The Walt Disney Company and Pixar Inc.: To Acquire or Not to Acquire?

November 2, 2018
Table of Contents

Case Problem 1

Company Analysis 2
SWOT Analysis 2

Industry Analysis: Porter’s Five Forces Error! Bookmark not defined.

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Case Problem
Animation is of enormous importance to Disney to ensure success over the next years.
● Should they reengineer Disney Animation to better compete with Pixar?
● Should they strike a distribution deal with another animation studio?
● If they stuck with Pixar, should they negotiate a new distribution deal and at what terms,
or should they instead acquire the entire company?

Company Analysis

1. Disney

History of Disney

● 1934 - the production of Snow White and the Seven Dwarfs; toys sales as a trademark
of Disney’s strategy
● A stray of hit films after Michael Eisner and Jeffrey Katzenberg (as chairman) joined
Disney in 1984
● In 1994, not being promoted to president, Katzenberg (who considered to be the
creative force) leaves the company; Joe Roth (former chairman of 20th Century Fox)
becomes chairman of Walt Disney Studios → for 6 years the company’s focus is on
live action films
● In the late 1990s was set up a “Secret Lab” for 3d CG films, however shuttered in
2001
● In 2000, Roth leaves, chairman position is taken over by the former head of Disney
Animation, Peter Schneider → goal to produce “emotional, thematic stories”
● In 2002, rival studio News Corp.’s 20th Century Fox exited the market → animator’s
salaries rose tremendously → aggressive cost-cutting mission: redundancies, less
number of characters in the scene, less amount of motion in the background
● In 2003, set up its own CG animation department → many staff needed to be
retrained → high costs, heightened tension, depressed morale → Disney slowed down
the production of animated films

SWOT Analysis (Disney)

Strengths Weaknesses
● Culture: open, collaborative ● Disney-produced animated films fell
environment below expectations
● Any employee can generate a story ● Lagging behind with 3d CG films
idea (“Gong Show” three times a (the Lab was shut down shortly after
year) its establishment)

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 ● Multiple revenue streams
● Strong focus on its main
competence: traditional 2d projects
● Strong position in the market: one of
the two companies that managed to
produce a blockbuster grossing
more than %100 million
● Production of several movies in a
year
● Work based on the purchased from
Pixar software; no market leading
software system developed in-house
● Animation is of crucial importance,
however due to the lack of internal
great results in the area needs to be
outsourced → high dependency on
other players in the market
● More cost-, time- and labor-
consuming production in comparison
to the competitors

Opportunities
● Long tail of revenues from
characters
● Sequels to previous productions as
well as to films created by Pixar
under the agreement; established
audience, reduced marketing costs
for sequels
● Higher revenue, income and brand-
awareness thanks to collaborations
Threats
● Katzenberg (who used to be the
creative force at Disney) leaves the
company and starts DreamWorks →
leakage of inside information,
stronger competitiveness
● Katzenberg brings along other
personnel → loss of important talent
● Falling behind in technology if no
software system produced in-house,
no opportunity to lease or purchase
from another company, or a rival
improves the proprietary technology

2. Pixar

History of Pixar
● In 1986, Steve Jobs bought the Lucasfilm computer business, then called Pixar
● The focus on being a computer hardware and software company → low sales on
graphics computers → cut of a third of the firm’s staff in 1991 → only the animation
division left
● In 1989 developed RenderMan (software system that applied texture and color to 3D
objects); Marionette (software tool for character animation and articulation) and
Ringmaster (production management system to coordinate and sequence the
animation)
● In 1996, stopped producing animated or partially animated tv commercials to pursue
movies as the main revenue stream
● Pixar purchased the computer division from Lucasfilm
● In 1991, set into producing a full-length movie financed by Disney

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SWOT Analysis (Pixar)

Strengths Weaknesses
● Generated a succession of box ● The aim at perfection may
office hits significantly hamper the production
● Standing out from traditional model and demotivate employees
● Production of only one movie per
(used 3D computer-generated
year → smaller portfolio than of the
models in spite of hand drawings) →
competitors → lower brand-
cost-, time- and labor- reduction
● Strong position in the market: one of awareness and loyalty from the
the two companies that managed to audience
produce a blockbuster grossing
● Diversification (full-time movies,
more than $100 million
short films; 2D, 3D, etc) can divert
● Developed its own computer attention from main competences
animation technology for generating ● Restricted own distribution channels
3D images: unlike any other software → need for collaboration with
system in the market, with 10 years of another studio → high dependency
proprietary → faster and cheaper on other players in the market
production than that of competitors
● Three proprietary technologies:
RenderMan (sold to Disney,
Lucasfilm, Sony and DreamWorks;
was the main source of revenue),
Marionette and Ringmaster
● Short films incorporated into
corporate strategy
● Blend of technological computer
staff and creative development
group
● Great focus on attracting talent and
fostering supportive working
environment (maximization of
employee interaction, freedom to
communicate, everyone is free to
offer ideas)
● Stayed close to innovations in the
academic community
● Pixar University to motivate
technical directors and artists to
study alongside the animators
● Temporarily excess employees are
assigned to R&D
● The largest returns in the market per
year, and even greater per movie

Opportunities Threats
● Higher revenue, income and brand- ● If another company develops and
awareness thanks to collaborations decides to sell a better technological

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 ● Potential to get the wanted deal with
Sony, Warner Brothers, or 20th
Century Fox
● Pixar University’s classes in
drawing, acting and motion as
means to attract new talent
solution, might lose the main
competitive advantage and one of
the most significant revenue sources
(the same applies with the expiration
of 10-years proprietary)
● With no further collaboration for the
distribution may lose its position on
the market

3. Relationship between Disney and Pixar

1986
- the two studios collaborate on the development of CAPS (Computer Animated
Production Systems)
1991
- deal to produce three full-length 3D CG animated movies (Disney: full financing,
movie rights ownership; Pixar: a participation fee based on total revenue for the
movie, coverage of over-budget expenditures)
1997
- Disney buys 5% of Pixar
- agreement according which Pixar exclusively produces at least five original full-length
animated films (production costs shared equally, Disney: marketing expenditures,
exclusive distribution and exploitation rights, including the right to produce sequels,
license fee if Pixar wants to exploit or distribute any of the productions itself)
1998-2004
- high dependency of Disney on revenue and characters produced by Pixar
- more than $3.5 billion of Disney Studio revenues come from Pixar CG movies
- more than $1.2 billion of Disney’s operating income come from Pixar’s production
- Pixar contributes 10% of revenue and over 60% of total operating income
2005
- Disney sets up a group, “Circle 7”, to produce sequels to Pixar movies

Renegotiation attempts from the side of Pixar (2002):

- Pixar covers all production costs in return of full ownership
- Disney receives a lower, fixed distribution fee
Counteroffer from the side of Disney (2003):
- Disney offers a stake in return for a higher distribution fee
Other questions raised (2004):
- for how long will Disney hold the rights to future Pixar movies
- will Pixar have any rights to the sequels
- what party will get television rights
→ no agreement reached
→ Pixar looks for another partner

Industry Analysis: Porter’s Five Forces

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 1. Competitive rivalry
Target family segment
- main competitors: Fox, Sony, Lucasfilm, DreamWorks, MGM, Universal, Paramount
- beneficial partnerships of rivals (e.g. DreamWorks with UK animation studio Aardman
Animations, a distribution deal between DreamWorks and Paramount)
→ fierce competition

2. Bargaining power of buyers

- ease of changing brands
- however, standing out high quality of production of both Disney and Pixar
- moderate price sensitivity
- access for Disney to the established customers pool through sequels to Pixar’s
productions
→ low bargaining power of buyers for Disney
→ moderate bargaining power of buyers for Pixar

3. Bargaining power of suppliers

- high dependency on software systems (e.g. RenderMan developed and sold by
Pixar)
- high dependency on the talent attracted
→ very low bargaining power of suppliers for Pixar
→ high bargaining power of suppliers for Disney

4. Threat of substitutes
- other family entertainment activities (e.g. themed parks, table games, books, events)
→ moderate threat of substitutes for Pixar
→ low threat of substitutes for Disney as it is more diversified in other entertainment
spheres

5. Threat of new entrants

- animated films generate the highest returns
- wider access to technology
→ low entry barrier
→ strong flow of rivals into animation market after 1937

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Evaluation of the different strategic options

Decisions to be made

Step 1: Target selection

(Based on framework from Chapter 4)

a) Are there any synergies to being in new (computer-generated (CG) feature film) and old
(2D traditional animation, theme parks, merchandise) businesses?

Roger Iger, CEO of Disney, identified entering into and developing the computer-generated
animation business as key for future business success.

However, going into the CG business is not only crucial for surviving in the competitive
environment, but there are also many synergies that can be derived from being in both
businesses. By putting together dissimilar resources, more particularly proprietary computer
technology with Disney’s assets like distribution capabilities, human resources, brand name,
etc., and low need for modification, positive connection synergies exist.

These were already experienced during the distribution deal phase with Pixar. After
distributing joint CG movies, Disney’s could benefit from traffic being driven to their theme
parks and retail stores. Also, they ability to produce sequences from these movies may be
considered a connection synergy. Last but not least, connection synergies allow Disney to
produce and publish movies faster and at lower costs.

b) What resources needed for the new business value chain do we already have? What do
we lack?

● Resource gap: Computer animation technology

○ Disney set up a “Secret Lab” as a response to growing popularity of three-
dimension CG films in the late 1990s but shuttered it in 2001
○ In 2003, Disney Studios set up its own CG animation department through which
it created films e.g. Chicken Little
■ But: extensive training was required and technology was not on par with
proprietary systems by competitors

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c) Identify the best inorganic growth candidates who can fill the gap.

● Pixar
○ 10+ years of proprietary computer animation technology to generate incredibly
lifelike 3D images and backgrounds
■ RenderMan: apply texture and color to 3-D objects for visual effects
■ Marionette: animate and articulate characters
■ Ringmaster: production management system to coordinate and
sequence the animation

● Fledging animation studios in California’s Bay Area e.g. Orphanage, Wild Brain Inc.
and CritterPix Inc.
○ Showed first successes (e.g. first awards) but in different league than Pixar

Based on Pixar’s experience and technological superiority, it represents the favored candidate
for collaboration compared to smaller but rising animation studios. Furthermore, CEO Robert
Iger knew that he wanted to maintain Disney’s relationship with Pixar, especially because of
their unmatched track record for producing hits.

d) Identify combination of best mode for best inorganic growth candidates and estimate the
value from this.

The two most promising modes of inorganic growth with Pixar represent a new distribution
deal or acquisition.

Option 1: New distribution deal

PROS CONS

A new distribution deal provides access to
Pixar’s technology without need for large
investment of capital and while retaining
more flexibility.
The distribution deal has been successful
in the past in terms of financial implications
for Disney. Pixar CG movies contributed a
total of more than $3.5 bn to Disney Studio
revenues and more than $1.2 billion to
Disney’s operating income (representing
10% and 60% respectively).
Pixar was already in talks with many other
studios like Sony, Warner Brothers and
20th Century Fox. Letting Pixar have a deal
with these competing studios would
weaken Disney’s competitive situation
significantly.
Distribution deals imply governance costs
resulting from complexity in communi-
cation, coordination and control. For
example, they had large disagreements
over sequel production.
There were tense relationships between
the CEOs, Jobs and Eisner, resulting from
personal conflicts but also having negative
effects on the deal.
Resulting from Pixar’s success and,
relatedly, bargaining power, the terms of
the renegotiated contract would have most
probably been rather unfavorable to
Disney, especially compared to the previous
deal. For example, under the alleged
contract to cover Ratatouille, Disney would
have only received a straight distribution
fee.

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 Option 2: Acquisition

PROS CONS

Disney would get exclusive access to An acquisition of Pixar implies a large

Pixar’s technology, which would strengthen
their competitive position.
An acquisition will align interests, facilitate
coordination and make it easier to control
behavior. This will lead to more favorable
outcomes as time can be spent on working
together towards a same goal. It will also
make it easier to realize the expected
synergies.
investment for Disney and of course also
has opportunity costs. This may lead to
stock dilution. Next to the costs for
purchase, there are also costs of
integration. Further, companies often
overpay or suffer from a diversification
discount after acquisitions.
A culture clash is likely to happen - also
because of the influence of Steve Jobs -
and needs to be managed well. Pixar is
known for its dynamic, independent working
culture whereas Disney may have a more
regimented culture.

e) Estimate organic growth value, and compare to the result of the previous step.

● Organic growth would require an enormous investment in training and building up

the technology. In addition to this, it would be very time consuming, which is
especially risky in the intense competitive environment that Disney is facing.

→ Organic growth does not represent a feasible option.

From the above analysis, acquiring Pixar seems to be the most promising strategic option and
the best way to exploit synergies.

Step 2: Valuation and negotiation

● Valuation strongly depends on the assumptions about an uncertain future and is based
on limited information. Using different quantitative methods, a lower and upper bound
for firm valuation can be determined.
● Given the market capitalization of $5.9 billion, investment banks estimated an
enterprise value fee between $6.5 billion and $7.4 billion.
● As Pixar is a public company, the easiest and most effective way to acquire the
company is a friendly takeover bid.

Step 3: Due diligence

After making an offer, Disney needs to verify its valuation by accessing private data.

Step 4: Implementation
Disney has to set up a new common organization that enables the exploitation of synergies.
They need to define how to share the resources and how to coordinate and link the activities
of Pixar and Disney. The biggest challenges will be

● Cultural differences: Pixar was a small, independent studio with a dynamic culture,
whereas Disney was a large, regimented corporation. Disney needs to make sure not
to impose its culture on Pixar, but to try to preserve the Pixar culture as it represents a

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 source of competitive advantage.

● Choosing the level of integration: Disney needed to choose how to group and link
activities across organizations to exploit synergies. In this context, it was very important
to preserve Pixar’s independence in order to maintain their expertise and culture. As
the main synergies were of the connection type, thus representing dissimilar resources
and low modification, a rather loose grouping is sufficient to exploit these synergies.
Therefore, Disney may use the “autonomy” or “peer” grouping types and link them
rather loosely (e.g. keep own processes instead of standardization) to manage the
collaboration.

Step 5: Post-deal evaluation

After the transaction, the performance of the new company shall be reviewed.

How did reality look like?

Disney acquired Pixar for $7.4 billion at a 3.8% premium over the stock price. It was perceived
as a success as both companies were well aligned. Furthermore, the expected synergies were
realized, as productions like “Cars” did not only lead to box office success but also fuelled
revenues from other sources like merchandise and theme parks. The success of the
acquisition was confirmed by the financial results: the stock price rose by 28% two years after
the merger and has since then shown impressive growth.

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