Disney CEO Defends Decision to Buy Playdom

Disney CEO Robert Iger defended his company’s recent decision to buy social game company Playdom for $563.2 million (CED July 28 p7) rather than just licensing in the social game space, in an earnings call. “The licensing business is obviously one that’s important to us,” but this was “one case where we felt that bringing” Playdom’s talent into Disney “and using that expertise to expand” Disney’s “awareness of, knowledge of, and business in social games -- in particular, social networking and digital media -- had real value,” he said.

Disney was “pursuing some licensing opportunities with ESPN and Marvel,” but as it looked “closely at the growth in that space, we felt that it’s growth that we should participate in essentially as an owner-distributor rather than just as a licensor,” Iger said. “The upside was enormous and the cost to enter the space in terms of the cost to make games was relatively limited, unlike the console business, where it’s substantially more expensive,” he said. Despite the relatively high cost associated with buying Playdom, “we feel that over time it'll be quite shareholder friendly and will be accretive to the owners of” Disney stock, he said.

Underscoring the importance of social gaming, Iger pointed to a recent Nielsen study that found social gaming in the U.S. had “overtaken personal e-mail as the number two activity on the Web,” Iger said. “We expect social gaming to grow at a compounded rate of more than 30 percent annually,” he said. Game playing on social networks is also “already a mainstream experience attracting a broad diverse customer base,” and Disney believes “it’s essential for us to have a robust presence in social networks and to do so in the right way,” he said.

Disney’s recent purchase of mobile game maker Tapulous (CED July 6 p7) also has helped Disney forge “a diversified, multi-faceted games business capable of creating a wide range of experiences to meet evolving consumer interests,” Iger said. Disney hasn’t said how much it spent to buy Tapulous. As was the case with Disney’s purchases of Pixar, Club Penguin and Marvel, the staffs of Playdom and Tapulous “will benefit from access to our content, brands and financial resources while operating in an environment that led to their initial success,” Iger said. There’s already been “a deal made between Marvel and Playdom for a social game based on a Marvel character,” Iger said, not saying which character.

Chief Financial Officer Jay Rasulo said there was also “the potential for an additional earn-out in payments of up to $200 million at the end of calendar 2012” through the Playdom purchase. “The deal was structured such that our projected return will be higher if the earn-outs are achieved. We expect the deal to be modestly dilutive to earnings for the next several years,” he said.

The company will also “remain in console games with Disney-branded titles” and some non-Disney-branded titles, despite devoting “resources to the creation of social games, mobile games and apps,” Iger said. But Disney has “concluded” that its “game strategy has to reflect basically how consumers are playing games” now, and “as we look at the sector we see a diversity of platforms,” he said. The console games that Disney makes “will in most cases be derivative of product that’s been made for other segments of the company,” such as its movies, he said.

Game playing and social networks are “here to stay,” Iger predicted. There’s “about a half a billion people who are members of Facebook already,” and “about 40 percent of those people participate in game playing,” he said. The “dual-gender” nature of social gaming also made the category “tailor-made for not only Disney-branded games, but Marvel and ESPN,” he said, noting other interactive game categories tend to be consumed mainly by males. There are now more than “50 million people who are members of various Disney, ESPN, and ABC Groups on Facebook,” so Disney enters the social game space “with a very, very solid base of people to market to and when you add to that the over 40 million people who are playing Playdom games already that seemed pretty compelling to us,” he said.

Iger also indicated he wasn’t concerned about Facebook’s strong presence in social gaming. “It’s already been demonstrated that game playing on Facebook is good for Facebook, and it’s good for the creators and the owners of the games,” he said. The recent addition of Facebook currency “can be viewed as Facebook acting like a gatekeeper,” but “the existence of that currency, I think, will enable more people to spend money” for their social gaming, “so I think it’s mutually beneficial,” he said.

Social games “exist on multiple platforms,” and Disney is “going to take a platform agnostic approach to the distribution of these games,” supplying them to not only Facebook, but “other social networks,” Iger said. There’s also “no reason why you can’t play some of these games on” other types of websites “or on mobile devices, and we intend to distribute rather broadly, particularly as we move our IP through Playdom,” he said.

Of digital media in general, Iger said: “We're just really at the beginning of pretty significant migration in terms of consumption and distribution.” There has been “a significant growth in consumption” of digital media and that growth has only been fueled by the recent launch of the iPad, he said. “We feel that in order for us not only to be relevant, but in order for us to grow our business, we have to be in this space."

Asked if the iPad could hurt Disney’s TV business, Iger expressed little concern. Apple CEO Steve Jobs and Iger “talk about a lot of things as it relates to digital media, and while we don’t agree on everything, we certainly are in agreement on the fact that devices like the iPad not only are game changers, but they probably offer us more opportunity than they threaten us,” Iger said. For example, ABC making content available on the iPad is giving viewers the “ability to access ABC shows that they may have missed” when they originally aired or that they didn’t record with a DVR, he said. “We actually like the product because it gives us an opportunity to basically expand our eyeballs and monetize in a broader way. To what extent it cannibalizes the initial business, we're not 100 percent certain, but our gut is that it’s relatively negligible and that people still watch most of their TV” programs in the traditional way, on a TV, he said.

The DVD market, meanwhile, “is challenged” and “will continue to be challenged,” Iger said. “There’s a lot more competition for people’s entertainment time -- social games being one primary example of that,” he said. The industry is also “dealing with largely a title-to-title environment” that is “very title driven” and where “collectability doesn’t seem to be as important as it once was except for real franchises and certain brands like Pixar,” he said.

Disney also plans to “become aggressive” on video on demand, Iger said. The company is “experimenting with” new release windows, including ones for video on demand, but it was “too soon to make specific comments or predictions about that,” he said. It “presents an interesting opportunity” because “there are people who we believe would like to see movies sooner than later and would pay a premium price to do that.” Iger declined to say what pricing Disney had in mind.

The company passed on a content streaming deal with Netflix, Iger said. “When we were considering an extension of” the deal that Disney had with Starz, “we had a few alternatives,” he said. “One of the opportunities was Netflix at that point,” but Disney decided that “doing the deal that we did with Starz was better than the alternatives,” he said. Starz wound up “making our films available to stream through Netflix” anyway, he said. As part of the new Disney-Starz deal, if Netflix reaches a “threshold” that Iger didn’t specify, “there’s more revenue that will flow to us through the Starz deal,” he said without elaborating.

Disney was “very pleased with” its results for Q3 ended July 3, Iger said. “We grew revenues substantially and improved profitability across the majority of our businesses,” he said. Disney’s studio entertainment business “delivered strong results in Q3, driven by the theatrical performance of” Toy Story 3, Alice in Wonderland and Iron Man 2, Rasulo said. Alice in Wonderland and Toy Story 3 were released in 3D, but Disney provided no details. Q3 results “also benefited from lower home video costs and increased TV distribution sales in international markets,” Rasulo said.

Total Disney revenue grew 16 percent from Q3 last year to $10 billion. Profit grew to $1.3 billion, 67 cents per share, from $954 million, 51 cents. Studio entertainment revenue jumped 30 percent to $1.6 billion and the segment’s operating income increased $135 million to $123 million. Interactive Media revenue soared 74 percent to $197 million and that segment’s operating loss narrowed to $65 million from $75 million, “primarily due to higher self-published videogame sales at Disney Interactive Studios, reflecting the performance of current quarter releases, partially offset by higher marketing costs,” it said. Disney released the games Toy Story 3 and Split Second in Q3 this time, but only Hannah Montana in Q3 last year.