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1. Mergers &
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3. ESADE Full-Time MBA
4. December, 2011

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CHAPTERS

Overview

 Movie Industry with Porter’s 5 Forces

 Pixar Company Overview

 Walt Disney Company Overview

Merger

 Walt Disney-Pixar Merger, Background Context

 Valuation

 Negotiation and Agreed Conditions

 Benefits, Synergies and Trade-Offs of the Deal

 Post-Merger
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OVERVIEW

Movie Industry Analysis with Porter’s 5 Forces

Supplier Power: Moderate
Suppliers in this industry are defined as people with technical and creative
film-making skills. We assess this threat to be moderate since with
technology, hand-drawn animation is being replaced by computer technology.
In addition, the needs for these computer animation skills start to be
outsourced from North America to Asia Pacific where there are significant
lower costs coupled with high quality computer animation production.

Barriers of Entry: High

The industry is dominated by a few key players (Sony, News Corporation,
Disney and Time Warner). With the lack of access to distribution channels and
the intense capital needed to create “blockbuster” films and hire famous
actors, it is very difficult for a new player to enter the market.

Buyer Power: Moderate

Buyers in this industry are defined as the end consumer or viewers of the
films. We assess this threat to be moderate as there are many potential
consumers with limited financial impact on the industry. In addition, the
industry is dominated by key players thus is able to limit the options for the
buyers. On the contrary, even though there are only a few options, there are
effectively zero switching costs for customers. Hence, watching a film by one
company does not make it more costly or difficult to then watch a film from a
competitor.

Threat of Substitute Products: Moderate

We consider substitute products to be theater or other forms of entertainment.
Internet is also a substitute form of entertainment as the concept of instant
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messaging was very popular at this time. Also, we can see the beginning of
the popular social network Facebook gain traction as it was launched in 2004.
Rivalry: High
Since there are only a few key players with similar percentage of market share
(ranges from 14%-19%), the competition between them is strong. To be more
competitive, the growing trend is to consolidate and acquire other studios. For
example, Vivendi acquired Universal in 2000, which was then acquired by GE
in 2004 and Viacom acquired DreamWorks in 2006.

Distributor Market
Share
Sony 19.20%
News Corporation (Fox) 17.00%
Disney 16.70%
Time Warner (WB) 14.90%
NBC Universal 10.80%
Viacom (Paramount) 10.80%
Lionsgate 3.60%
Other 7.00%

2006 Box Office Market Share

Sony News Corporation

(Fox)
Disney Time Warner (WB)
NBC Universal Viacom (Paramount)
Lionsgate Other
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Pixar Company Overview

Pixar begins in 1979 as the Graphics Group, which is a part of the
computer division of Lucasfilm. Initially the group started selling a computer
system called Pixar Image Computer to government agencies and the medical
community. However, the imaging computer never sold well. In 1984 John
Lasseter left his job as the animator at Disney and joined the computer
animation group of George Lucas. To show off the device’s capabilities, the
group started developing short animated clips, which then turned into
animated commercials, including campaigns for Tropicana, Listerine, and
Terminator 2.
In 1986 Steve Jobs bought the company from George Lucas for
$5million and ads another $5million of capital. The newly formed company
was headed by Jobs, who served as Chairman and Chief Executive Officer of
Pixar. At the time, 44 people were employed at Pixar.
Between 1987 and 1989, two short films Luxo Jr. and Tin Toy received
Academy Award nominations for Best Animated Short Film and various other
awards such as the Golden Gate Award at the San Fransisco International
Film Festival.
In 1990, Pixar went through a rough time selling its hardware
technology and imaging software to Vicom Systems and had to reduce its
workforce to 42 people. However, the following year it managed to secure a
$26 million deal with Disney to produce three computer-animated feature
films, the first of which is Toy Story. The alliance had begun. In the meantime,
Pixar continued to make award winning commercials.
In 1995, Toy Story was released and became the highest grossing
movie of the year, making $192 million in U.S box office and $362 million
worldwide. The movie was distributed by Disney and received numerous
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awards. At the same time Pixar went public, offering 6,900,000 shares at $22,
beating Netscape as the biggest IPO of the year.

Walt Disney Company Overview

Walt Disney is one of the major companies in the world that has
provided entertainment to generations of fans since 1923. The company
together with its subsidiaries consists of four main segments: media networks,
parks and resorts, studio entertainment and consumer products.
Since the very beginning, the company has been known for its creative
content and great storytelling. In 1923 Walt arrived in California, started the
Disney Brothers Studio and began making independent movies.
In 1927, Walt decided to pursue all-cartoon series and the mouse is
born. After his distributor took the rights of the first character, Walt created the
mouse, named Mortimer, which his wife changed to Mickey. Mickey Mouse
became an overnight sensation and a series of cartoons followed.
In 1932, one of his cartoons of the Silly Symphony won the Academy
award for best cartoon, the first year that the award was offered. Until the end
of the decade, Disney won that award annually.
In 1934, Disney decided to move into animated feature films and
created the Snow White and the Seven Dwarfs. This was a radical concept
and in 1937 after the film was finished, it became the highest grossing film of
all time.
During World War II, Disney lost most of its markets and the company
lost money on the next several films, bringing financial problems to the
company.
During the 50s Walt Disney was constantly trying to come up with new
ideas, and he felt that there should be a place where adults and children
should spend time and have fun together. Thus he created Disneyland in
1955. The park was a huge risk for the company, as it had taken millions of
dollars in bank loans to build it. But it paid off. It became an enormous
success and finally put the company in solid financial footing.
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After Walt’s death in 1966, his successor Roy Disney continued his
brother’s vision of creating a second park in Orlando. It opened its doors in
1971 and immediately became the top-grossing park in the world with more
than 11 million visitors in its first year. Japanese and European parks
followed. However, during the years of parks construction, the revenue from
movies dropped. Thankfully, in 1984 Mickael Eisner became CEO and
managed one of the most impressive turnarounds in history. He revitalized TV
and movies, with a strong commitment to quality programming. Disney’s next
33 movies were profitable. In addition, he maximized theme parks profitability
by raising prices, expanded working hours and lifted restrictions on the
number of visitors allowed in the park.
In 1995, the company acquired ABC and launched its internet division,
Disney Online. Eventually total revenues rose up to $32 billion with a net
income of $2.5 billion.

MERGER

7. Walt Disney-Pixar Merger. Background Context

In May 1991, Pixar and Walt Disney entered into the Feature Film
Agreement. Under this Agreement as mentioned, Pixar would develop and
produce three computer animated feature films. Disney would be responsible
for its marketing and distribution.
A few years later in 1997 Pixar and Disney entered into Co-Production
Agreement, which replaced the Feature Film Agreement established in 1991.
This new Agreement defined, on an exclusive basis, Pixar to produce five
animations for distribution by Disney - A Bug’s Life, Monsters, Inc., Finding
Nemo, The Incredibles, and Cars. The movie’s revenues of these movies
were shared 50% to each partner. This partnership built huge profits for both
companies; the total box-office revenue from these 5 movies was more than
$3 billion.
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However as time passed by, some issues occurred amongst the two
parties. For example, Disney refused to include Toy Story 2 within the 5
movies mentioned in the Co-Production Agreement. Disney ignored Pixar’s
request in launching Toy Story 2 in form of Home Entertainment, instead of
motion pictures.
In 2004 both companies attempted to reach a new agreement, which
ended up failing. The conditions under the negotiation included Pixar having
control of the entire products, getting the ownership over the films and also
the films in production under their old agreement. Pixar also wanted financial
freedom, which means that they would finance the films on their own and
collect all the profits. Disney would only do the films distribution and get 10 to
15 percent from the distribution fee.
In early 2006, Disney agreed to acquire Pixar with 2.3 Disney’s shares
issued for each Pixar’s share and merged two companies worth $ 7.4 million
in an all stock deal. Pixar Vice President, John Lasseter, would become Chief
Creative Officer of the combined Disney-Pixar animation studios as well as
the Principal Creative Advisor at Walt Disney Imagineering, to help with the
design of new attractions at Disney theme parks. Current Pixar President, Ed
Catmull, would become President of the new combined Disney-Pixar
animation studios.
This alliance would enable both Disney and Pixar to collaborate without
the barriers that comes from producing the product from two different
companies with different shareholders and management teams.

Time Line
"I don't think Disney had any choice about doing this deal with Pixar,"
said NPR correspondent Kim Masters, author of Keys to the Kingdom: The
Rise of Michael Eisner and the Fall of Everyone Else. "They had tried for a
long time to rejuvenate their own animation operations, and they just couldn't
get it nailed. The options were: Bring Pixar in, or let Pixar go somewhere
else."1
1http://www.techzone360.com/news/2006/06/12/1678408.htm
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The time to complete this deal was limited, the sides knew each other
from previous mutual work and they knew what was in stake. It was either
acquiring Pixar or having a possibility of a competitor purchasing it. The fact
that Steve Jobs was the major shareholder with more than 50% allowed this
deal to be done quickly.
The deal was agreed on 24.01.2006 and was pending the approval of
the shareholders. On May 5th the shareholders of Pixar agreed on selling the
company to Disney, and the whole acquisition was completed shortly after
that. As any other major merger, the deal had to be approved by regulation,
for anti-trust considerations. All the regulatory approvals were received before
the final vote of the shareholders.

Advisors
Three investment banks helped to create this deal. From Pixar’s side it
was Credit Suisse, while from the opposite side there were Bear Stearns and
Goldman Sachs’ lead by the head of technology M&A. It could be seen that
the top investment bank with a senior officer was involved in the deal, and the
importance the investment banks.

The Transaction
The actual transaction of Disney purchasing Pixar was relatively
straightforward. Disney agreed to convert every share of Pixar into 2.3 shares
of Disney, so it was a 100% equity transaction. Disney issued 279 million new
shares in order to do the transaction. However, in order not to dilute the
excising shareholders, Disney bought back 225 million shares in the market.
So the actual impact on the balance sheet of Disney could be seen as paid in
cash for 80% of the deal, and sharing the remaining 20% of the capital with
Pixar shareholders (of course, assuming that the existing shareholders did not
sell their shares during the buyback).
The price (in stock) that was set by Disney was $7.4 billion, with Pixar
having $1.1 billion in cash and equivalents. So effectively, Disney paid $6.3
billion dollars for Pixar. At the time of the merger announcement, the price of
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Disney´s stock was $25.52/share and Pixar´s was $57.50/share. The exact
price of Pixar´s stock for the transaction was an average market price for 5
consecutive days, ending at 2 days before the announcement.
Steve Jobs founded Pixar and was a major stakeholder with 50.6% of
the shares. Upon the completion of the transaction, Jobs became the biggest
sole holder of Disney´s stock (with 7% control).

Multiples
According to Thomson Financial, Pixar´s stock was trading at 84 times
the annual earnings and was the most expensive in the industry. Disney´s
stocks, however, were trading only at 17 times to the earnings, making them
one of the cheapest in the industry. We believe that such difference in
multiples was due to the fact that Pixar was a leader in the industry with 6
blockbuster movies, while Disney was looking for a driving engine to increase
sales. The result was that Steve Jobs “exchanged” expensive stock into a
cheaper stock, and a transaction like that might look decretive to Disney´s
shareholders. However, there was, of course, a strategic angle in this
acquisition, as mentioned above.

Valuation
As a matter of fact, Disney paid $59.78/share to Pixar by giving
Disney’s stock. If we calculate the premium over Pixar’s stock price at the
moment (Jan-24th-2006), it is about 4% (the share price was $57.75 on Jan-
24th). Considering that this deal took several months to complete and the
stock price surged 10% since the beginning of 2006 due to the speculation
over this deal among investors, we could consider the real premium to
potentially exceed 10%.
However, considering that Disney paid much more premium to the
target companies’ shareholders when they merged ABC and Marvel, this 10%
could be considered as “cheap”.
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Year Targe Deal size Premium Payment

t
199 ABC 19 billion 27% 60% Cash +
6 USD Stock
200 Pixar 7.4 billion 4% 100% Stock
6 USD
200 Marvel 4.3 billion 29% 60% cash +
9 USD Stock

We cannot specify the reason behind this difference because there

could have been many environmental factors, which might have affected.
However, we consider that the main idea of compensation for the
shareholders of Pixar (Steve Jobs owned 50%, which could affect the price as
well) was meant to be achieved by future capital gain coming from both
companies’ synergy.

Negotiation and Agreed Conditions

Even though Disney acquired 100% shares of Pixar and made it a

wholly-owned subsidiary, it appears that Disney tried not to “dilute” Pixar’s
competency as much as possible and leveraged Pixar’s strengths to enhance
Disney’s creative capability rather than controlling it strictly.
To start with, both companies agreed to keep both Disney and Pixar’s
production units (Disney animation studios and Pixar animation studios)
separated. Pixar’s animation studio kept its location in Emeryville, California
with Pixar’s sign on it even after the merger. Furthermore, according to the
“Agreement And Plan Of Merger” registered in SEC about this deal, Disney
agreed to keep Pixar’s HR policy basically intact. It shows that Disney took
motivation and loyalty of employees of Pixar fully into account to avoid having
many employees leave due to the merger.
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In addition to separating Pixar at the organizational level, Disney tried

to leverage Pixar’s brand and capability to enhance Disney. Instead of
branding new films as new “Disney” product, it chose to keep “Pixar” brand by
using “Disney-Pixar” brand for the products produced by Pixar after the
merger (“Cars” was the first product distributed under the new brand).
Furthermore, Disney appointed Steve Jobs as a board of director at Disney,
Ed Catmull (president of Pixar) as a president of both Disney and Pixar
animation studios, John Lasseter (Pixar’s creative director) as a chief creative
officer of both Disney and Pixar animation studios. Having those persons from
Pixar as top executive of Disney shows that Disney expects them to be an
enabler to enhance Disney’s struggling performance in production.
As we discussed already, Disney’s main target is not only the existing
Pixar’s highly recognized product lines but also the talents who can make a
difference in Disney’s future performance. To put it the other way around,
Disney loses most of its fruits of the deal if it loses those talents. To prevent
this, Disney put several clauses in the agreement. First, losing John Lasseter
or Ed Catmull can be a deal-breaking event. Second, Disney named some
key employees who are critical to keep Pixar’s creative capabilities and
culture as required for employees to join new company. Those employees
include Andrew Stanton, the director of "Finding Nemo"; Peter Docter, the
director of "Monsters Inc."; Brad Bird, the director of "The Incredibles"; the
director and writer Bob Peterson; the story artist Brenda Chapman; the editor
and director Lee Unkrich; and the sound designer Gary Rydstrom.

8. Benefits, Synergies and Trade-offs of the deal

The alliance between Disney and Pixar will yield great benefit to both
parties. The benefits for each partner can be identified as the followings.
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Disney

 To acquire core strengths of Pixar in producing computer motion

pictures. At the time Disney started developing its computer animation
films, Pixar already generated more than 30 billion dollars from its 6
animation motion pictures.
 Decrease in competition mainly because Pixar is the large player in
the industry in terms of developing and producing computer animation
films, which in collaboration with Disney can greatly increase its
market power.
 Increase in revenue by merging with Pixar. Merging with Pixar will help
Disney to generate new sources of revenues from high-quality new
type of films and to get more profit from merchandise and theme park
tickets.
 Access to computer generated imaging technology.

Pixar

 Focus on its core strengths in producing the computer animation,

without investing in production line for making merchandise and home
entertainment.
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 Disney has the various lines to produce merchandises and have a

place to distribute so Pixar also gain the benefit of being able to
produce the other lines of products such as apparels, toys, and so on.

Moreover, after the deal, stockholders got an increase share price from
merging the two companies. For example, shares of Pixar gain nearly 3%
from after-hours trading and Disney’s stock gained about 1.8% in regular
trading.

Title Year Box office

Monster University 2013 - With regards to synergies, the team up of these
Brave 2012 -
two big animation production companies will
Cars 2 2011 $552M
Toy Story 3 2010 $1,063M enable better human resource. They can
Up 2009 $731M
exchange the valuable human resource
Wall E 2008 $521M
Ratatouille 2007 $624M between Disney and Pixar, which enables them
Cars 2006 $631M to better, produced even top hit motion pictures.
The Incredibles 2004 $631M
Finding Nemo 2003 $868M Both parties can market its production together
Monsters, Inc 2001 $526M and get more profit. Considering the structure of
Toy Story 2 1999 $485M
A Bugs Life 1998 $363M this deal, both companies can concentrate on
Toy Story 1995 $362M their individual strengths, which will turn in an
increase of productivity and generate more
sales.

Post Merger
Overall it was a very successful integration, which was intensely
discussed in the press as well as the management literature and research.
The financial results (and here we only look at the Box office success,
not taking into account the retail revenues Disney achieved through its wide
distribution and sales network in its Parks, etc) clearly prove this success.
Since the merger, Disney-Pixar generated $4.1 billion in Box office revenues
in only 5 years. Compared to $3.2 billion in the previous 9 years.
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There were two major issues that the public and Wall Street feared
after the acquisition of Pixar through Disney. One was that Disney – with its
sheer size - would trample Pixar’s creative power and turn the Pixar
executives into mere Disney-puppets. The other scenario depicted a spoiled
team of Pixar executives and animators, completely unwilling to make this
partnership a success and not respecting the requests of its new owners.
But luckily, both apprehensions didn’t materialize. On the contrary, the
merger is noteworthy for the success it had and how apparently easy the
integration was so far. Despite many mergers that destroyed more value than
they were anticipated to create (especially in the media sector), Disney and
Pixar made it work. Wall street showed its content with this deal with an
average stock price of $25 before the deal, about $35 after one year and still
a stable $30 after almost two years.

The main reasons for this great result are as follows:

1) The investors see potential for Disney to leverage Pixar’s computer-
animated character to be used across its vast network (parks, channels,
etc). One successful example for this opportunity is “Cars”. While it was not
one of the biggest blockbusters for Pixar/Disney (“only” $460million in the
cinemas and $27million in DVD sales), the revenues in retail products
reached about $5billion for Disney for “Cars” only (through an online world,
an ice-skating show and a “Cars” world in Disney World, etc).
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2) Pixar’s willingness to change and adapt to being part of an international

conglomerate. Not only did Pixar decide to not mainly push for new movies
anymore, but also allow for sequels (Toy Story, Cars). The executives also
changed their mind on another production channel: Direct-to-DVD was now
also a part of Disney-Pixar’s portfolio. Pixar even allowed the partial
production of these movies to be performed by outside animators from
India, which was categorically impossible, before Pixar’s executives feared
a loss in quality and damage to the brand.
3) The experience of Bob Iger (having been bought with his companies twice
himself) how a merger should be done was also a key influencing factor for
its success. The two companies strictly followed the well-known tactics to
make a merger work, like effective communication to the employees but
also came up with some more unusual approaches. For example, the
executives agree on a detailed list of things that Pixar would not have to
change after the merger (e.g. the health benefits) and concrete guidelines
on how to protect Pixar’s creative culture. There is a steering committee
that oversees animation for both Disney and Pixar studios, with the mission
to maintain and spread the Pixar culture. Also Pixar employees were not
forced to sign an employment contract, whereas this policy exists in
Disney. Regarding this list of promises, a Pixar executive was quoted in the
NY Times2: “We’ve never had to go back and look at it. Everything they’ve
said they would do they have lived up to.”
4) One of the key-learnings of Mr. Iger was that a successful merger cannot
happen in a rush. “There is an assumption in the corporate world that you
need to integrate swiftly,” Mr. Iger said. “My philosophy is exactly the
opposite. You need to be respectful and patient.” This becomes visible in
many details (such as keeping the same email-addresses for Pixar
employees or no forced adaption of the strong corporate culture of Disney)
but mainly the overall trust that was build over time and acknowledged by

2 www.nytimes.com/2008/06/01/business/media/01pixar.html?pagewanted=all
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Mr. Lasseter when he said: “It took about a year before there was a
collective letting down the guard”.
5) Analysts identified another key-factor for the success of this merger. Bob
Iger gave the new talent acquired through Pixar extra responsibilities to
help improve Disney and drive it into a new direction. One analyst, familiar
with the deal, commented in the NY Times 3: “If you are acquiring expertise,
then dispatch your newly purchased experts into other parts of the
company and let them stretch their muscles.” Disney did exactly this by
assigning the Pixar team to turn around Disney’s animation department,
which they achieved! The influence Pixar had at Disney becomes clear
when John Lasseter says: “Disney has become a filmmaker-led studio and
not an executive-led studio. We are very proud of that.” Another key factor
to ensure Pixar’s influence at Disney was that the deal required that Pixar's
primary directors and creative executives also had to join the combined
company.
6) The transformational leadership of the key-leaders (Steve Jobs and John
Lasseter) in Pixar was brought into and widely adopted by Disney. Their
ability to lead teams that bring a willingness to quickly adapt to new
challenges in a rapidly changing environment is legend and (as seen
above) also works in Disney. 4

Additional bibliography:
(Disney.com) http://corporate.disney.go.com/corporate/complete_history.html
(Pixar.com) http://www.pixar.com/companyinfo/history/index.html
http://en.wikipedia.org/wiki/Pixar

3 www.nytimes.com/2008/06/01/business/media/01pixar.html?pagewanted=all
4 Haley and Sidky 2009: Making Disney Pixar Into A Learning Organization