Mini-Case 11



Minicase 24

Planning New Magic at Disney

After its success domestically, the Walt Disney Company (Disney) decided to share its magic with the rest of the world. Euro Disneyland would introduce to Europe a theme park and resort concept that Disney had developed -- and seemingly perfected -- in the United States and Japan over the preceding 35 years. Disney devised a complex financing structure for the Euro Disneyland Project. At the time it was arranged, the financing for the project was viewed as innovative. One article praised the structure and commented that Disney had applied all the lessons it had learned from its earlier three theme parks in California, Florida, and Tokyo. It seemed that Disney was well on its way to a huge success even before it had begun construction.

Project Description

Disney planned to build Euro Disneyland on approximately 4,800 acres of land located 32 kilometers due east of Paris. Disney chose this site based on availability, communications, and proximity to potential customers after considering more than 200 possible sites in France and Spain. Approximately 17 million people lived within a two-hour drive. More than 100 million lived within a six-hour drive. About half of the developable land, 2,115 acres, would be devoted to entertainment and resort facilities. Another 1,994 acres would be set aside for retail, commercial, industrial, and residential purposes. The balance of 691 acres would be used for regional and primary infrastructure, such as roads and railway tracks.

Upon completion, Euro Disneyland would be the largest theme park and resort development in Europe. It would be ideally situated at the hub of a vast transportation network. Euro Disneyland would be linked to Paris by the RER (regional express metro) suburban railroad system. It would be linked to the rest of France and Europe by the A4 motorway and by the high-speed train à grande vitesse (TGV) railroad network.

The project would feature two separate theme parks, which would be built in phases. Phase I would include the Magic Kingdom theme park to be followed by other facilities that would open within the next two years. Phase II would include a second theme park. Disney planned to build a comprehensive resort facility containing more than 20 hotels, six of which would be ready by the time the Magic Kingdom opened.

Disney

Disney is a diversified, international entertainment firm whose operations consist of three principal segments: theme parks and resorts, filmed entertainment, and consumer products. Disney is acknowledged as the world's leading theme park operator.

Disney management had set a 20% growth target for the firm. Expansion of the theme park operations was an integral part of Disney's strategy for achieving this target. With a well-penetrated American market, Disney realized that international expansion was crucial. The first international expansion took place when the Tokyo Disneyland theme park opened. The success of this project prompted Disney to explore other international opportunities. Europe seemed to be an ideal site because of the development of the European Union.

Project Ownership Structure

The original plan called for Disney to build, own, and operate the Euro Disneyland project in a similar manner to which it operated Walt Disney World (Disney's Florida theme park) and Disneyland in southern California. This ownership arrangement would ensure Disney 100% of the future earnings potential of the park. While this ownership structure would enable Disney to retain 100% of the upside potential, it would also leave Disney with 100% of the risks inherent in such a tremendous financial undertaking.

Disney subsequently set in motion a series of transactions that altered the ownership, management, financing, and control of the Euro Disneyland project. Exhibit 24-1 illustrates the resulting ownership structure, which reduced Disney's equity interest in the project to 49%. The transactions that led to this structure included an initial public offering (IPO) of common stock by the main project firm, which had never earned any revenues.

Project Financing

The project financing transactions Disney initiated transformed Euro Disneyland from an internally financed, privately owned project into a highly leveraged, publicly owned entity in which Disney would hold only a minority interest. However, in spite of its minority interest in the equity of the project, Disney would control the construction and operation of the theme park and also have the right to own and control the development of the hotels and other real estate.

The project financing would introduce many additional stakeholders into the Euro Disneyland Project through a two-stage process. The first stage would involve a private placement of common shares and debt securities called Obligations Remboursables en Actions (ORAs) to four investor banks and EDL Holding. EDL Holding would serve as the shareholder of record for Disney's 49% stake in the new company. The second stage of this process involved EDSCA's IPO. The IPO would result in 50.5% of the shares being sold to the investing public. (The remaining 0.5% would be retained by the four investor banks that had provided part of the initial outside financing for the project.)

The first phase of the Euro Disneyland project initially had a projected capital cost of FF14 billion. The projected sources of these funds, in millions of French francs, are shown in Exhibit 24-2.

Leverage

Exhibit 24-3 provides a pro forma balance sheet for EDSCA. Assuming the exercise of the outstanding options and warrants and a successful IPO, equity would amount to FF6,577,984,000, and EDSCA's debt-to-equity ratio would be approximately 41%. However, Disney projected that the debt-to-equity ratio would subsequently increase to approximately 200% just prior to completion of the first phase of the project. Disney felt that the project could support this much debt because it expected to sell the project's hotel real estate at a substantial profit and use the proceeds to pay down debt.

The Initial Public Offering

EDSCA went public in one of the largest IPOs of common stock by a company that had no operating history. The IPO was successful. The shares were offered at FF72 each (£7.07 each in the United Kingdom). The net proceeds of FF5.73 billion were used to repay debt, including FF1.9 billion of project development loans extended by Disney to fund construction costs. Approximately 86 million shares were offered but within three days, total demand reached 10 times that. The shares were listed for trading on the Brussels, London, and Paris Stock Exchanges.

Exhibit 24-4 provides financial projections for the first five years of the project’s life. Prepare a set of projections for the project for the following 20 years (years 6 to 25) and use them to analyze the project's profitability.

Questions

1. Using the format of Exhibit 24-4 as a guide, project the net profit for the following 20 years (years 6 to 25) based on the following assumptions:

• Each class of revenue after year 5 grows at a 5% annual rate.

• Each class of operating expenses after year 5 grows at a 5% annual rate.

• In other expenses (income), royalties equal 5% of total revenues.

• In other expenses (income), preopening amortization is zero after year 5.

• Annual depreciation, annual interest expense, annual interest and other income, and annual lease expense are constant after year 5.

• Management incentive fees grow at a 7.5% annual rate.

• Euro Disneyland’s income tax rate is 42%.

2. Calculate the present value of Euro Disneyland's equity at time 0 (when the park opens) and at time –3 (the time of the IPO, three years before the opening). Make the following assumptions:

• Dividends are 75% of net profit for years 1 to 25.

• At the end of year 25, the terminal value of equity is worth 10 times the year’s net profit.

• Euro Disneyland’s cost of equity capital is 15%.

3. Recalculate the value for Euro Disneyland estimated at time –3 for two cases where the assumptions are changed to the following:

a. Revenues after year 5 grow at 6% and operating expenses grow at 5%.

b. Revenues after year 5 grow at 5% and operating expenses grow at 6%.

EXHIBIT 24-1

Ownership Structure for the Euro Disneyland Project

[pic]

EXHIBIT 24-2

Sources of Funds to Pay the Projected Capital Cost

(Millions of French Francs)

EDSNC EDSCA Total

_______________________________________________________________________

Bank loans FF 4,300 FF 200 FF 4,500

Government loans 3,000 1,800 4,800

EDSNC equity 2,000 - 2,000

EDSCA equity 1,000a 1,700 2,700

Total FF 10,300 FF 3,700 FF 14,000

___________________________

a EDSCA invested this amount in EDSNC.

EXHIBIT 24-3

Pro Forma Balance Sheet of EDSCA

(Thousands of French Francs)

| | |Pro Forma |

| |Assets | |

| |Intangible assets |FF 8,644 |

| |Tangible assets |475,630 |

| |Deposits | 4,232 |

| | Total fixed assets |488,506 |

| |Construction in progress |1,748,653 |

| |Current assets: | |

| | Accounts receivable |761,994 |

| | Cash and investments |5,560,133 |

| | Total current assets |6,322,127 |

| |Deferred charges | 710,460 |

| |Total Assets |FF 9,269,746 |

| | | |

| |Liabilities and Equity | |

| |Share capital |FF 1,700,000 |

| |Share premium |4,870,675 |

| |Accumulated losses |(24) |

| |Current period net income | 7,333 |

| | Subtotal |6,577,984 |

| |ORAs and warrants |0 |

| |Deferred taxes |4,688 |

| |Current liabilities | |

| |Payable to Euro Disneyland S.A. |1,908,567 |

| |Other accounts payable | 537,124 |

| | Total current liabilities |2,445,691 |

| |Deferred revenues | 241,383 |

| |Total Liabilities and Equity |FF 9,269,746 |

EXHIBIT 24-4

Financial Projections for Euro Disneyland

(Millions of French Francs)

|Year |1 | |2 | |3 | |4 | |5 |

|Revenues: | | | | | | | | | |

| Magic Kingdoma |FF4,246 | |FF4,657 | |FF5,384 | |FF5,853 | |FF6,415 |

| Second theme park |0 | |0 | |0 | |0 | |3,128 |

| Resort and property development |1,236 | |2,144 | |3,520 | |5,077 | |6,386 |

|Total revenues |5,482 | |6,801 | |8,904 | |10,930 | |15,929 |

|Operating expenses: | | | | | | | | | |

| Magic Kingdom |2,643 | |2,836 | |3,161 | |3,370 | |3,641 |

| Second theme park |0 | |0 | |0 | |0 | |1,794 |

| Resort and property development |796 | |1,501 | |2,431 | |2,970 | |3,694 |

|Total operating expenses |3,439 | |4,337 | |5,592 | |6,340 | |9,129 |

|Operating income |2,043 | |2,464 | |3,312 | |4,590 | |6,800 |

|Other expenses (income): | | | | | | | | | |

| Royalties |302 | |333 | |387 | |422 | |717 |

| Preopening amortization |341 | |341 | |341 | |341 | |341 |

| Depreciation |255 | |263 | |290 | |296 | |625 |

| Interest expense |567 | |575 | |757 | |708 | |1,166 |

| Interest and other income |(786) | |(788) | |(768) | |(778) | |(790) |

| Lease expense |958 | |950 | |958 | |962 | |975 |

| Management incentive fees |55 | |171 | |477 | |963 | |1,820 |

|Total other expenses (income) |1,692 | |1,845 | |2,442 | |2,914 | |4,854 |

|Profit before taxation |351 | |619 | |870 | |1,676 | |1,946 |

|Taxation |147 | |260 | |366 | |704 | |818 |

| Net profit |FF204 | |FF359 | |FF504 | |FF972 | |FF1,128 |

__________________________

aIncludes the Magic Kingdom Hotel.

Source: Euro Disneyland S.C.A., Offer for Sale of 10,691,000 Shares.

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