By Lonne Jaffe
December 15, 2017

On Thursday, the Walt Disney Company (DIS) announced that it had reached a deal to buy most of the assets of 21st Century Fox (FOXA), including its film and TV studios, in a deal valued at $66.1 billion, including debt. As part of the announcement, Bob Iger, Disney’s chairman and CEO, agreed to delay retirement from July 2019 to the end of 2021 to lead the combined business. Iger also recently announced a soon-to-be-launched Disney digital video streaming service, infusing more tech DNA into Disney, generating a rich source of data to fuel future Disney machine learning systems, and putting the company in direct competition with tech-savvy juggernauts such as Netflix (NFLX) and Amazon (AMZN) Prime Video—and perhaps even Google’s (GOOG) YouTube, Facebook (FB) Video, and Apple (AAPL) iTunes.

In all of the buzz around these high-profile announcements, one of Iger’s most impressive talents is often overlooked: He is a master at effective capital allocation. At age 37, Iger moved from a career in broadcast sports to lead ABC Entertainment before taking the CEO role at The Walt Disney Company. Since the day Iger took the helm at Disney, earnings have exploded, and the company’s high-value intellectual property assets have increased its economic power dramatically.

What is capital allocation? As a discipline, it has many dimensions, including some that are relatively mundane. For example, a company should borrow when interest rates are low, issue new stock when shares are overvalued, and buy back stock when shares are undervalued.

While at Disney, Iger has had a razor-sharp focus on market selection, an extremely important facet of effective capital allocation. No matter how well a company executes, if it is focused on a fundamentally unattractive market, its initiatives are unlikely to be successful. There are a variety of factors that can contribute to making a market more attractive to a particular company. Is the market sizable, growing, and high-value? Does the company have brand permission to play in the market and any comparative advantages?

A market can be substantially more attractive to a particular company if that company enjoys sustainable barriers-to-entry in the market—real economic power. A barrier to entry is anything that makes it difficult for a competitor to enter a particular domain. For example, Facebook, Twitter (TWTR), and LinkedIn enjoy powerful network effect barriers-to-entry. Network effects are a type of demand-side economy-of-scale. As dominant players in their respective domains, they become more valuable as more people use them, making it extraordinarily difficult for competitors to steal away their users. Another important barrier to entry is supply-side economies-of-scale, which can give a company an insurmountable cost advantage.

Early on, Iger recognized the barrier-to-entry offered by Disney’s brand power and the government-enforced trademark and copyright protection of its iconic characters. Disney’s characters represent a form of protected intellectual property that lasts many decades. During his tenure, Iger leveraged this economic power to make concentrated investments in businesses as varied as Walt Disney Studios, Disney Consumer Products, Disney Cruise Line, and Walt Disney Parks and Resorts—as well as the upcoming Disney digital video streaming service. These investments have both leveraged the Disney brand value as a competitive advantage and helped to keep the brands and characters vibrant, healthy, and valuable. Under Iger, Disney has regularly acquired companies, such as Marvel Entertainment and Lucasfilm, that bought along with them valuable expertise, revenue, trademarked and copyrighted characters, fans, and additional brand equity.

 

As part of the deal with Fox, Disney says the agreement will allow it to reunite Fox’s Marvel X-Men, Deadpool, and Fantastic Four characters with the rest of the “Marvel family under one roof and create richer, more complex worlds of inter-related characters and stories that audiences have shown they love.” This will likely take place after the release of the two-part Avengers: Infinity War movies, marking the end of the Marvel Cinematic Universe’s “Phase Three” arc. The intellectual property associated with these new characters will have synergy not only with the rest of the Marvel movie franchises, but will also supercharge Disney’s digital streaming service, Disney Parks and Resorts, Consumer Products, etc. In turn, properties such as Disney’s digital video streaming and Disney Parks & Resorts will help to nurture characters such as the X-Men and bring them to new audiences.

Iger also isn’t afraid to look at Disney’s existing businesses and divest of them if they are in segments that are no longer strategic to the company. Making the decision to divest of an existing business is often much more emotionally challenging than making new investments decisions, but market “de-selection” can be as important to effective capital allocation as new market selection. In 2010, Iger sold Miramax Films to an investor group for $660 million. The cash raised from a divestiture can be used for other, more attractive initiatives, or can be used to return capital to shareholders, through stock buybacks or dividends.

Effective capital allocation is a never-ending process, and one that requires continuous change. As Iger once put it, “The riskiest thing we can do is just maintain the status quo.”

Lonne Jaffe is managing director of Insight Venture Partners.

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