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Euro Disneyland It is 1987, and in a muddy sugar-beet field 20 miles east of Paris, Walt Disney Co. is creating Euro Disneyland. By the time of its scheduled opening in 1992, Euro Disneyland (EDL) is expected to cost FF 15 billion ($2.5 billion based on an exchange rate of FF 6 _ $1). Most signs point to the park’s success. Two million Europeans already visit its American parks every year. And Paris demographics look great: In two hours, 17 million people could drive to the park and 310 million people could fly to the park. Disney’s risk appears to be modest. It has invested $350 million in planning the park but has put up just $145 million for 49% of EDL’s equity. Public investors will pay $1 billion for the other 51% in a stock offering in October 1989. The public company, through its traded shares, will give Europeans a chance to participate in the success of the project once the gates open in 1992. (When the stock begins trading on the Paris Bourse in October 1989, Disney’s stake will be valued at $1 billion—an $855 million gain in value.) Even if profits are weak, Disney will rake in fat management fees. And it could clean up just on the land: It has rights to buy 4,800 acres from the government at just $7,500 an acre—compared with $750,000 an acre for similar land in the area. Disney can resell chunks to other developers for any price it can get. The acreage should jump in value once high-speed rail lines from Paris and London (via the Chunnel, the tunnel under the English Channel) are in place. But there is risk nonetheless. The most critical variable is attendance. Many experts think surprises may await Disney. They doubt that attendance will meet Disney’s expectations. Others think that the crowds will come but will spend less than Disney projects. Disney faces other unknowns as well. MCA/Universal, which will be bought by Matsushita in 1990, is thinking of building a park in London, which would cannibalize Euro Disneyland’s attendance. There’s also the grim winter weather, which prompts European parks to close until spring. Then there’s the challenge of training 12,000 Europeans, half of them French, to be Disney “cast members.” Bowing to French individualism, Disney will relax its personal grooming code a bit. Disney may also decide to change its ban on booze if customers call loudly enough for wine and beer. Disney claims that its experience with Tokyo Disneyland, its last major development project, shows that it can deal with non-American culture and bad weather. Tokyo Disneyland was completed on time and within 1% of budget. It has also been a huge commercial success. Financing In March 1987, Disney and the French government sign a “Master Agreement” for Euro Disneyland. In accordance with that agreement, Disney forms a holding company to control development of the entire site. It pays $145 million for 49% of the holding company’s shares and sells 51% of EDL to European investors for a little over $1 billion; of the latter shares, around half are sold to the French. 1 Copyright © 2005 John Wiley & Sons, Inc. The holding company set up as an SCA (Societé Commanditeé par Actions), a unique French corporate form that is very similar to an American limited partnership. Disney is the gerant, or general partner. The SCA structure allows Disney to control management, even with a minority shareholding. Thus, even though the holding company owns EDL, Disney will manage it and collect an estimated $35 million a year in royalties on sales of admission tickets, food, and souvenirs. The master agreement is basically an inducement for Disney to bring Euro Disneyland to Paris rather than to Spain’s Mediterranean coast. The inducements include the following: Loans of up to FF 4.8 billion are available from a French government agency. The loans carry a fixed interest rate of 7.85%, in contrast to a normal commercial rate of 9.25%. EDL can use accelerated depreciation to write off the construction costs of its extravaganza over a 10-year period. The French government will invest $350 million in park-related infrastructure. This includes sewer and telephone trunk lines, subway and road links to Paris, and a new line of its 156-mileper-hour train a grande vitesse (TGV) that will link EDL to the Chunnel (and thence to London), Brussels, and Lyons. Disney is allowed to buy 4,800 acres of land at 1971 prices. The average cost is FF 11.1 per square meter compared with FF 1,000 per square meter for development land in the Paris suburbs. The French government agrees to cut the value-added tax (VAT) on ticket sales to just 7% instead of the usual 18.5%. Disney will structure the $2.5 billion Euro Disneyland project so that the operating losses created during construction can be used, along with the accelerated depreciation benefits, as tax shelters. These tax benefits will be sold to a group of French companies for $200 million. Equity contributions include the $1.15 billion stock sale plus Disney’s $350 million investment in project planning. The remaining $800 million of project financing will come from loans subsidized by the French government. The repayment schedule on these loans is as follows (in FF millions): Euro Disneyland will also require about $115 million in working capital initially, and this amount is expected to grow at the rate of sales revenue. The working capital will be financed by French franc bank loans carrying an interest rate expected to average about 9.5% annually. Financial Projections Disney’s projections assume a minimum 1992 attendance rate at Euro Disneyland of 11 million visitordays and maximum of 16 million. These numbers compare with 1988 attendance at the domestic U.S. 2 Copyright © 2005 John Wiley & Sons, Inc. parks of 25.1 million for Orlando’s Disney World and 13 million for Anaheim’s Disneyland. In projections of future years’ attendance, a conservative 3% annual growth rate is reasonable. The range of EDL attendance figures based on these assumptions is shown in Exhibit V 2.1. The next step is to forecast individual expenditures at the park on a daily basis, for admission as well as for food and merchandise. Disney’s projections assume that each visitor will spend FF 78.6 on merchandise, FF 59.5 on food and beverages, and FF 5.5 on parking and other items (e.g., stroller rentals). Admission fees are estimated at FF 144.4 apiece. These estimates are based on 1989 francs. French inflation is expected to increase these figures by 5% each year. As of late 1989, the French franc:dollar exchange rate was about FF 6 = $1, but this rate could obviously vary considerably. For example, U.S. inflation is expected to average about 4% annually, about 1% below the expected French inflation rate. Euro Disneyland will also collect “participation fees” from various corporate sponsors, such as Kodak and Renault. These fees are payment for the privilege of sponsoring specific attractions in return for promotional considerations (e.g., Kraft’s “The Land”) and are expected to approximate $35 million in 1992. EDL’s pretax operating margin is expected to be about 35%. That money will not all flow into the hands of EDL shareholders. EDL must pay interest on its debt and French tax. The effective tax rate is estimated at 55%. In addition, EDL must pay Disney royalties, a base management fee, and an incentive-based bonus fee. Under the master agreement, Disney will collect 10% of the revenues generated by ticket sales and 5% of all expenditures on food, beverage, and merchandise. Disney also can collect significantly higher fees from EDL if the park exceeds certain operating cash flow (OCF) targets. Specifically, Disney will collect 30% of the park’s OCF in the range of FF 1.4–2.1 billion; 40% of all OCF between FF 2.1 and 2.8 billion; and 50% of all OCF above FF 2.8 billion. Disney will receive no incentive fee if the park’s OCF is less than FF 1.4 billion. In this case, the operating cash flow will equal operating income as Disney has sold its depreciation tax benefits. 3 Copyright © 2005 John Wiley & Sons, Inc. In November 1989, Walt Disney Co. announced plans to add a movie studio theme park as the second gated attraction to Euro Disneyland. The movie studio theme park is expected to open in 1996. In addition to strengthening Disney’s film production capabilities in Europe (where the movement to enforce geographic quotas continues to gain momentum), the second attraction could add as much as FF 3.3 billion to 1996 operating revenues. Questions 1. These questions are related to the $800 million (FF 4.8 billion at FF 6 = $1) in French governmentsubsidized loans. a. What is the value to Disney of the French government’s loan subsidies? b. What exchange risk is this project subject to from the standpoint of Disney? How can financing be used to mitigate this exchange risk? c. Suppose it turns out that having $800 million in franc financing actually adds to Disney’s economic exposure. How should this affect Disney’s willingness to accept the full amount of financing offered by the French government? 2. Based on purchasing power parity, project the dollar:franc exchange rate from 1989 through 1996. 3. What is the range of projected dollar net income for Euro Disneyland for the years 1992–1996? 4. Suppose the terminal value at the end of 1996 is estimated at seven times net income for 1996. Using a 15% cost of capital, what is the range of net present values of Euro Disneyland as a stand-alone project? 5. Using the same 15% cost of capital, what is the range of net present values of Walt Disney’s investment in Euro Disneyland? 6. Should Walt Disney go ahead with this project? What other factors might you consider in estimating the value of Euro Disneyland to Walt Disney? 4 Copyright © 2005 John Wiley & Sons, Inc.