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Walt Disney & Pixar

Disney should acquire Pixar at a purchase price of $7.4 billion, which is a fair price, in my
opinion for reasons provided below.

A decade after the tremendous success of Lion King in 1994, Disney now finds itself at a
crossroads. After Lion King, every movie had performed well below expectations for them in
terms of revenue. The qualities that once strengthened Disney had now become their weakness.
Disney was now overstaffed and incurring heavy salary expenditure. They were also reliant on
traditional animation methods, which meant they spent 80% of their income in paying the
animators for a method that took a long time to produce movies at an inflated budget. There
was no evidence that their latest release, Chicken Little, was going to provide them more than
a temporary relief from their declining fortunes. Moreover, animators salary had risen by
almost 4 times just in the space of five years. Rival animation studios now attempted to lure
creative talent away, which meant Disney had to keep paying exorbitant amounts as animator
salary. Disney suffered a loss of $158 million in 2001, which triggered a phase of cost
reduction, as pending projects were now getting postponed. Thus, it was clear that Disney
were struggling to keep up with the rising costs and increasing competition.

Pixar Incorporated is an extremely competent, successful and innovative animation studio run
by one of the most accomplished CEOs in corporate history. Steve Jobs made Pixar break away
from traditional animation technology and adapt 3D Computer Graphics technology. As the
technology was homegrown, Pixar had the proprietary rights to it. Also, by replacing hand-
drawings from hundreds of animators, Pixar was able to save time and money. Pixar was able
to produce much more aesthetically pleasing animated movies at a lower cost and faster than
its competitors. This CG technology is one of the biggest reasons why Disney should
acquire Pixar. With an acquisition, Disney can finally get their hands on this technology
and gain synergistic benefits.

Pixars success is evidenced by the tremendous Box Office performance that Disney could
achieve in partnership with them, as they grossed more than $350 million worldwide for each
of their movies. Pixars last movie mentioned in the case, The Incredibles, grossed $632 million
and their 6 movies raked in an average of $538 million. In comparison, the 15 movies that
Disney produced as standalone animators after the Lion King gave them an average of $220
million in revenue. Between 1998 and 2004, Pixar contributed to $3.5 billion to Disneys
revenues. These numbers provide a very compelling picture as to why Disney needs
Pixars expertise and efficiency. They have performed significantly well in collaboration
with Pixar.

The original co-production agreement struck-between Disney and Pixar was heavily favourable
to Disney. Disney would split production costs equally with Pixar, but Pixar would get its share
of revenue only after accounting for the marketing expenses and the distribution fee payable to
Disney. The distribution fee was set at 12.5%, which was considerably higher than the industry
average, again favouring Disney. Furthermore, Pixar had no share in revenue from theme parks
and location-based entertainment. Disney also retained exclusive distribution rights for the
movies, which means that if Pixar wanted to break away from Disney and make sequels, they
had to pay a licensing fee to Disney. This deal was struck when Pixar was not in a position of
power, and Disney was an established giant in the industry. But over the course of the next
decade, Pixar brought a lot of attributes to the table that they could now use as a bargaining
chip for negotiations. The Disney-Pixar partnership reached a breaking point at the time of
release of Cars. As Pixar attempted to gain some controlling rights to the movies, they
received significant pushback from Disney. This ultimately resulted in Pixar walking away
from the partnership and looking for new suitors. Disney needs to realise that it can no longer
partner with Pixar on their own terms, as Pixar now deservedly commanded a fairer
share. If they want to control Pixar, they must acquire them and perhaps even a pay a
premium to achieve the acquisition.

Another key reason why Disney should acquire Pixar at a premium is Pixars unique ability to
merge creative storytelling with superior technical knowhow. Many other competitors tried to
replicate Pixars success, but they simply couldnt. This was because they didnt possess
Pixars creative or technical talent and internally developed resources. The company culture at
Pixar also contributed to their success. They didnt just hire talented people, but also made sure
that they were the right fit for the company. As the case best states, a team can be extremely
talented and yet be the most dysfunctional group on the planet. Pixar treated their animators as
actors, as they would be the one bringing the story to life. They encouraged freedom to
communicate and an open exchange of ideas among their employees. They also created an
environment where employees can freely offer ideas without feeling threatened. They vowed
to stay close to the innovations in the industry, by establishing Pixar University. This was very
important to Pixar, as innovative excellence was a cornerstone of their success. These factors
resulted in a culture that was extremely professional and highly effective. Above all else,
this company culture was needed at Disney, and makes a solid argument for the

Disney had to fend off competition from the likes of Fox, Sony, Lucasfilm, Dreamworks,
MGM, Universal and Paramount. With Pixar at their side, Disney can gain an upper hand
against their competition, and continue to dominate as industry leaders. As CG technology
developed, the competition has become a lot fiercer. Even start-up animation studios now
produced award-winning movies. Their most formidable rival was Dreamworks. With former
Disney head Katzenberg, Dreamworks produced shock hits such as Shrek, Madagascar, Shrek
2 which appealed to a wider demographic than Disney movies. This competition had started
to limit Disneys options and it should now seriously consider an acquisition of Pixar if
they want to stay relevant in the animation industry.

Disneys new head, Robert Iger obviously knew that Disneys relationship with Pixar needed
to continue. The acquisition would be a good strategic move and give synergistic benefits to
both companies. Disney could leverage Pixars superior animation technology and storytelling,
and Pixar could benefit from Disneys stream of ancillary revenue of amusement parks and
merchandising. There are some potential pitfalls, such as a mismatch of culture and Steve Jobs
strong personality creating animosity among the board of directors. But these potential pitfalls
outweigh the potential advantages. Both companies could achieve a lot more together if
they work for the same set of shareholders, to achieve a common objective.

According to Investment Banking experts, the price that Disney could have to pay to acquire
Pixar ranged from $6.5 billion to $7.4 billion. The exchange ratio of shares was expected to be
2.3 : 1. Given Pixars strong position in negotiations, they will likely demand a price that is
closer to $7.4 billion. Pixars projected P/E ratio was 46, and Disneys was 30. This does not
necessarily mean that this is a bad and expensive deal for Disney. A company with a higher
P/E can also grow earnings and revenue at a faster rate, and therefore command a higher price
for this potential of future higher earnings. Pixar is commanding this higher price on the
evidence of past performance and the exponential growth potential. Yes, Disney can make 65
sequels at that price, but those sequels would be unsuccessful without Pixars creative and
technological touch. The concerns over the talent exodus are also, in my opinion, a problem
that is manageable. Given the aforementioned company culture at Pixar, it has hard to imagine
that a consolidation would make them give up the positive and open work environment. If the
acquisition is managed with care and attention to detail, the possibilities for both companies
are endless.