disney/25"/mike1st/mark2nd

DAN TURNER

Staff Reporter

Long after most of the 12,000-or-so shareholders at last week's annual meeting had left to enjoy their free tickets to Disneyland, Walt Disney Co. Chairman and Chief Executive Michael Eisner abandoned his carefully scripted pep talk for a question-and-answer session, during which he made a somewhat startling acknowledgement:

"People are assuming that the Walt Disney Co. is going to keep growing at the same rate it has in the past," Eisner said. "We're having some problems with ABC, and I just wouldn't assume that."

Eisner, the highest-paid corporate executive in U.S. history, made the remarks in an effort to deflect criticism of his own 10-year employment contract, which ties his compensation to Disney's growth. He was trying to tell shareholders that his contract may not turn out to be as rich as some people think.

Eisner's public acknowledgement that the salad days at Disney may be leveling off is only one of many signs that the company has reached a crossroads in its evolution. Despite all the hype at last week's meeting and the robust performance of Disney stock, the company's earnings were actually lower in 1996 than 1995 the first time that has happened since Eisner arrived in 1984.

After increasing shareholder value at a compounded annual rate of 27 percent a year since 1985, Disney has attained a size at which that kind of growth is no longer possible, analysts say especially because of last year's $19 billion acquisition of Capital Cities/ABC Inc., which has a far slower growth curve than Disney's other operations.

"You're talking about a bigger, more mature, more complex company, and I don't think you could possibly expect them to maintain the 20 percent return on equity they've managed in the past," said Arthur Rockwell, research director at Yaeger Capital Markets.

Indeed, as Rockwell points out, one of the strongest indicators that Disney's upper management is preparing for a more down-to-earth era can be found in a seldom-mentioned aspect of Eisner's employment contract.

Eisner's compensation package has three main components: a $750,000-a-year salary, a bonus and stock options.

Under Eisner's 1989 contract, his bonus was tied to the company's return on equity (derived by dividing net income by shareholders' equity, which is the book value of the company). Under Eisner, Disney has achieved average return on equity of about 20 percent a year, bringing Eisner a bonus of $9.9 million in 1994 and $14 million in 1995.

But Eisner's new contract abandons the return-on-equity formula. Instead, the bonus is now tied to his ability to increase earnings per share over a target growth rate of 7.5 percent.

"Eisner's not stupid," Rockwell said. "He realizes that the formula he had before was not going to make him as rich."

While return on equity is a concrete measure of a company's earnings growth, earnings per share can be easily manipulated through various accounting maneuvers. Further, even a company with flat growth can improve earnings per share simply by buying back shares although Eisner's contract includes a share multiple, meaning his bonus is lower if there are fewer shares outstanding.

Eisner's contract is far from the only indicator that Disney is a very different company in the ABC era. Last year's financial performance was unusually flat for a company that has grown as steadily as Disney.

Disney encourages investors to look at its financial results on a pro forma basis which involves combining Disney's and ABC's pre-merger 1995 figures for a more-accurate comparison with post-merger 1996 figures. The pro forma numbers show a slight gain in net income and earnings per share in 1996 over 1995.

But the actual numbers are less sunny. In 1995, Disney's actual net income was $1.4 billion ($2.60 a share), compared with $1.2 billion ($1.96 a share) in 1996.

The lower results reflect losses at ABC which is struggling with low TV viewership ratings and decreased ad revenues. The network also had high expenses as a result of the merger.

Wall Street generally has ignored the warnings. Since September, Disney's share price has risen from $57 to around $76, where it was trading last week (though its performance in the past year is surprisingly lower than the that of the S & P; 500).

Of course, the problems at ABC are by no means an indicator that Disney won't continue to be far more profitable than its peers in the entertainment industry. The company continues to roll out hit products and films, and the positive response to the recent launch of its Club Disney attraction in Thousand Oaks indicates that it has another winner on its hands.

At last week's meeting, billionaire investor Warren Buffett whose Berkshire Hathaway Inc. holding company owns 24 million Disney shares stood up to defend Eisner and said he expects continued strong growth through the next decade.

"I advise you to keep your stock," Buffett told Disney shareholders.

Eisner's contract, which includes options for 8 million Disney shares with an estimated value of anywhere from $195 million to $400 million, was approved by 88.8 percent of the proxies last week even though it was adamantly opposed by some shareholders.

Some experts on entertainment industry employment contracts said Eisner is worth it.

"It really is a matter of supply and demand, because people like Eisner are very, very unique," said attorney Jim Baer, a partner at Katten, Muchin & Zavis who specializes in entertainment contracts. "Running a huge entertainment company isn't like running a company that manufactures widgets. There's a great deal of creativity involved, and you have to be able to deal with not just right-brain people, but left-brain people."

Further, Eisner's pay is almost entirely connected to his ability to increase the value of Disney stock for shareholders, a compensation strategy that more and more large companies are adopting for their CEOs.

"It's like when a baseball player signs a $25 million contract," said entertainment analyst Steve Cesinger with investment bank Greif & Co. "People just think, 'My God, how can one individual make that much money?' But they don't see the big picture; they don't see how many tickets that ballplayer sells."

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