Dan Loeb’s Chapek Punch List

Happy Wednesday, welcome back to Dry Powder.

The summer is winding down, but there’s few slow days on Wall Street. In today’s column, I explore the odds that Dan Loeb’s nearly billion-dollar investment in Disney will be enough to sway C.E.O. Bob Chapek into adopting a laundry list of changes, from spinning ESPN to reconfiguring its cost structure. Perhaps Chapek, the cold-hearted operator (I use the phrase respectfully), might prove more amenable than his more talent-friendly predecessors.

When you cut through it, all Dan Loeb really really wants Bob Chapek to do is slash Disney’s bloated costs and pay down the company’s $50 billion of debt. And maybe shake up the board. And maybe spin ESPN. And, oh wait…

WILLIAM D. COHAN

Unlike say Warren Buffett or Bill Ackman, investors who like to buy and hold until the pain becomes too acute, Dan Loeb has a reputation for being nimble, and opportunistic. He once told me that investing is simply all about figuring out when to do something that’s obvious, and when to do something that’s contrarian. At the outset of the pandemic, for instance, Loeb made what he deemed to be the obvious decision to invest in Disney, telling me it was a “tremendous company” with “a great brand” and he was very excited about being able to buy the stock at a discount that resulted from the negative impact that the quarantine had on the company’s parks, sports rights, cruise business, and theatrical releases. Loeb’s Third Point hedge fund owned stock in Disney worth more than $900 million at its peak, and then ultimately sold out of the position completely earlier this year. Meanwhile, shares in Disney rose around 70 percent between May 2020, about when he bought the first time, and August 2021, when he disclosed his first Disney stake. He made a killing.

More recently, on August 15th, Loeb disclosed that he had taken another bite of the Disney apple, amassing a roughly $750 million stake in the company. This time, however, his money came with a few requests, which he politely yet forcefully articulated in a letter to Disney C.E.O. Bob Chapek. I’ve known Dan for a long time and have written about his financial exploits for years. He lives large (but tastefully), as you would expect of a billionaire hedge fund manager. He’s got an apartment at 15 Central Park West, a home in the Hamptons, a private-jet and a megayacht. He’s a big surfer. (Third Point is named after a break in a favored surfing spot near his hometown of Los Angeles.) He’s got a world-class collection of contemporary art. He’s plenty open-minded, borderline liberal, but he’s also a longtime proponent of charter schools and not much of a fan of the woke curriculum that has overtaken many of the private schools in New York City. And, for a hedge fund manager who has often used activism as a tool, he actually prides himself on being a reasonable guy. He’s not one to hold out for the last dollar.

When you cut through it all, what Loeb really wants Chapek to do is cut Disney’s bloated costs and pay down Disney’s $50 billion of debt. Loeb’s first priority for Disney, at least according to the letter, is that Disney do something about its cost structure. “Disney’s costs are among the highest in the industry, and we believe Disney significantly under-earns relative to its potential,” Loeb wrote. “We urge the Company to embark on a cost cutting program,” to improve profit margins and by selling off “excess underperforming assets.” Of Disney’s nearly $82 billion in revenue for the last 12 months (ending July 2), there were some $69 billion of related expenses, excluding depreciation and amortization. That $69 billion is what Loeb is targeting.

Loeb has all kinds of suggestions for how Chapek can achieve Loeb’s goals: among them, spin off ESPN, buy up the rest of Hulu, and shake up the board composition. But at the end of the day, I’m told, he wants Disney’s stock price to double, to $240 a share. If he gets what he wants or most of what he wants, relatively quickly, I suspect Loeb will be gone and then move on to the next thing before Bob Chapek can say Turning Red 2. You know, time value of money and all. But if not, well, Loeb could make Ron DeSantis look like a warm up act.

The Anti-Iger

Loeb seems to think that Chapek is the right man to do the cost cutting. Unlike Bob Iger, the previous Disney C.E.O., or Kevin Mayer, who wanted the job that Iger gave to Chapek, the midwestern C.E.O. does not appear to be quite so much in the thrall of the Hollywood entertainers, upon whom companies such as Disney feel the need to lavish all kinds of perks, including private jet trips on Gulfstream 650s and red-carpet parties. Loeb, who has had some recent back and forth with Chapek, I am told, thinks Chapek is more of a technocrat than a Hollywood impresario, and therefore he is likely to be more willing to cut Disney’s bloated cost structure down to size without fear or favor, pretty much in the same way that David Zaslav and his hatchet man, Gunnar Wiedenfels, seem to be doing over at Warner Bros. Discovery.

Chapek may not have the charisma of Iger or even Mayer but, as he proved at Disney’s theme-park division, he knows how to deliver the profits and increase margins. In the rarefied world of billionaire hedge fund managers like Loeb, cold-hearted operators are respected. And that combination was good enough for the Disney board to give Chapek a three-year contract extension, despite his DeSantis snafu.

Disney, after all, has $51.5 billion of debt, which also seems to be a big concern for Loeb. In his letter to Chapek, he twice broached the subject of the debt load, much of which resulted from Disney’s 2019, $71 billion acquisition, for cash and stock, of 21st Century Fox. (Many think Disney overpaid for Fox, the price of which was driven up during a battle for the company with Comcast, Disney’s archrival.) Loeb wants Disney to continue the suspension of its cash dividend, a policy started during the pandemic when it closed its theme parks, and use the cash savings—about $3.2 billion per year—to either pay down debt, buy back stock, or “organically reinvest in the business.”

In another place in the letter, Loeb asked Chapek to give some renewed thought to spinning off ESPN—an idea that my partner Dylan Byers first surfaced here in Puck last October—and load up the spun-off ESPN with “an appropriate debt load that will alleviate leverage at the parent company.” Loeb wrote that he knows spinning off ESPN is not a new idea. “While I understand you have considered this idea in the past,” he wrote, “we urge the Company to retain advisors to reassess the desirability of the transaction in the current environment, recognizing that a key determination would be the proforma capitalizations, cash flow and credit profile of both companies.” He’s also not necessarily averse to having Disney hold onto ESPN and then use its free cash flow to pay down debt. But he seems to want Chapek to explain to investors just what his intentions are for the sports channel once and for all. (I’m reliably told that Disney is considering a near-term Investor Day, giving Chapek the opportunity to shed light on his plans for ESPN, among other Disney assets.)

Look, $50 billion is a lot of debt, there’s no doubt about that, but I’m not sure why Loeb is so fixated on paying it down. There are mitigating factors. First, according to its latest quarterly filing with the Securities and Exchange Commission, Disney also has $13 billion of cash on its balance sheet, putting its net debt at $37 billion. Disney also generated around $12 billion of EBITDA, according to Wall Street research, for the last 12 months, ending July 2. That’s a leverage ratio of around 3x EBITDA, comfortably within the range of credit ratings for investment-grade debt. So, while Disney does objectively have a boatload of debt, it also has a boatload of cash and a boatload of EBITDA that can be used to pay down that debt.

This is a very different dynamic, for instance, than at Warner Bros. Discovery, where David Zaslav, who is managing $52 billion of debt, has trimmed the company’s sails for 2023 to what he hopes will be $12 billion of EBITDA, down from a projected $14 billion. At $12 billion of EBITDA, WBD’s leverage ratio is around 4.5x EBITDA, closer to the edge of the investment grade/junk bond line. Still, Loeb worries. I’m told he’d like Disney to generate $10 billion of free cash-flow a year and he thinks the combination of cost-cutting and paying down debt to reduce interest expense will get Chapek there. We’ll see. (In the first nine-months of the current fiscal year, Disney’s free cash flow was a negative $317 million, according to a S.E.C. filing.)

The Hulu Pickle

Loeb has a few more thoughts up his sleeve. He’d like Chapek to sooner rather than later have Disney buy the 33 percent of Hulu that is still owned by Comcast. Contractually, Disney is not obligated to buy that one-third stake in Hulu from Comcast until early 2024. Loeb would like Chapek to do it before then, but realizes that might empower Comcast to have an “unreasonable price expectation” for its Hulu stake.

In May 2019, Disney and Comcast entered into an agreement that gives Disney full operational control of Hulu. Starting in January 2024, Comcast can compel Disney to buy its stake in Hulu, and vice-versa, for the greater of the fair market value of Hulu at that time or a value of Hulu of $27.5 billion, putting a floor on Comcast’s stake in Hulu at $9.2 billion at least. It will probably be valued considerably higher. (As of July 2, Disney valued Comcast’s stake in Hulu at $8.6 billion on its financial statements. Hulu had 46.2 million paid subscribers as of the same date, with an average monthly revenue of $12.92.) It’s another cost-saving play for Loeb, or so he says. “We believe that integrating Hulu directly into the Disney+ [direct-to-consumer] platform will provide significant cost and revenue synergies, ultimately reigniting growth in the domestic market,” Loeb wrote Chapek.

Loeb also wants changes to the Disney board, and has identified at least two new potential board members—one man, one woman—that he’d like Chapek to consider. Of course, Chapek doesn’t have to consider Loeb’s suggested changes to the Disney board. But it would probably make his life easier if he did, by giving Loeb something he wants that is much easier to do than big cost cuts or organizing the spin-off of ESPN. Corporate C.E.O.s are human too. Chapek might well tell Loeb he’s willing to consider adding his proposed candidates to the Disney board and then never do it. (GE’s Jeff Immelt did something similar with Ed Garden, a partner at the hedge fund Trian Partners. In the end, Garden only went on the GE board after the board replaced Immelt with John Flannery.)

Loeb obviously believes the current Disney board isn’t up to snuff, and he’s tried to let Chapek know that in the gentlest possible terms. “Disney is a world-class company that deserves a world-class board of directors who possess diverse talents and experience with strengths in technology, advertising, and consumer engagement, as well as proven track records of leading large complex organizations and creating shareholder value,” he wrote. “This is not meant to single out any current board members, but we believe there are gaps in talent and experience as a group that must be addressed.” For its part, Disney rebuffed Loeb’s claims about its board. “Our independent and experienced board has significant expertise in branded, consumer-facing and technology businesses as well as talent-driven enterprises,” the company said in a statement. “The board has also benefited from continuous refreshment with an average tenure of four years.” (Disney declined to provide me with any additional statement in response to Loeb’s letter.)

The Disney board is surprisingly diverse, especially for one of the most corporate of American companies. In addition to Mary Barra, the C.E.O. of GM, and Safra Catz, the C.E.O. of Oracle, the board chairman is Susan Arnold, a former executive at Procter and Gamble and a longtime executive-in-residence at the Carlyle Group, the Washington based private-equity juggernaut. The board also includes Maria Elena Lagomasino, a former JPMorgan Chase banking executive, who now runs a private-office business, and Amy Chang, a former technology executive and corporate advisor. In addition to Chapek, there are also a few men on the Disney board, including Michael Froman, the former U.S. Trade Representative and now the the vice-chairman of MasterCard; Francis deSouza, the C.E.O. of Illumina (whom I wrote about in Puck last year); Derica Rice, the former president of CVS Caremark; Mark Parker, the executive chairman of Nike; and Calvin McDonald, the C.E.O. of Lululemon.

My bet is that Dan is going to give Chapek some space here, as long as he’s matriculating the ball down the field toward the twin goal posts of cost-cutting and debt paydown. The other good news for Chapek is that in the past month, the Disney stock is up 12 percent, roughly the same time frame during which Loeb bought back in. On the other hand, if Chapek is just doing the lip-service thing to Loeb, then watch out: the teeth will be bared and things could get ugly quickly. Dan is patient and flexible but not infinitely so. All one has to recall is the fight he had with Sony, during which he called for the break-up of the company, including its Hollywood division.

My best guess is that as long as Chapek cuts some costs, improves Disney’s profitability, and the Disney stock price responds, he may never have to address Loeb’s concerns about ESPN, the board’s composition or the company’s turn toward wokeness. Loeb might well be gone before any of those longer term questions come to pass. On the other hand, he could also return again and buy yet another stake in the company when the next money-making opportunity presents itself.

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