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THE PENNSYLVANIA STATE UNIVERSITY SCHREYER HONORS COLLEGE DEPARTMENT OF ECONOMICS AN ACCRETION / DILUTION ANALYSIS OF THE WALT DISNEY COMPANY’S ACQUISITION OF TWENTY-FIRST CENTURY FOX, INC. VICTORIA A. ARNOLD SPRING 2020 A thesis submitted in partial fulfillment of the requirements for baccalaureate degrees in Economics and Finance with honors in Economics Reviewed and approved* by the following: Joris Pinkse Professor of Economics Thesis Supervisor Russell P. Chuderewicz Senior Lecturer of Economics Honors Adviser * Electronic approvals are on file. i ABSTRACT The purpose of this thesis is to analyze The Walt Disney Company’s acquisition of the various assets of 21st Century Fox, and the subsequent spinoff of the rest of Fox’s assets. More specifically, the thesis will determine the specific operating scenarios in which Disney will achieve an accretive or a dilutive outcome. In order to achieve these results, I will complete a detailed accretion/dilution analysis through various financial modeling techniques. The numerous operating cases tested in this analysis will be determined by the synergies associated with the transaction, which will be subject to my discretion after the completion of in-depth research on the two companies, the industry, the macroeconomy, the overall financial market, etc. I hypothesize that accretion will occur in this acquisition when Disney incurs moderate revenue synergies and significant cost synergies. In addition, I hypothesize that movie ticket prices will increase in the years following the acquisition, on top of a decreased movie output by the combined entity. ii TABLE OF CONTENTS LIST OF FIGURES ..................................................................................................... iv ACKNOWLEDGEMENTS ......................................................................................... v Chapter 1 Overview ..................................................................................................... 1 A. Brief History of The Walt Disney Co. ........................................................................ 2 B. Brief History of Twenty-First Century Fox, Inc. ......................................................... 4 Chapter 2 Competitive Landscape ............................................................................... 5 A. Industry Overview ....................................................................................................... 5 B. Key Competitors .......................................................................................................... 5 Chapter 3 Review of M&A Activity ............................................................................ 9 A. Motives for M&A Activity ......................................................................................... 9 I. Strategic Motives .................................................................................................. 9 II. Financial Motives ................................................................................................ 10 III. The Walt Disney Company - 21st Century Fox, Inc. ......................................... 11 B. Determining the Acquisition Price .............................................................................. 11 I. Valuation Methods ................................................................................................ 12 II. Additional Risks to Consider ............................................................................... 15 Chapter 4 Strategic Review ......................................................................................... 18 Chapter 5 Review of Deal Timeline and Structure ...................................................... 20 A. Timeline of Events Leading to Acquisition ................................................................ 20 B. Share Price Performance of Disney and Fox ............................................................... 22 C. Deal Structure .............................................................................................................. 23 Chapter 6 Methodology ............................................................................................... 25 A. Overarching Model Assumptions ................................................................................ 25 B. Disney Operating Model Assumptions........................................................................ 26 C. 21st Century Fox Operating Model Assumptions ....................................................... 29 D. Transaction Assumptions ............................................................................................ 31 E. Case Methodology ....................................................................................................... 32 F. Case Analysis ............................................................................................................... 34 Chapter 7 Impact on Entertainment Industry ............................................................... 36 A. Oligopolistic Competition ........................................................................................... 36 B. Licensing Contracts between Theaters and Film Distributors ..................................... 39 iii C. Negotiating Power of Film Distributors ...................................................................... 40 D. Antitrust Regulation & Consumer Welfare ................................................................. 43 I. Overview of Antitrust Policy ................................................................................ 43 II. History of Antitrust Legislation in the United States .......................................... 44 III. Current Antitrust Regulation .............................................................................. 45 IV. Termination of the Paramount Consent Decrees................................................ 52 Chapter 8 Conclusion ................................................................................................... 55 BIBLIOGRAPHY ........................................................................................................ 58 ACADEMIC VITA ...................................................................................................... 62 iv LIST OF FIGURES Figure 1. Key Transaction Information .................................................................................... 1 Figure 2. Overview of Disney’s M&A Activity ..................................................................... 3 Figure 3. Percent Change in Stock Prices from First Rumor to Close of Acquisition ............. 23 Figure 4. Disney Inputs ............................................................................................................ 26 Figure 5. Fox Inputs ................................................................................................................. 26 Figure 6. Disney Income Statement ......................................................................................... 27 Figure 7. Disney Balance Sheet ............................................................................................... 28 Figure 8. Disney Statement of Cash Flows .............................................................................. 28 Figure 9. Fox Income Statement .............................................................................................. 29 Figure 10. Fox Balance Sheet .................................................................................................. 30 Figure 11. Fox Statement of Cash Flows ................................................................................. 30 Figure 12. Sources & Uses of Funds ........................................................................................ 31 Figure 13. Creation of New Goodwill ..................................................................................... 32 Figure 14. Pro-Forma Balance Sheet ....................................................................................... 32 Figure 15. Pro-Forma Income Statement ................................................................................. 33 Figure 16. Synergy Cases ........................................................................................................ 34 Figure 17. Accretion / Dilution Cases ($) ................................................................................ 35 Figure 18. Accretion / Dilution Cases (%) ............................................................................... 35 Figure 19. Combined Market Share of the “Big Six” Film Distributors in the United States 38 Figure 20. Distribution of Market Share by the “Big Six” Film Distributors ......................... 38 Figure 21. Annual Attendance at Sundance Film Festival ...................................................... 39 Figure 22. Distribution of Market Share by the “Big Six” Film Distributors, Assuming Disney Acquired Fox in the Terminal Year ................................................................................ 43 Figure 23. Average North American Movie Ticket Prices, Adjusted for Inflation and Pegged to 2019 Prices ...................................................................................................................... 49 v ACKNOWLEDGEMENTS I would like to thank Dr. Pinkse and Dr. Tybout for their support and guidance throughout this process. I would also like to thank Dr. Woolridge for his continued support throughout my career at Penn State and for believing in me from the beginning.