A Big Head Rolls At Disney

Published in Investing on 25 April 2012

The company's movie studio chief steps down after another costly flop. Yet the company still looks like a solid entertainment play.

A version of this article was originally published on our US site, Fool.com.

Studio executives have a limited shelf life in Hollywood -- especially if they release a flop. Rich Ross, who resigned as Disney's (NYSE: DIS.US) movie honcho last week, was responsible for a pair of them. Most recently he signed off on the sci-fi epic John Carter and the animated bomb Mars Needs Moms. His departure bruises the reputation of the Mouse, but fear not -- it's still in pretty good shape.

Your favourite character on a lunchbox

Ross failed to deliver Disney what it wanted, which, to put it allegorically, was more pirates -- Pirates of the Caribbean, that is. In other words, over the past few years the company has aimed to produce splashy big-budget movies that turn a healthy profit and thus possess the potential to become franchises.

That's because the company's success depends in large part on leveraging its intellectual property across all of its business units. A successful movie series can beget a best-selling action figure or a popular Disneyland ride (or vice-versa in the case of Pirates). That's how the Mouse keeps its margins consistently between 10% and 12% and its cash flow robust enough to maintain or increase its dividend over time.

Contrast this with a purer entertainment play like Lions Gate (NYSE: LGF.US), for which every reporting period is a roll of the dice. In 2011 the company posted wildly mixed quarterly net results of $46.1 million, $12.2 million, -$24.6 million and -$1.7 million. Sometimes the Lion roars, and sometimes it whimpers. What it doesn't produce is predictable earnings or a dividend.

Part four coming soon

The thirst for good franchises was a big reason Disney spent a lot of dosh to acquire animation kings Pixar (price: $7 billion) and comic book empire Marvel Entertainment ($4 billion). Both have proven success in creating strong series that produce nice returns on a fairly regular basis (Pixar with Toy Story and Cars, and Marvel with its army of superheroes).

This is the aim of every big Hollywood player these days. Lions Gate caught the bug when it acquired the studio that produces the Twilight franchise, and it's now really taking off in that respect with The Hunger Games. The latter series had a smashing debut with the eponymous film in the chain; three sequels will be made, and each will probably bring in box office sales comparable to the $540 million worldwide the first installment has raked in so far.

The smaller guys like Lions Gate are getting good at this. DreamWorks Animation (NASDAQ: DWA.US), for example, made a mint with its Shrek series, which collectively grossed almost $3 billion worldwide. The company's next release is the third title in the Madagascar franchise, which will hit movie screens early in the crucial summer season.

Lead by example

Disney didn't want to rely solely on its acquisitions for franchise hits. This is why the company was still swinging for the fences as far as its proprietary releases were concerned. As wasteful as this might seem considering the expensive nosedives of movies like John Carter, it actually illustrates the strength of the company's underlying business.

Why? Because its diversification is smartly conceived and works exceptionally well. Of the company's nearly $10.8 billion in total revenue this past quarter, none of its five business units were responsible for more than a third.

In fact, at the end of the day the studio entertainment division is comparatively small: It's the third-largest of the five and contributed only 15% to total revenue. Hollywood history is littered with John Carter-sized money-losers putting studios out of business. For Disney, such a flop will mean only disappointing quarterly results and a new captain steering the ship.

Ever onward

Rumour in Hollywood has it that whoever next occupies the big chair at Disney's movie studio will give up the hunt for big, cross-promotable franchises. That's unlikely, as the company has too many proven successes behind it to abandon that approach completely. Also, its tightly diversified structure makes that strategy irresistible; what company wouldn't want to have a hit movie, popular amusement park ride, eagerly viewed TV show and bestselling toy set all rolled into one?

That's the great advantage Disney has over its rivals. And its non-movie divisions are humming along, with the three largest remaining ones posting solid year over year operating income rises this past quarter.

This is in contrast to the sickly core businesses of companies like Sony (NYSE: SNE.US), which, like Disney, operates a big-time Hollywood studio. Unlike Disney, it's been putting up gasp-inducing losses recently -- to the tune of nearly $3 billion in its most recent fiscal year.

Thick-skinned shareholders

It's telling that Disney's stock actually rose in the wake of the John Carter release, when it became obvious the film wasn't going to attract the crowds it needed to turn a profit. Disney investors, aware of how well the company can perform when it isn't releasing underperforming movies, didn't seem spooked by the failure. There's little reason they should have been, and that remains the case with the company's latest executive casualty.

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jadeplant 25 Apr 2012 , 9:27am

The "John Carter is a flop" story, repeated with glee by UK media, is a bit of an over-simplification. Its takings were damaged by poor marketing - notable example, taking out any reference to Mars that might have hooked in potentially interested cinema visitors. Some bloke called John Carter? Never heard of him.

Among folks with affection for pulp fantasy/early sci-fi, who knew what it was and went to see it, there's been very positive reaction. It's actually a good film. If they release a decent DVD, ideally with nice extras for fans, I expect it to do well. I think I saw a story somewhere that it was doing better in non-US cinema sales.

Should the person responsible for the afore-mentioned marketing go? That's a different question.

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