ISBN: 0-03-028931-9

Chapter 4 Financial Planning and Forecasting

Forecasting Disney's Future

In early 1998, corporations were reporting earnings for 1997. Simultaneously, security analysts were issuing their forecasts of earnings of 1998. Stock prices were extremely volatile, moving up with a good earnings surprise – that is, where reported EPS was higher than analysts had been expecting – and down with unpleasant surprises. Corporate executives know that these reactions will occur, so they generally try to give analysts early warnings when unpleasant surprises are likely to occur. The logic is that unpleasant surprises increase uncertainty about the future, so a stock will react less negatively to low earnings if the drop is anticipated than if it is a complete surprise.
Corporate finance staffs also review their own internal plans and forecasts during the first part of the year. Firms' formal plans are generally completed in the fall and then go into effect at the start of the year, so early in the year information starts coming in that indicates how the year is shaping up.
For executives at Walt Disney Co., 1998 was a particularly difficult year. After several years of outstanding performance, Disney's earnings fell, causing a sharp drop in its stock price. Trying to address investors' concerns, Disney's Chairman and Chief Executive, Michael Eisner, began his annual letter to shareholders with the following words:

To Disney Owners and Fellow Cast Members:

I am looking out the window and can see the seasons change (yes, the seasons do change in Los Angeles - the eucalyptus leaves droop more and the sprinklers go on less often). I am reminded that our rhythms are set by the seasons and that any number of human endeavors are ruled by the calendar. Such as this annual report. Every 12 months we compile it, and every 12 months I sit down to write you this letter.

There's just one problem with this annual exercise: It implies that businesses can be run in neat 12-month chunks of time. Unfortunately, the business cycle has its own seasons, which are not ruled by the orderly and predictable orbit of the earth around the sun. Indeed, at Disney, we live by a 60-month calendar. We set our goals over rolling five-year timelines. In this context, each year is more like a season. Some are sunny and some are overcast, but each is merely a period of passage and not a destination. Our five-year calendars force us to think long-term. They make us devise strategies that add value, not squeeze profits.

Eisner went on to tell shareholders that the company's long-run forecast remained promising. After acknowledging that Disney had problems in its entertainment and broadcasting divisions, he went on to state that the company was taking steps to cut costs and to improve operations. Eisner also stated that Disney's earnings had been hampered because it had begun a series of expensive new projects, including Disney's Animal Kingdom, its Cruise Line, the launching of ESPN magazine, and the renovation of Anaheim Stadium. However, he argued that they were laying the groundwork for future profitability.
In spite of Eisner's assurances, many analysts are doubtful about Disney's prospects, although others are betting that given its track record, the stock will rebound in the future. Unfortunately, no crystal ball exists for predicting the future. Instead, both corporate insiders and investors must base decisions on their own financial forecasts. While forecasting is necessarily somewhat subjective, we discuss in this chapter some basic principles that will improve financial forecasts. By the time you finish the chapter, you will have a good idea about how to forecast future results for Disney or any other company.

DISCUSSION QUESTIONS

1. Looking at Disney's current status and the recent stock performance, which factors do you think led Disney to its current state?
2. What is your assessment to date of each of the expansion projects mentioned by Mr. Eisner? Successful, unsuccessful, or uncertain?

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