Mickey Vs Mario: Buffett’s Omission Mistake in Disney and Any Magic Character Innovators in Asia? – Bamboo Innovator Weekly Insight
July 20, 2015 Leave a comment
|“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”|
|BAMBOO LETTER UPDATE | July 20, 2015|
|Bamboo Innovator Insight (Issue 92)
Mickey Vs Mario: Buffett’s Omission Mistake in Disney and Any Magic Character Innovators in Asia?
Walt Disney: “I only hope that we never lose sight of one thing – that it was all started by a mouse.”
Nintendo’s Shigeru Miyamoto, creator of the character Super Mario: “Since we first created Mario, people have compared him to Mickey Mouse. I’ve always said Mickey Mouse evolved with each evolution in animation. From early on, I wanted Mario to be that character in the digital world, so that with each digital evolution, he was there to usher in the next era.”
Buffett: “Well, I made a terrible mistake. We owned a chunk of Cap Cities/ABC and merged with us and we kept the Disney stock for a while and then we sold it. That was before Iger took over. We probably shouldn’t have sold Cap Cities/ABC because ESPN – we owned 80 percent of ESPN and that of course has been the home run asset of all time.. Bob Iger is a home run hitter. I mean he is really, really good. And he’s a great guy on top of that.”
Buffett: “We bought 5% of the Walt Disney Company in 1966. It cost us $4 million dollars. $80 million bucks was the valuation of the whole thing. 300 and some acres in Anaheim. The Pirate’s ride had just been put in. It cost $17 million bucks. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in….in 1966 they had 220 pictures of one sort or another. They wrote them all down to zero – there were no residual values placed on the value of any Disney picture up through the ‘60s. So for $80 million bucks, and you got Walt Disney to work for you. It was incredible. You didn’t have to be a genius to know that the Walt Disney company was worth more than $80 million. And the reason was, in 1966 people said, ‘Well, Mary Poppins is terrific this year, but they’re not going to have another Mary Poppins next year, so the earnings will be down.’ I don’t care if the earnings are down like that. You know you’ve still got Mary Poppins to throw out in seven more years…I mean there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time…I went out to see Walt Disney (he’d never heard of me; I was 35 years old). We sat down and he told me the whole plan for the company – he couldn’t have been a nicer guy. It was a joke. If he’d privately gone to some huge venture capitalist, or some major American corporation, if he’d been a private company, and said ‘I want you to buy into this’…they would have bought in based on a valuation of $300 or $400 million dollars. The very fact that it was just sitting there in the market every day convinced people that $80 million was an appropriate valuation. Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street.”
Warren Buffett missed holding on to and sold out his investment in Disney (DIS, MV $201bn) – twice.
What are the important timeless investment lessons that value investors can learn from Buffett’s candid and wise admission of his omission mistake in Disney so as to identify and evaluate the scalability and sustainability of character-based or content business models? In Asia, Nintendo (7974 JP, MV $24.3bn)’s Super Mario and Sanrio (8136 JP, MV $2.5bn)’s Hello Kitty immediately comes to mind as the “Disney of Asia” with their popular characters, including the unlisted publishing giant Hitotsubashi Group-Shogakukan’s bluish robot cat character Doraemon controlled by the secretive Ōga family. Besides Nintendo and Sanrio, are there overlooked character innovators in Asia who have the potential to globalize their characters?
Character-based or content business model is able to reaps gains from the same intangible character asset over and over again and with profit multiplier effect as the character is leveraged into weaving products (merchandise, games) and services (theme parks, movies) around the character. However, the very strength of the intangible character asset is also its biggest weakness as the business model suffers blowup risks when this core key asset becomes stale from neglect, complacency and underinvestment.
First up was in 1966 when Buffett used a sum-of-the-parts (SOTP) valuation analysis to evaluate Disney’s intrinsic value. Disney was assessed to be undervalued at $80m with its hidden assets in the library of 220 films in the vault, the emergent growth of the theme park business with 300 acres in Orange county where the Anaheim park attracted 9 million customers a year, and an innovative owner-operator in Walt Disney running the place. Importantly, Buffett did not commit the common serious mistake made by SOTP in being overly obsessed with the hidden asset value and overlooking the more important aspect of the core content-character business driving Disney’s earnings. While the consensus view the Disney characters, such as “Mary Poppins” that was created in the musical fantasy film which was widely considered to be one of the greatest films of all time and Walt Disney’s “crowning achievement”, as unsustainable in generating blockbuster-like earnings year after year, Buffett believe these characters can be shown to kids the same age seven years later, and that they are “like having an oil well where all the oil seeps back in” and that “you get a new crop every seven years and you get to charge more each time”. Classics such as Sleeping Beauty and Cinderella are still refreshed, remade and retold since they were created more than 60 years ago, reinforcing merchandise and theme park sales and the brand equity of the Magic Kingdom. However, Buffett was eager to prove his worth to his clients and did not wait till seven years to realize his Disney crop. Buffett sold the stock a year later after it climbed 50% from his investment of $4m for a 5% stake, now worth over $10bn.
Second was nearly 30 years later when Buffett’s 1979 investment in Tom Murphy-Dan Burke’s Capital Cities-ABC was acquired for $19bn by Disney in 1995. Buffett got his payment in Disney shares. At the news conference announcing the deal, Buffett sat on the dais with Disney Chairman Michael Eisner and Cap Cities/ABC Chairman Thomas Murphy, and said: “This deal makes more sense than any other deal I have seen except for the  Cap Cities and ABC deal. It is a merger of the No. 1 content company [Disney] with the No. 1 distribution company [ABC].” Buffett sold off his Disney shares which went on to compound over 500%.
Why did Buffett sell off his Disney shares for the second time? The decision appears to have something to do with his assessment of the management, “before Iger took over” in 2005. The long-running legal battle in removing Disney president Michael Ovitz in 1996 had resulted in an extraordinary statement in 2006 by the chief judge of the Delaware Chancery Court who wrote that Eisner had “enthroned himself as the omnipotent and infallible monarch of his personal Magic Kingdom” and described Eisner’s behavior as falling “far short of what shareholders expect and demand from those entrusted with a fiduciary position.” The deterioration in the management quality culminated in 2003 when Roy E. Disney, the son of Disney co-founder Roy O. Disney and nephew of Walt Disney, resigned from his positions as Disney vice chairman and chairman of Walt Disney Feature Animation. His reason for resigning was his feeling that there was too much micromanagement within the studio, flops with the ABC television network, the company’s growing timidity in the theme park business, Eisner’s refusal to establish a clear succession plan, the studio releasing a string of box-office movie flops starting in the year 2000, and the Walt Disney Company turning into a “rapacious, soul-less” company.
When the key intangible asset that drives the profit-multiplier business model becomes stale, all the tangible pieces and financial numbers in the Magic Kingdom from merchandise, movies and theme parks start crumbling off, just like Cinderella reduced back to her rags when the spell wears off after midnight. Who could have faulted Buffett for selling off Disney shares for the second time to get off the Cinderella ride before midnight?
So how can value investors better assess the management quality and culture that nurture and harness the profit-multiplier power of the fragile intangible character asset? We like to recap what we wrote in our 23 March 2015 article “The Physics of Music and the Asian Innovators”:
“In our years of interacting and observing entrepreneurs and managers in Asia, we find that there seemed to be two kinds: some who would look for flaws in ideas and people, and then pounce to kill them; and others who started from a place of seeking and promoting good, new and original ideas and people. When the “idea and people promoter” saw flaws, they pointed them out gently, in the spirit of improving them – not eviscerating them. The “idea and people killer” were not aware that they were serving some other agenda, which was often to show others how high their standards are. The innovators understand the difficult, ephemeral process of developing the new. The innovators understand that looking beyond the pretty and rigorous checklist for something original, authentic, something surprising and unproven, are necessary for genuine value creation – and must be a conscious effort.
We also want to observe that the corporate culture are NOT infested with the kind of people that populated Disney in the late 1970s as remarked by Pixar’s founder Ed Catmull in his inspiring and thought-provoking book Creativity, Inc.: Overcoming the Unseen Forces That Stand in the Way of True Inspiration:
“Unbeknownst to me, soon after our meeting at Lucasfilm, John Lasseter would lose his job at Disney. Apparently, his supervisors felt that The Brave Little Toaster was – like him – a little too avant-garde. They listened to his pitch and, immediately afterward, fired him. What John hadn’t realized when he joined Disney Animation, however, was that the studio was going through a rough, fallow period. The animation there had plateaued much earlier – no significant technical advances had been made since 1961’s 101 Dalmatians, and many of its young, talented animators had left the studio, reacting in part to an increasingly hierarchical culture that didn’t value their ideas. When John arrived in 1979, Frank Thomas, Ollie Johnston, and the rest of the Nine Old Men were getting up in years – the youngest was 65 – and had stepped away from day-to-day business of moviemaking, leaving the studio in the hands of a group of lesser artists who had been waiting in the wings for decades. These men felt in was their turn to be in charge but were so insecure about their standing within the company that they clung to their newfound status by stifling – not encouraging – younger talents. Not only were they not interested in the ideas of their fledgling animators, they exercised a sort of punitive power. They were seemingly determined that those beneath them not rise in the ranks any faster than they already had.”
We think this lesson from Disney is poignant for Asia which is at a critical transition phase in succession risk (and opportunity) with the patriarchs and matriarchs handing over the reins of their business empires to the right capital allocators, whether to their heirs or professional managers. Many of the Asian successors are like Disney’s highly experienced and well-qualified men-in-charge in the late 1970s.
Above all, we think a corporate culture focused on KPIs is downright unhealthy as it results in gaming of the performance measurement system and distances people from creating an idea larger than oneself that can involve co-creators in the value creation process.”
The culture to foster – and limit! – innovators can be seen in Nintendo when it hired a student product developer named Shigeru Miyamoto in 1977.
Read more about the stories of the trials and tribulations of Nintendo and Shintaro Tsuji’s Sanrio
at the Moat Report Asia: http://www.moatreport.com/updates/
Value investors will do well in character-content business model by assessing the goodness of the dream, the willingness of the leaders to love the drudgery it involves and not take short-cuts and engage in complex opportunistic financial engineering activities to generate short-term profits that lead to the festering of long-term problems and impairments down the road.
Commitment, attitude, care and dedication have much more to do with character than pay and perks. At the center of character are dreams for life and work. Behind the rational, practical-minded efforts in building a “business”, the Bamboo Innovators like Walt Disney, Yamauchi-Iwata-Miyamoto and Shintaro Tsuji are pursuing their dreams. Walt Disney’s dream popped out from a mouse character to reflect and reveal the human in us in a perturbed world:
“Mickey Mouse popped out of my mind onto a drawing pad 20 years ago on a train ride from Manhattan to Hollywood at a time when business fortunes of my brother Roy and myself were at lowest ebb and disaster seemed right around the corner. We have created characters and animated them in the dimension of depth, revealing through them to our perturbed world that the things we have in common far outnumber and outweigh those that divide us. When people laugh at Mickey Mouse, it’s because he’s so human; and that is the secret of his popularity.”
A good dream is a crucial inner resource for leaders. Great businesses and great ideas usually originate in an individual’s deepest aspirations. A compelling image – of a better world and a best life for themselves – impels them forward through obstacles and hardships and engages the aspirations and dreams of others.
The important test of a good dream can be the willingness to sacrifice other dreams for it. Even the greatest leaders, with all their extraordinary talents, have had to make great sacrifices to pursue what they valued most. Commitment to a dream for life or work usually has real costs. A good dream is a calling, a vocation. Perhaps the unorthodox wisdom for a good dream is as British essayist Logan Pearsall Smith wrote: “The test of a vocation is the love of the drudgery it involves.” Love of drudgery may be a better test of a healthy dream than excitement or inspiration. Good dreams have deep roots in a person’s character and everyday life, not in the images and seductions of the society around them. Bamboo Innovators make a difference in the world by refracting their dreams through an endless series of small and large efforts – over hours, weeks, and years. The journey is long and arduous, with many challenges, temptations, and ordeals along the way. What finally determines success or failure are the hand of fate, the strength of the commitment to one’s dream, and one’s moral code.
The Moat Report Asia
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
This month of July, we highlight Asia ex-Japan’s largest maker of a mission-critical automotive electronics part that is dubbed the “nervous system” in cars whose electronic content is rising due to the Green, Connected, and Autonomous automotive trends. Without this “nervous system”, the various auto parts cannot start and work. While it is considered a Tier-2 auto parts supplier, [Company’s name] directly participates in the design process of Tier-1 suppliers for most of its [Flagship product’s name] to be “designed-in” and as a result, enjoys sole supplier rights during the first 2-3 years following a new model launch. In addition, [Company’s name] has changed its sales model in China from a distributor model to direct selling, forging Tier-1 relationship with the major Chinese automakers, including accounting for over 50% of [Flagship product’s name] used in emerging electric vehicle maker BYD (1211 HK). Its top ten customers account for around 44-50% of sales. [Company’s name] has pursued the strategy of a diversified customer base to lower operating risk so that “no one “no one customer can seal the life and death of [Company’s name]”, and the rest of sales are contributed by hundreds of customers.
In the ruthless cut-throat automotive industry, the fact that [Company’s name]’s EBITDA margin at 33% is twice that of world-class Bosch India (BOS IN), arguably the best auto parts company listed in Asia, and [Company’s name]’s ROE of 20.5% is also higher than Bosch’s 14.5% speaks volume about [Company’s name]’s wide-moat advantage in securing long-term pricing power and earnings sustainability with the major OEM carmakers by winning their trust to strike long-term partnership. Bosch India trades at an expensive valuation premium of EV/EBITDA 42.9x compared to 12.2x for [Company’s name]. [Company’s name], with its technical superiority in developing low-cost innovative solutions and in generating higher profitability and growth, deserves to command comparable a higher valuation. Short-term downside is protected by a decent cash dividend yield of 4% and supported by a healthy net-cash balance sheet generated from internal free cashflow as opposed to external equity or debt funding.
Led by the highly inspiring Mr. C, [Company’s name] has toiled for more than 10 years since it entered China before bearing some of the fruits. [Company name]’s sales has climbed nearly 31% since FY11 while EBITDA growth is stronger at 78% with the impressive improvement in gross margin from 34.2% to 42.1% due to greater sales weight of higher value-add products that include [Flagship product’s name] for electric vehicles (EVs). Now the growth momentum has hit the tipping point for [Company’s name] to accelerate its profitability significantly in its visible long runway to supply the mission-critical automotive electronics part that is dubbed the “nervous system” in cars whose electronic content is rising due to the Green, Connected, Autonomous automotive trends. Net profit and EBITDA could potentially double in the next 5 years by FY2020, pointing towards a doubling in market value.