Disney Buys Lucasfilm, But Is It A Trap?

By Stephen D. Simpson, CFA | October 31, 2012 AAA

For many Star Wars fans, the news that came out Tuesday evening read more like something from The Onion or a Halloween prank. The American media megalith Disney (NYSE:DIS) announced that, not only did it reach an agreement to acquire Lucasfilm from George Lucas for about $4.1 billion, but that a new Star Wars movie would be in theaters by 2015, with many more following thereafter. While this deal looks a little riskier than those for Pixar and Marvel, Disney has a habit of monetizing media franchises more successfully than analysts usually predict.

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The Terms
Disney announced that it had reached an agreement to acquire Lucasfilm from George Lucas for $4.05 billion in a deal that will be financed with 50% cash and 50% stock. This deal not only includes the well-known Star Wars franchise (and related rights), but also other business units such as LucasArts, ILM and Skywalker Sound. Assigning a valuation to the deal is a little tricky, as Lucasfilm's earnings are well off the recent peak of 2005 (the year in which "Star Wars: Episode III - Revenge of the Sith" was released). Information provided from Disney suggests 2012 revenue of about $850 million, with about one-quarter of that coming from consumer products. Back in 2005, however, operating income was in excess of $500 million.

Relative to past deals, this is in line with the $4 billion or so that Disney paid for Marvel in 2009, and clearly less than the $7.4 billion paid for Pixar in 2006. While those deals were also seen as expensive and risky at the time, both have proven value-additive for Disney.

A Deal More About Tomorrow Than Today
The biggest part of the announcement, at least for Star Wars fans, was that Disney expects to release a new Star Wars movie in 2015, with additional movies following about every two or three years thereafter. Although there were few details about whether these would be structured as new trilogies or serials, there was mention made of Lucas providing story treatments for the next three movies.

It seems relatively certain that the success of future Star Wars movie releases will have the most to do with whether this deal succeeds for Disney. Although there was widespread criticism of the last Star Wars trilogy, they still did well at the box office (and even the ill-considered "The Clone Wars" CGI film grossed about $70 million worldwide). There will certainly be risks here for Disney, but the four Marvel movies released since that deal have all grossed more than $350 million worldwide. Even "John Carter of Mars," which was not Marvel, but was considered a "flop," still had a relatively successful run, earning nearly $300 million box office. Assuming that Disney can maintain some measure of quality, and considering the scope of the Star Wars universe, it's not hard to imagine an enduring movie franchise here comparable in output to James Bond.

This deal can pay off for Disney in other ways as well. Although there are already Star Wars-themed attractions at Disney parks and some consumer product tie-ins, ownership could expand these opportunities further. Moreover, in-house distribution of movies should produce better economics, while Disney's capabilities should also enhance international revenue and expand the licensing possibilities. The deal for Lucasfilm could also be an opportunity to leverage more content across Disney's existing media assets. The "Star Wars: The Clone Wars" cartoon presently brings in more than a million viewers for Time Warner-owned (NYSE:TWX) Cartoon Network, and there has been discussion for many years of a live-action TV series based on Star Wars.

Lucas' comments in recent years about being tired (and/or retired) and disenchanted with the modern-day movie-making and marketing process suggested to me that a sale like this was a real possibility, and if Disney didn't step up, then Time Warner, Viacom (Nasdaq:VIA) or News Corp (Nasdaq:NWS) very likely would have.

The Bottom Line
There is certainly risk in this deal for Disney, but for all of the cynicism and jaded comments about the state of the Star Wars franchise, I suspect that a well-reviewed new movie will pack the theaters without much difficulty. Although it will take time, I think this deal will earn a good return for Disney over the long term. At the same time, this is a good example of how Disney leverages its strength and cashflows. While companies such as DreamWorks Animation (NYSE:DWA) have indeed done a good job of launching new media franchises such as Shrek and Kung Fu Panda, the financial wherewithal gives Disney the option to buy what it feels it needs to buy, and leverage that intellectual property (IP) across multiple money-making channels.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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