Disney’s Marvel acquisition: a strategic financial analysis

The Finance University under the Government of The Russian Federation

(The Finance University)

 

International Finance Faculty

 

 

 

 

 

Review on article:

«Disney’s Marvel acquisition: a strategic financial analysis»

 

 

 

Made by:

Student of IFF 1-1m

Yury Tyurbeev

 

Research Advidor:

Alexandra V. Akhmetchina

 

 

 

 

Moscow 2013 

Article review

Disney’s Marvel acquisition: a strategic financial analysis

Joseph Calandro Jr

As you probably know, in August 31, 2009 Disney company announced its acquisition of Marvel Entertainment, Inc. From my point of view the main idea of this article is to check fairness and adequacy of price paid by Disney for Marvel. So, the instrument which the author used to check price is making a business valuation of Marvel company on the date of acquisition by himself.

First of all, the author remind us about three popular approaches used in pricing the acquisitions. They are discounted cash flow, multiple based valuation and comparables. In this case I need to tell that three main approaches exist in business valuation: income approach, market approach and cost approach. So, the approaches mentioned by author are not approaches, they are methods within generally recognized approaches. So, discounted cash flow method is a method within income approach, multiple based and comparables valuations are within market approach. Hereinafter Joseph Calandro Jr describes drawbacks of three methods mentioned above, which connect with inability this methods to adequately reflect strategic plans of acquirer (Disney). I’d like to object to author’s opinion, because I think that at least one method (discounted cash flow method) can include all the strategic plans and potential synergies from the acquisition if the DCF model will be constructed correctly and under reliable assumptions.

Since the author emphasized limitation of three method of business valuation, he decided to use alternative approach, the modern Graham and Dodd method, which is employed by outstandingly successful investors like Warren Buffett. On this moment I’d like to tell you that this point was a reason why I chose this article. I was interested in new Graham and Dodd method for me and wanted to know more about it.

After the reading article and some supplementary materials concerning Graham and Dodd method of business valuation I can shortly determine key points of this method. This valuation method is based on four-level value continuum. The first level is net asset value, which is derived by adjusting the balance sheet on a reproduction basis. Earnings power value is the next level, which is derived by estimating a level of past earnings that is sustainable into perpetuity. Most of the time, earnings power will relatively reconcile asset value, which is indicative of the base case value profile. When earnings power significantly exceeds asset value it reflects the existence of a possible franchise, which the Graham and Dodd approach defines as a sustainable competitive advantage. Growth is the final level of value. The G&D approach focuses on determining a price that contains a reasonable margin of safety, or discount from estimated value.

So, let’s consider valuation process step by step. The first is determining net asset value. Net asset value is the value of an entity’s assets less of its liabilities. Net asset value or net asset method is one of the methods within cost approach of business valuation. Of course, it is not simple process subtracting liabilities from assets value of the company. Before we can calculate net asset value we need to make some adjustments to balance sheet classes, e.g. to accounts receivables, accounts payables, some accruals, fixed assets and so on. The author of the article made these adjustments and obtained the result of $424 million, which is only slightly more than 10 percent of the $4 billion deal price.

The second level of value along modern Graham and Dodd value continuum is earnings power value (EPV), which for Marvel amounted to $1.7 billion or four times the NAV. The process of calculating EPV consists in normalizing income statement of the target’s income statement for the latest five years. The main idea of this normalizing process is obtaining sustainable measure of cash flow into perpetuity. Additionally we need to make some adjustments to several lines of expenses, such as depreciation & amortization, overhead or pension expenses.

The difference between EPV and NAV gives Marvel a franchise value of $1.3 billion, which indicates the possible existence of franchise. The next step of valuation process is to validate the value. To do this author determines the activity of Marvel company. Marvel’s franchise consists of its portfolio of characters, which generates relatively strong cash flow from loyal customers and are protected by various intellectual-laws. The portfolio includes such well-known characters as Spider-man, X-men, Avengers, Iron man, Hulk, Thor and so on. For example, if someone wanted to make a movie about any one of Marvel’s characters they must first obtain Marvel’s permission to do so, and then pay royalties for the privilege. This combination of customer attachment and legal protections makes Marvel a vigorous and secure franchise. One important point remains to mention. In recent years before the acquisition Marvel decided to make films about its characters itself. This activity resulted in huge earnings obtained from Iron man and the Hulk filmizations.

Nevertheless, the business valuation analysis determined that Disney paid a premium (growth value) over EPV of $2.3 billion or 57% of deal price. The author’s calculation assumes reinvestment rate of 21.3%, which is definitely aggressive assumption. From the point of author’s view, the price paid for Marvel is too high, because the growth component of value is very big and it doesn’t contain a margin of safety.

So, Disney’s $4 billion acquisition price is highly sensitive to reinvestment rate assumptions. At the same time Marvel as a company have some risks. Joseph Calandro selected intellectual property and earnings power risks. The first is the risk of Marvel’s intellectual property protections expiring. A second risk arises because some of Marvel’s best known characters are contractually obligated to other studios. For example, Spider-man to Sony, and X-men to 20 Century Fox. And the third , the earnings power of Marvel’s lesser known characters is unknown and therefore risky. In conclusion of article, Joseph noted the importance of Disney’s risk-management over Marvel’s potential issues.

Today, from the point of 2013, we can confirm that Disney’s Marvel acquisition is definitely fortune investment. For the last three years Marvel earned $1.5 billion on the Avengers, $1.2 billion on Iron Man triquel in 2012 and 2013. Now in theatres is shown the sequel of Thor. And on the moment of article’s review writing this film earned $0.5 billion. And all this revenue was earned only on the films. As you know Marvel raises money on its comics, some royalties, toys and etc.

In final part of the review, I’d like to focus your attention of usefulness of Graham and Dodd method of valuation. In all fairness it has to be added that it is not new approach of business valuation. It’s some kind of new method, which combines some elements of three main approaches. Net asset value pertains to cost approach, Earnings power value is connected with income approach. In spite of this fact the method is really useful. I agree with author’s opinion that Graham and Dodd approach facilitates greater levels of insight into key deal assumption, value drivers, risks, and post-acquisition strategies. As an illustration of the utility of this method I want to represent one of the graphs used in the article:

I think this picture above confirm clarity of this method. In the result of analysis the target’s price was divided by three components: the value of target’s assets, the value of target’s future earnings as a stand-alone company and the main growth value. Growth value is the premium the acquirer paid for future growth opportunities and potential synergies. As the deal of purchasing Marvel by Disney is definitely strategic acquisition the Graham and Dodd method is absolutely applicable to the valuation of this deal price.