Why Disney wants DreamWorks
Spielberg & Co. could give the Mouse House a needed boost in studio profits and more.
NEW YORK (Fortune) -- It's a no-brainer why DreamWorks wants to ally with Walt Disney.
It didn't come to terms with preferred partner Universal Studios, and the distribution deal expected to be announced today with Disney should end a period of limbo for the vaunted mini-studio that Steven Spielberg and pals set up 15 years ago. But for Disney, this is an atypical deal that underscores a lot of fundamental changes at the House of Mouse of late.
First off, though, let's agree that the biggest reason for Disney or anyone else to be in business with DreamWorks is to secure a relationship with Spielberg - duh, he's the most successful director in history and no slouch as a producer.
That, more than anything else, answers why Disney would want to do a deal like this under which it takes an expected 10% fee for distributing DreamWorks releases but also is expected to provide some debt financing to supplement the company's new Bollywood backers.
But as I discovered in my recent story on the renaissance of Disney and its chief executive Bob Iger, the way the company thinks about its film business has changed significantly. Disney was among the first of the studios to significantly reduce the number of films it releases this year.
But in doing so, Iger and Disney Studios chairman Dick Cook also decided to refocus the company around the Disney brand - ergo, family entertainment - while significantly cutting the output and investment in films under the company's Touchstone and Miramax labels.
The mantra at Disney these days is to create cross-company franchises - everything from Pixar's "Toy Story" and "Cars" to Disney Channel hits "Hannah Montana" and "High School Musical" - that can spawn offshoots in other businesses and around the world.
"I don't care if a Touchstone movie does $100 million on $30 million of cost," Iger told me three months ago. "Its success doesn't breed any other success in the company."
That's a bit of a harsh quote - I imagine Iger does just care a little - but the context was the poor reception for recent Touchstone releases like the Spike Lee-directed "Miracle at St. Ana" and "Swing Vote," starring Kevin Costner. In fact, Touchstone will act as Dreamworks' distributor under the deal.
Partly because of misses, partly because of the timing of releases and largely because of a decline in DVD sales in the past quarter, Disney's studio segment reported revenue down 26% and operating income off 64%, to $187 million, in the quarter ended December 27, 2008. More worryingly, Sanford Bernstein estimated (before reports of the DreamWorks alliance surfaced last week) that it expects operating income at the studio division to decline to $619 million in 2012 from nearly $1.1 billion last year .
Out of Disney's four main reporting segments - cable and TV networks, theme parks, consumer products and the studio - the latter is the only one expected to decline in both revenue and profitability terms over that period. In an interview with me last fall, Disney Studios' Cook said that getting smaller or winning fewer awards - Disney has never won a "best picture" Oscar, though of course Miramax has - did not trouble him.
Declining margins, though, are problematic - and if DreamWorks pans out, it could help both in that regard and, in theory at least, in new material that can be pumped through Disney's vast consumer products and cross-media machinery. (The DreamWorks news also surfaced speculation about Disney looking to sell Miramax, but a Disney insider says now is not a great time to be selling anything.)
More broadly, like all the media conglomerates, Disney (DIS, Fortune 500) could use all the help it can get in exciting investors about its growth prospects in these gloomy times. Its stock price had a nice run and until recently held up much better than other media conglomerates'. But it has dropped nearly 40% over the past six months, hitting levels last seen in 2003.
Even Disney's long-held position as the world's largest media conglomerate by market value has come into jeopardy: It stood at $36 billion on Friday, while Time Warner (TWX, Fortune 500) was nearly $35 billion. (In any event Time Warner's value will shrink accordingly in a few weeks once it splits off its Time Warner Cable (TWC) unit into a separate public company.)
DreamWorks (DWA) is not exactly what it once was either: Conceived as a full-scale studio, it was most recently aligned with Paramount and is now essentially a shingle for Spielberg and DreamWorks CEO Stacy Snyder to own a big piece of their own projects, which includes the upcoming "Transformers" sequel and a Spielberg production of the Belgian cartoon "Tintin." (A lesser rationale for the deal, two insiders said, is a desire by Spielberg to produce more family fare than he has in recent years.)
There's plenty of irony in this pairing, given that former Disney executive Jeffrey Katzenberg was one of DreamWorks' co-founders, along with David Geffen, who is no longer actively involved. Katzenberg, of course, now heads up spun-out DreamWorks Animation, which in many ways is Pixar's chief rival. Indeed, Pixar is the only studio with which Disney recently had a similar distribution deal with - and it went so well that Disney ended up acquiring the company three years ago.
The "DisneyWorks" alliance will probably not result in a similar outcome, but it's a compelling plot twist nonetheless in an uneasy industry where, these days, you don't know what's going to happen next.