(FORTUNE Magazine) – Michael Eisner, the famously hands-on CEO of Walt Disney, is up to his old tricks. Last night he screened a rough cut of Dinosaurs, Disney's big animated movie for next summer; he loved the story but complained that some jokes were stale. Today he's holding a four-hour brainstorming session about Mickey Mouse, looking for ways to keep the 71-year-old rodent relevant. (One idea: a skateboarding Mickey.) Later, he'll watch Peter Jennings' newscast on Disney-owned ABC and surf the Internet to see how the company's Websites stack up. Is this any way to run the world's most troubled entertainment giant?

After all, as Eisner sweats the details, earnings are dropping, top executives are defecting, and Disney stock is plunging like a ride down Splash Mountain.

"Maybe I'm crazy," Eisner says, "but I don't consider this a crisis. I don't think our problems are in the fabric of our company. And I don't have my head in the sand." Sitting down for a two-hour interview, he admits mistakes. He says, for instance, that he should have settled former studio chief Jeffrey Katzenberg's suit against the company earlier to avoid a "parade of horrors" (see box). And he concedes that the company has sustained real damage: "It's like a train wreck, only nobody got killed." But Eisner denies that he has lost his touch. "The criticisms of me and Disney today," says the 57-year-old chief executive, "are as shortsighted as were the praises of me and Disney in the high economic times."

Sunday nights on ABC, Michael Eisner--celebrated CEO, business magazine cover boy, and author of his own life story--still hosts The Wonderful World of Disney. The rest of the week, life is not so sweet in the Magic Kingdom. Certainly shareholders have reason to feel grumpy, with the stock trading at about 37% below last year's high. There's no quick fix in sight either. Tarzan, the $160 million summer blockbuster, won't have much impact on earnings; the movie cost too much to make and isn't selling enough T-shirts and toys because the market's glutted with Star Wars stuff. That's one of the scary things about today's Disney: The company has grown so big and its problems are so far-reaching--ranging from the phenomenon of "age compression" to the explosion of media choices--that they can't be fixed by a couple of hit movies or TV shows or more Disney stores. The other scary thing is this: Disney seems less able than ever to cope with adversity. That's because Eisner, for all his creativity and charisma and grand plans, presides over an insular--some say arrogant--corporate culture where decision-making is hierarchical, centralized, and slow. It's an utter mismatch for the Internet age. "This isn't Mickey's house anymore," says a former Disney insider. "It's a multibillion-dollar company."

Eisner does have a plan. He is cutting costs and reengineering a company that got bloated with success. He's making overseas growth a top priority. He wants Disney to be an Internet giant, taking on Yahoo and America Online. And, yes, he'll keep on tweaking theme park rides and screening ABC pilots and driving subordinates up the wall with his meddling, because he fervently believes that if you demand high quality and develop synergy, financial results will follow.

"The interesting thing about our company," Eisner says, "which I think is extremely flattering, is that everybody takes for granted that we make good products. They think, Oh, the Disney cruise ship, they take a wand and a little pixie dust and all of a sudden you revolutionize the cruise industry from floating Vegas hotels to romantic ocean liners. There are zoos all over the world, and up comes the Animal Kingdom. Or Tarzan, or the Lion King on Broadway--people say, 'They have no trouble with the creative thing.' Well, it's the creative thing that turns the company around."

Besides, he declares, a bit impatiently: "We are the most profitable media company in the world. We're being buried a little prematurely here."

He's right about the bottom line. Last year Disney reported revenue of $23 billion, operating income of $4 billion, and net income of $1.9 billion--its net was far more than that of Time Warner (owner of FORTUNE's parent), News Corp., and Viacom combined. For the current fiscal year, which ends Sept. 30, Disney's revenue is expected to reach $24 billion. But all other key indicators are down, some shockingly so. For the first nine months of fiscal 1999, excluding a one-time gain from an asset sale, Disney reported declines in operating income of 17%, net income of 26%, and earnings per share of 27%. Some Wall Street analysts have cut their fiscal 1999 earnings estimates as many as five times since last summer, and 13 of 25 analysts have a "hold" on the stock, according to Zacks Investment Research. The company has simply stopped growing, and it isn't a momentary dip either: Operating income fell slightly last year too, and Disney isn't expected to match its fiscal 1997 earnings until 2001 at the earliest--a startling comedown for a company that, for a decade after Eisner took over in 1984, delivered annual profit increases of 20% and a return on equity of 20%. Return on equity, a key benchmark that has been sliding ever since Disney's 1996 merger with Capital Cities/ABC, has slipped below 10%, estimates analyst Laura Martin of Credit Suisse First Boston. "Some people have the impression that Disney still is what it was--an animation company that generated great returns on capital," Martin says. "But that may be over."

Until recently Disney was propelled by a handful of big ideas that were executed almost flawlessly. First, Disney released its library of beloved animated films on video just as VCRs took off; nine of the ten bestselling titles of all time are Disney movies, and most, like Snow White and Cinderella, were paid for long ago. Second, Eisner and Katzenberg revived Disney animation with instant classics like Aladdin and The Lion King, which made big profits at the box office and on video and spawned even bigger ancillary revenues from licensing and merchandising. Third, Disney built more than 700 retail stores in the U.S., Europe, and Asia. Finally, the company embarked on a vast expansion of Walt Disney World, creating and updating dozens of attractions and building an astonishing 15,000 hotel rooms since 1988. (They called the strategy "Put the heads in the beds.") Disney's market capitalization soared from about $2 billion before the Eisner era to $85 billion at its peak in April 1998. Thanks to the rising stock price, Eisner got fabulously rich too, exercising accumulated stock options that gave him pretax gains of more than $500 million since 1992. He still holds 12.7 million shares, according to Disney's latest SEC filings, worth about $330 million at today's prices.

So what's gone wrong? Start with the fact that all the businesses that powered Disney, with the exception of the theme parks, are slumping. Home-video earnings have tumbled, partly because consumers now have shelves filled with Disney animation. Revenues from licensing and merchandising are down, partly because of the economic downturn in Asia, and sales and profits from the Disney Stores have declined because product lines have grown stale. "How many Mickey Mouse T-shirts can you sell?" asks Christopher Dixon, entertainment industry analyst for Paine Webber. Altogether, Disney's all-important Creative Content segment, which includes movie and TV production, home video, licensing, merchandising, and the stores, saw its operating income fall from $1.7 billion in 1997 to $1.4 billion in 1998; it decreased by another 42% during the first nine months of fiscal 1999. If that were a movie, they'd call it Honey, I Shrunk the Earnings.

In Eisner's view, the problems are unrelated. "A lot of things happened together to make our earnings slide," he says. Disney is attacking each concern, slashing costly production deals in the movie business, releasing fewer live-action movies, resting its classic video titles longer between releases to rekindle demand, and merging overseas distribution forces for film and video. To boost demand for consumer goods, the company will try to coordinate marketing in big retailers such as Wal-Mart. "We'd like to have a Disney boutique to sell the T-shirt, the lunchbox, the sheets and towels," says Peter Murphy, Disney's self-assured 36-year-old head of strategic planning.

Suppose, though, that the declining sales of videos and merchandise reflect a more fundamental issue--weakness in the Disney brand. This notion is such heresy inside Disney that everyone, including Eisner, dismisses it out of hand. "We have research on our brand in 20 or 30 countries, and we are almost without exception the No. 1 or No. 2 brand," Eisner says. Disney executives say that if the brand were in trouble, Disney's theme parks would be suffering along with the rest of the company; as it is, they're thriving--even the one in France. In the theme parks and resorts segment, revenues and operating income grew by 10% and 13%, respectively, in 1998, and they've grown by 14% and 13% so far this year. "We have as many kids lining up to see Mickey Mouse as ever," says Paul Pressler, 43, the president of Walt Disney Attractions. "And our merchandise has done great." Disney World has reached beyond its core audience of young families to beckon convention-goers, older people, and "pre-families," which is Disney-speak for single people. And it's capturing more money from visitors who stay in all those new hotels.

Sure, Disney's theme parks rule--it's parents who decide on family vacations--but the brand isn't holding up as well in crowded arenas like videogames and cable TV, where kids are more autonomous. Disney's interactive unit is an also-ran in the booming videogame business. On cable, the Disney Channel ranks a poor third in viewing among kids ages 2 to 11, behind market leader Nickelodeon and the Cartoon Network. Both Nick and Cartoon, relative newcomers to the kids' business, exploited Disney's vulnerabilities. "The Nickelodeon opportunity was to get inside the lives of today's kids," says Nickelodeon President Herb Scannell. "We've been contemporary. They've been traditional." While Disney characters are drawn from myths, history, and storybooks--just about every big Disney animated feature could begin with the phrase "long ago and far away"--Nickelodeon's TV shows and movies tell stories about real kids. Today the Viacom unit captures more than 50% of the audience of all children's TV programming.

When Disney tries to exude a hipper aura--think of the bestselling Phil Collins soundtrack from Tarzan--the company is more likely to speak to baby-boomer parents than to their offspring. Here's where that idea of "age compression" comes into play. Kids grow up faster these days, the experts say, and start emulating teenage behavior when they're 9 or 10. They rebel against their parents and shy away from a "good for you" brand like Disney. Ten-year-old boys who watch wrestling or South Park on cable and 9-year-old girls who love Ricky Martin think Disney is for little kids. "They've never gotten past the problem that their core audience is girls 2 to 8 and their moms," says a former Disney executive. And even among young kids, the hot properties lately are Nickelodeon's Blues Clues, PBS's Tele-tubbies and Nintendo's Pokemon, now a hit TV show on the kids' WB, yet another new kid-vid network.

The cluttered kids' marketplace points to another fundamental problem facing Disney--competition on a scale the company hasn't faced before, across all its businesses. Warner, Dreamworks, and Fox do feature animation. Universal just opened a second Florida theme park. Fox Sports is taking on ESPN. Can you begin to see why managing Disney today is harder than it was a decade ago?

What changed everything, of course, was Eisner's boldest stroke as CEO: his $19 billion merger with Cap Cities. That deal, cheered at the time, still appears strategically sound--the idea was to marry Disney content with ABC's broadcast and cable distribution. The problem has been execution. While ESPN and other cable properties have grown, no unit of the company is as besieged as ABC. It will lose money this year for the first time in a decade, despite a fantastic advertising marketplace, because audiences are splintering and programming costs keep climbing. (Disney agreed under competitive pressure to spend $9.2 billion--that's right, billion--for NFL rights for ABC and ESPN through 2008.) Operating income for the company's broadcasting segment, which includes ABC, its TV stations, 80% of ESPN, the Disney Channel, ABC Radio, and stakes in Lifetime, A&E, the History Channel, and E! Entertainment, grew by just 3% last year; it's down 18% so far this year, mostly because of ABC. "I'd be the first to say the results of the ABC television network, particularly in prime time, have been disappointing since the merger," says Robert A. Iger, 48, the lifelong ABC executive who is chairman of ABC Inc. While Iger's bailiwick extends way beyond the network, he keeps a close watch on programming and told FORTUNE in 1997, "Prime time is my No. 1 priority." Since then, ABC's ratings for its 18- to 49-year-old target demographic have fallen by another 13%, leaving the network No. 3, behind NBC and Fox. Oops.

Wait, it gets worse. Remember how the merger was supposed to marry content and distribution? That's not working well either. Owning and broadcasting a hit, then selling the reruns, is the best way to make big money today in television. Just ask Rupert Murdoch, whose Twentieth Century Fox TV studio not only owns the biggest hits on Fox--The Simpsons, The X-Files, and Ally McBeal--but also produces The Practice and Dharma & Greg for ABC, as well as key shows for NBC, CBS, and the WB. By contrast, Disney's Touchstone Television production studio has failed to develop a prime-time hit for ABC or anyone else since creating Home Improvement in 1991. Out of sheer frustration, Eisner last month merged the Touchstone studio into ABC; the idea is to save money and force the two units to cooperate. "It's a fantastic opportunity to reengineer the way television is done," says Lloyd Braun, the studio president who co-chairs the merged unit with ABC's Stu Bloomberg. Like a movie studio, ABC Entertainment now will develop, own, finance, and distribute more of its own content.

The trouble is, the new model could seal ABC off from the rest of the television world. While ABC executives say they'll still buy shows from studios like Warner Bros. and Fox, the studios worry about doing business with the new, vertically integrated ABC. "You're going to have to demonstrate to me in tangible ways that I'm going to get a fair shake," says Sandy Grushow, president of Fox's Twentieth Century Television. The other networks, meanwhile, suspect that any show they get pitched by a Disney entity will be an ABC reject. Beyond that, the merger adds another layer and the prospect of infighting at ABC Entertainment, now run by a posse that includes newcomer Braun, programmers Bloomberg and Jamie Tarses, network President Pat Fili-Krushel, ABC Inc. president Steve Bornstein, and Bob Iger, who still reads scripts of key ABC shows on weekends. Nor is Eisner shy about weighing in; he helped shape the fall lineup and ordered ABC to negotiate tougher deals with its affiliates and program suppliers, which are not happy. This management by committee has never worked in television, and it's not working at Disney-ABC.

There is much more at stake here than the unwieldy operation of the TV unit. The new ABC structure is emblematic of what may be Eisner's thorniest problem, if only because he doesn't seem to recognize it: It's Disney's corporate culture. Under Capital Cities, ABC was run in a determinedly decentralized way; executives were given authority and responsibility as long as they exercised fiscal discipline, and the company was generally well run. The Disney approach reflects different values: centralized control, an obsession with synergy at the expense of individual business units, a suspicion of outsiders, and a muddying of responsibility. The results speak for themselves.

Writing about the Disney culture is tricky because knowledgeable critics are unwilling to speak on the record; the company's just too powerful. But talk to enough people and you hear similar complaints. One persistent theme: Eisner insists on making too many decisions himself, which clogs the decision-making process. So do the roomfuls of strategic planners who analyze everything. A second complaint: Eisner's too tough. Working with Disney is notoriously difficult, so much so that a group of partners, including Coca-Cola, AT&T, Delta, and Kodak, used to meet informally to trade tips on how to cope.

A related point about Eisner: In spite of his affability, he doesn't really value other people. That's one reason the death of his longtime second-in-command, Frank Wells, in 1994, was a seminal event. Wells commanded Eisner's respect like no one else, told him when he was off-base, and deftly softened his edges. They were a great team. Eisner tried to replace him with Michael Ovitz, a crucial error at just the wrong moment. Ovitz's management got the ABC merger off to a dismal start, and his 16-month tenure scarred the company. Since then, strong executives have left, among them former CFOs Stephen Bollenbach and Richard Nanula, Internet guru Jake Winebaum, and former ABC executives Geraldine Laybourne and Steve Burke.

Finally, the critics say, the company has simply grown too big to be run from the top down. Eisner's approach worked for the old Disney, where the focus was on a single brand; he could gather a cadre of executives at his Monday lunches and get things done. Now Disney must manage multiple brands in a world where speed counts and partnerships are vital. A respected ex-Disney executive told me, "The company has changed and the world has changed, but Michael hasn't changed. Now he's got to change."

Eisner and his lieutenants bristle at the criticism from unnamed sources, and you can't blame them. Yes, they say, Disney is tough, but so are GE and Microsoft--which, by the way, lose lots of executives, too, because they have an abundance of talent. To the charge that he meddles, Eisner pleads guilty with an explanation: He wants Disney to excel. (Even his detractors say he has great instincts.) When he heard from a friend that the cast members at Disneyland Paris weren't as helpful as those at Walt Disney World, he recommended better training. "Is that meddling or is that insisting on a high standard of excellence?" Eisner asks. "If there's an area where I think I can add value, I dive in. Yes, at certain times I paralyze people. I'm never satisfied. It gets people crazy, I know that." But Eisner also says he leaves his best executives, like theme park chief Pressler, alone. "There's no brain drain," he says. "We have unbelievably strong management."

Eisner's turnaround strategy focuses not on Disney's culture but on operations, fiscal engineering, and growth. Consolidation and cost cutting are already under way across the board, with the movie division leading the way. Studio chief Joe Roth has already cut spending by about $550 million annually, by making fewer movies. "It focuses everyone much more closely on the films at hand," Roth says, "and ironically, I am quite sure that--for the fifth time in six years--we will be No. 1 in market share again this year."

Disney is also looking to sell Fairchild Publications, a magazine company. Sources say Disney also expects to write off a big chunk of the $9.2 billion NFL deal. In a move that should please Wall Street, CFO Thomas O. Staggs is reworking Disney's compensation system so that executives will be evaluated on cash flow and return on equity as well as on reported earnings; that's designed to encourage business units to use capital more efficiently. The theme park segment, in particular, has been a huge consumer of capital, but it will use less after new parks open near Disneyland and Tokyo Disneyland in 2001.

Disney's best growth opportunity probably lies overseas. Right now, the company gets about 21% of its revenues from abroad, less than other global brands like Coca-Cola (63%) or McDonald's (61%). That's why Bob Iger's recent promotion to president of Walt Disney International puts him in a crucial role, spearheading what Eisner calls "a monumental change in the way the company is structured." Iger has begun to overhaul all of Disney's operations outside the U.S., which grew up haphazardly as each business--film, TV, the stores, cable, or theme parks--built foreign outposts that reported back to the home office. Now those businesses will also report to regional executives in charge of continents or key countries; each territory will also get its own CFO and brand manager.

That may sound like more Disney layering, but Iger says it offers major advantages. First, the company will save money through consolidation, whether in renting office space or buying advertising. Disney also expects to do a better job of tapping into local trends. Iger cites a revealing example: "It's having someone in Japan who would see the Pokemon phenomenon at an early stage and have the clout, really, through me, someone who has a seat at Michael's table, to be able to raise the consciousness level of the company about that potential quickly and effectively." Interestingly, the idea is not to delegate authority but to shorten the distance between the rest of the world and Eisner.

Eisner's other major focus is the Internet. Here, too, centralization is the watchword. Last month Disney agreed to combine its Internet assets with Infoseek, a search engine and portal company that it is buying outright; the properties, including the Go portal, ABCNews.com, ESPN.com, Disney.com, Family.com, and others scattered in five locations on both coasts, will operate as a single unit under a CEO to be named later. "This is to consolidate the Internet assets so that we can have them under common management with one agenda and one vision," says CFO Staggs, the 38-year-old architect of Disney's Internet strategy. The company will then issue a tracking stock called go.com that can be used as acquisition currency and a way to compensate talent.

Disney's assets should make it a force online. Its ESPN.com and Disney family sites are category leaders, and the company has unparalleled promotional platforms in ABC and ESPN. In a matter of months, they helped make Go the fifth-ranked portal, behind AOL, Yahoo, Microsoft, and Lycos. And all the Disney Websites should sing when high-speed access makes it easier to watch video online. "As bandwidth expands," Eisner says, "content becomes more important. You must have sports and news and entertainment, or you are going to be a Western Union messenger in a fax world." He envisions a universe in which ABC News clips, ESPN game highlights, and movies like Aladdin are distributed online, cutting out middlemen like cable operators or Blockbuster Video. "I believe the entire company's product will mostly be distributed through the Internet," Eisner says. He's a passionate Internet user too, peppering his web guys with suggestions. Says Staggs: "The only person I get more e-mail from than Michael is my mom."

The strategy sounds smart. Of course, buying ABC sounded smart too. Once again, it'll come down to execution. Patrick Keane, a Jupiter Communications analyst, likes Disney's web assets but worries that "diversified media companies move at glacial speed when it comes to the Internet." Disney can't be as focused on new media as people at AOL and Yahoo are every day. And the straitlaced Mouseketeers will have to learn to live in an unbuttoned Internet culture, says new-media consultant Gary Arlen of Bethesda, Md. "Have you ever been to Disney World?" he asks. "You walk out of a ride and land in a place that sells souvenirs. They'd like to manage the Internet that way." Even with perfect execution, Disney's Internet investments need time to pay off; in the meantime, they'll dilute earnings.

Time is what Eisner needs too. Time for the cable and phone companies to help make his broadband Internet vision a reality. Time to build overseas. Time for DVD to take hold and provide another chance to resell the library. Time to create the next Tarzan and a hit for ABC, time for new theme parks to open, time to reinvent Mickey once more. Time, perhaps, to appoint a strong second-in-command with clout, whether it's Bob Iger or Paul Pressler or a dark horse who has yet to emerge.

Because he enjoys the support of the Disney board, Eisner can be patient. "We're in a transition period," he says. "I would rather have every quarter be up. It was for 13 years. Everybody loves you. [But] you can't manage a company like ours quarter to quarter, maniacally, so that the media will write good things about you." He likes to quote Warren Buffett, whose Berkshire Hathaway, at last count, owned 51 million Disney shares: "I close my eyes and think about what a company's going to look like in ten years before I invest." Paine Webber's Chris Dixon says Disney's assets are top-notch: "It may take time, but we believe the values are there."

Other investors won't wait. They note that despite the earnings downturn, Disney is still priced as a growth stock; it trades at about 35 times this year's projected earnings, a 25% premium to the S&P 500. The Capital Research & Management Group, whose entertainment industry investments are managed by respected media analyst Gordon Crawford, used to be Disney's largest institutional shareholder, with 41 million shares as recently as last year. Crawford has sold them all.

So be it, says Eisner. "You can always tell your friends through the rough times," he says. He still gets to go to the movies, test-drive theme park rides, surf the Net, and call it work. And maybe it's just his turn to suffer in the media doghouse. After all, CEOs Gerald Levin of Time Warner and Sumner Redstone of Viacom fell out of favor when they struggled to get their arms around companies engorged by big acquisitions. Such mergers aren't easy. The challenge for Eisner is to learn from experience, show a little humility, seize the opportunity to shake up his company, and, perhaps, change his own stripes and let go a little. That's a lot to ask of anyone who's been as successful as he has for so long. But this isn't the old Disney. And the old Disney magic just isn't working anymore.

REPORTER ASSOCIATE Carol Vinzant