the ABC purchase has looked like a blunder almost from the outset.
The trouble with the acquisition is that Disney bought a mature distribution network at a premium price. Rather than looking aggressively at and being willing to pay up for the emerging distribution networks (America Online and Yahoo!), which had better economic models in place and offered growth, Disney went with the tried-and-true.
Then, not unexpectedly, network television viewership was down 10% across the board in 1998. It is highly unlikely that this subpar performance was just a one-time event. All indications (from consumer behavior to corporate financial performance) are that the world is moving toward interactive environments, away from centralized information (ABC, CBS, NBC) and toward decentralized community interaction (AOL, Yahoo!, Fool).
And why hasn't Disney benefited from this revolution?
The problem is that Disney loaded up on borrowings and now has over $11 billion in long-term debt, demanding interest payments in excess of $600 million per year. When the Internet transition arrived with ferocious force, Microsoft -- with more than $10 billion in cash -- could outbid Netscape into network domination. But Disney couldn't outbid any of the Internet start-ups that were backed intensely by venture capitalists and the public market.
Consequently, The Mouse was truly caught between that hard place and a rock.
Its television network was losing audience to the Internet. And young Internet companies were capturing mindshare, in large part because they had near limitless access to capital and the foresight to throw it all into interactive network building. And that left Disney's technology investments looking second rate -- disappointing for what was arguably the leading entertainment brand on the planet.
So what can Disney do now?
Disney has committed to a rigorous assessment of its business performance and priorities. The company has reduced its spending on new movies. It wants to create more cost efficiencies across all of its businesses. Also, the company is committing more of its resources to the Internet. I believe that, ideally, Disney would've just settled its lawsuit with Mr. Katzenberg -- but hopefully it'll be completed quickly, without much more emotion. And then, I hope that the organization will re-ignite its wonderful brand by committing entirely toward a few core beliefs and principles (i.e., selling off assets that don't fit the model).
Finally, and perhaps most radically, I think Disney should spin off ABC and use the proceeds to power up investments in interactive education and entertainment programming.
To close, here is a link to Disney's Rule Maker score. With a score of just 29 points -- when ranked against Time Warner, Viacom, and Yahoo! -- Disney continues to fall short of our Rule Making expectations. If you'd like to respond to this article, drop a note in our Rule Maker Companies folder.
Tomorrow night, Phil Weiss will talk about Nike's aspirations to the throne.
Tom Gardner, Fool
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Day Month Year History R-MAKER -0.11% -2.30% 9.51% 38.56% S&P: -0.35% 0.38% 9.35% 35.27% NASDAQ: +0.91% -0.65% 15.22% 52.85% Rule Maker Stocks Rec'd # Security In At Now Change 2/3/98 48 Microsoft 39.13 79.69 103.63% 6/23/98 34 Cisco Syst 58.41 109.25 87.04% 5/1/98 55 Gap Inc. 34.37 61.94 80.21% 2/13/98 44 Intel 42.34 60.63 43.20% 2/3/98 22 Pfizer 82.30 114.38 38.97% 5/26/98 18 AmExpress 104.07 131.00 25.88% 2/17/99 16 Yahoo Inc. 126.31 155.69 23.26% 2/6/98 56 T. Rowe Pr 33.67 38.13 13.22% 8/21/98 44 Schering-P 47.99 50.44 5.09% 2/27/98 27 Coca-Cola 69.11 67.06 -2.96% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 82.38 28.04% 3/12/98 20 Eastman Ko 63.15 78.94 25.00% 3/12/98 17 General Mo 72.41 85.56 18.17% 3/12/98 15 Chevron 83.34 96.25 15.49% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 48 Microsoft 1878.45 3825.00 $1946.55 6/23/98 34 Cisco Syst 1985.95 3714.50 $1728.55 5/1/98 55 Gap Inc. 1890.33 3406.56 $1516.23 2/13/98 44 Intel 1862.83 2667.50 $804.67 2/3/98 22 Pfizer 1810.58 2516.25 $705.67 5/26/98 18 AmExpress 1873.20 2358.00 $484.80 2/17/99 16 Yahoo Inc. 2020.95 2491.00 $470.05 2/6/98 56 T. Rowe Pr 1885.70 2135.00 $249.30 8/21/98 44 Schering-P 2111.7 2219.25 $107.55 2/27/98 27 Coca-Cola 1865.89 1810.69 -$55.20 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1647.50 $360.80 3/12/98 20 Eastman Ko 1262.95 1578.75 $315.80 3/12/98 17 General Mo 1230.89 1454.56 $223.67 3/12/98 15 Chevron 1250.14 1443.75 $193.61 CASH $70.09 TOTAL $33338.40
Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and
it adds $2,000 in cash (which is soon invested in stocks) every six months.