Overview

Over the past two years, Disney’s (DIS) earnings multiple has shrunk from 22x to 17x, while Apple’s (AAPL) has risen from 12x to 17x. Remarkably, they now trade at the same multiple, while Disney enjoyed a premium of 80% in earlier years, reflecting its strong brand and durable business. While Apple is flying high right now along with the rest of the technology sector, an acquisition of Disney would serve as a hedge against an inevitable downturn in the handset cycle, and drive more recurring service revenue at Apple.

Rationale for deal

The handset world has largely been reduced to a duopoly between Apple and Samsung. While Amazon (AMZN) and Alphabet (GOOG) have had limited success so far in the handset hardware space, they are bound to try again. It behooves Apple’s management and board to try and strengthen their business while they can.

Apple has tried to get into the entertainment business with no success. It has nothing to show for its acquisition of Beats in 2014 for $3 billion. Apple TV is an embarrassment whose number of users pales in comparison to other hardware devices like Fire TV or Roku. There have been rumors for years that the company is going to enter the television business, but so far nothing has happened. 

Meanwhile, wireless carriers are getting into the content business. AT&T (T) is in the process of buying Time Warner (TWX), Verizon (VZ) bought Yahoo, and T-Mobile (TMUS) is offering free Netflix (NFLX) subscriptions to family plan subscribers.

An acquisition of Disney would offer tremendous synergies to Apple. Both are creative-talent companies based in California, with similar cultures that would facilitate an easy integration. Disney’s CEO, Bob Iger, serves on Apple’s board. Iger is scheduled to retire in July 2019 with no obvious successor, and a deal will solve this problem. Further down the line, there is no heir-apparent to Tim Cook at Apple either, and adding Disney’s bench of management talent will widen the available pool.

Disney is at a crossroads, having decided to pull its content from Netflix, increasing its investment in loss-making BAMTech, and planning to launch its own streaming business. On its own, this business is likely to be sub-scale, but combined with Apple’s customer base, it will be a potent endeavor.

Synergies

There would be the usual cost synergies with removing a redundant layer of high-level common functions in investor relations, finance and HR. However, the real attraction would be in how Disney’s businesses can be integrated into the Apple eco-system.

Disney’s main businesses and the potential synergies are as follows:

Media Networks: This business comprises the cable networks like ESPN and broadcast networks like ABC. The live programming and scripted shows could form the basis for a streaming TV service for Apple customers.

Parks and Resorts: This segment houses the theme parks and cruise ships. Integrating iOS into Disney’s existing technology would enable customers to use their iPhone or Apple Watch to book their place in a line, check into their hotel or cruise, book activities and pay for meals.

Studio Entertainment: Disney makes the best kid-friendly movies in the world. The film library can be used as a base to provide a streaming movie service while providing iPhone users sneak previews of upcoming releases.

Consumer Products & Interactive Media: Disney’s merchandising expertise could be used to customize iPhones, from a Star Wars theme for nerds to a Frozen princess for kids.

Financial impact

Unlike many of the momentum-driven unprofitable companies in today’s market, Disney is a profit machine and an acquisition would be accretive even without accounting for the synergies and strategic fit.

An acquisition for a 30% premium at $130 per share would mean an outlay of $200 billion.  This price would be higher than what Disney’s stock has ever traded at, and is highly likely to be acceptable to its shareholders. It could be funded with $100 billion of cash and the issuance of 650 million Apple shares, providing some measure of tax deferral for long-time Disney shareholders. With a modest amount of cost synergies (a few hundred million dollars a year), Disney would contribute $10 billion a year in annual profits before financing costs of $3 billion (assuming a 3% cost for the cash/debt). This would drive 3% earnings accretion for Apple before any revenue synergies. Please note that I am using 2017 earnings estimates for both companies because 2018 estimates look inflated at this point.

Will it happen?

A $200 billion deal would obviously be a blockbuster of a scale that one does not see often. In fact, it would be the biggest of all time, beating out Vodafone’s (VOD) purchase of Mannesman for $172 billion in 1999. (Adjusted for inflation, that deal would be bigger). Given Apple’s quarter trillion dollar cash position (okay, it’s only $160 billion net cash after accounting for debt), I don’t think financing would be a problem, even though most of its cash is abroad. With no product overlap, the deal should face no problem on the regulatory front. I believe equity investors would welcome it and drive Apple’s stock higher.

In 2004, Comcast (CMCSA) made an unsolicited offer for Disney, but it was not consummated due to opposition from Comcast’s shareholders and Disney’s refusal to negotiate. The company could try again and recently settled for buying DreamWorks Animation. Admittedly, it would be more difficult now that Comcast owns Universal.

Disney is a unique asset available at a reasonable price and would represent a fantastic fit for Apple. Back in 2010, when Apple had a mere $50 billion cash pile, then-CEO Steve Jobs said that the company was keeping its powder dry for any strategic opportunities that came along. Seven years later, the powder pile has quintupled, and could get soggy if the company waits much longer!