How Did Michael Eisner Make Disney Profitable?

April 18, 2005

by Edward Jay Epstein

The hollywood economist The numbers behind the industry.

How Did Michael Eisner Make Disney Profitable?
By Edward Jay Epstein
April 18, 2005

Q. "How's your wife?"
A. "Compared to what?"
—Henny Youngman routine

What is the proper measure of a Hollywood mogul? For entertainment reporters, it's often a mogul's personal behavior. The more incidents of arrogance and insensitivity they uncover, the more they assume that a mogul is an ineffective leader. Consider the recent frenzy of items about Michael Eisner, which ended in his announced resignation from Disney. It will be recalled that Eisner alienated a host of would-be moguls—including Jeffrey Katzenberg (whom he called a "midget"), Michael Ovitz (whom he called a "psychopath"), Roy Disney (whom he kicked off the board), and Harvey Weinstein (whom he forced out of Miramax). These men, by one means or another, yielded an El Dorado of gotcha items to the press. What was lost in this morality tale was the story of Eisner's transformation of Disney. He turned a faltering animation-and-amusement-park company into one of the world's most successful purveyors of home entertainment. If you look at Eisner's metrics—the numbers that Wall Street believes are unambiguous indicators of a company's performance—Disney boomed under Eisner.

Eisner's Metrics, which are all public numbers:
Category             1984            2004               Percent change
Disney's Revenues $1.5 bil.    $30.8 bil.          +2,000
Disney's Income     $294 mil. $4.49 bil.          +1,600
Tax-Free Cash Flow $100 mil. $2.9 bil.           +2,900
Stock Price             $1.33       $28.40             +2,100
Market Value           $1.9 bil.   $57.4 bil.           +3,000
Enterprise Value     $2.8 billion $69 bil.             +3,200

In 1984, when Eisner took command, the "Mouse House" produced only one animated picture every three to five years. Its entire film library had only 158 features, and its single cable channel, the Disney Channel, lost money. In addition, Disney had virtually no income from sales of videos. To keep afloat, the company depended on its amusement parks and its Mickey Mouse licensing. Yet even with these assets Disney had a tax-free cash flow of just $100 million. Its share price, reflecting this precarious financial position, was $1.33 (adjusted for splits).

In 2005, Disney was one of the richest companies in America. Its enterprise value—Wall street's favored measure of an entertainment company—had increased 32-fold since 1984 and stood at $69 billion. Its tax-free cash flow had increased 29 times, to $2.9 billion. Its film library had grown to 900 features, which were licensed on TV and sold on video and DVD, and its home-entertainment division accounted for nearly one-third of the revenues of the entire industry. Its share price, reflecting this robust health, had risen to $28.25.

Eisner's success becomes even more impressive when compared with his peers. Between 1984 and 2005, TimeWarner wrote off $99.7 billion; Vivendi-Universal, $40.6 billion; Viacom, $21.2 billion; News Corporation, $7.2 billion; and Sony, $2.7 billion. Among the six companies ("the sexopoly") that now dominate the TV industry, Disney alone did not write off any loss during this time.

How did Eisner succeed in adding $65 billion in enterprise value to Disney at a time when his rivals were faltering? Having come from television, Eisner saw that Disney's future would be in home entertainment—not in movie theaters.
Consider just two decisions he made that brought about this corporate transformation.

The first came in the mid-'80s. At the time, Disney studio executives (including Katzenberg) were arguing that to release the company's beloved animated movies on video cassette would kill any profits to be made from re-releasing them in theaters. Eisner perceived the situation differently, and he put the videos into stores. Within a few years, video sales were providing almost all the profits for Disney's movie division and, by 2004, Disney raked in $6 billion from videos and DVDs sales.

The second decision came in 1995, when Eisner bought his old alma mater, Capital Cities/ABC, for $19 billion. With this single coup, Disney got not only the ABC network and TV stations, it also got 80 percent of a sports network, ESPN. Since the cable operators needed this sports network to attract subscribers, Disney charged them a "carriage fee" just for the right to intercept its satellite signals. Disney was able to ratchet up this charge, which is effectively a tax on cable households, by 20 percent a year, getting as much as $2 a month for every subscriber signed up by cable operators.
With the success of ESPN, Disney gained such enormous leverage over the entire cable industry that, in 2004, the company earned a record $1.94 billion in bottom-line operating income from its cable channels alone. To put this number in perspective, it was nearly triple the $662 million Disney earned from all its movie production and distribution, stage plays, records and music publishing, television library sales, videos, and even its booming DVDs (which accounted for about 80 percent of the $662 million).

These numbers did not go unnoticed by the fund managers who controlled two-thirds of Disney shares. As it became increasingly clear that Eisner had hit the jackpot with ESPN, these fund managers focused more and more on Eisner's inability to convert the enormous appreciation of Disney's assets into a stock-market payoff. One way to bring about that payoff would be to install new management who were willing to sell assets—even ESPN. Although Disney's shares had increased by 10.6 percent since 2001—which was a better performance than most of Disney's rivals—that was not enough to satisfy investors. In March 2004, 43 percent of shareholders voted to withhold their support from Eisner. This vote further fueled the bad publicity, and Eisner picked Robert Iger to be his successor. Fittingly, Iger headed Disney television, and he should continue Disney's transformation into a home-entertainment empire.

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