Kathryn Harris

Some of the magic seeped from the wizardry of Walt Disney Co. in its court battle with former studio chief Jeffrey Katzenberg, which will determine the size of a bonus due him. Old deals, scrutinized in the trial, look like hobgoblins now.

Take film financing. No studio was more adroit in raising "off-balance sheet" money for film production in the late 1980s, when a new management team led by Chairman Michael Eisner raked in $800 million from investors who bought shares in three partnerships to finance 66 Disney films. The partnerships were run by Silver Screen Management Services Inc.

Now, as the trial unfolds, we're learning more about the costs of those deals. Like ghosts, the Silver Screen partnerships won't go away, even though Disney paid $500 million to end the relationships.

Disney had to share the unexpectedly large profits from hit films such as "Good Morning Vietnam," "Three Men and a Baby," "The Little Mermaid" and "Beauty and the Beast." By the end of 1997, more than $1.3 billion had been disbursed to Silver Screen partners, with at least $330 million more due in 1998.

A big chunk of the money was paid by Disney to rid itself of the Silver Screen partners' claim on future profits. In September 1995, Disney agreed to pay $500 million to buy out all three Silver Screen partners' remaining interests in its films.

Now Katzenberg, who left Disney in 1994 to co-found DreamWorks SKG, is using the Silver Screen buyout to calibrate the bonus he is in court to collect. Katzenberg contends that he is due $578 million based on a contract provision granting him a 2 percent share in future profits from films and TV shows initiated during his decade at Disney.

The Silver Screen partnerships are ones that Disney executives "wish they'd never heard of," said one veteran Wall Street analyst who, like most analysts watching the trial from afar, didn't want to be quoted by name.

Had it not been for the Katzenberg trial, most shareholders, journalists and readers would be unaware of the Silver Screen denouement. Disney didn't issue a press release or disclose the $500 million buyout in its fiscal 1996 annual report filed to the Securities and Exchange Commission.

Maybe the buyout wasn't "material." But now? I searched in vain for a current Disney executive who might discuss the pros and cons of the Silver Screen partnerships. "No one (is available) until this trial is over," said Disney spokesman John Dreyer.

For its part, Silver Screen Management reported the buyout in SEC filings. But who other than the doctors, lawyers and other investors who bought Silver Screen units paid attention to film partnerships of yesteryear? The investments lost allure in the United States because of the attractiveness of the soaring stock market. Silver Screen Management raised its last money for Disney in 1988.

By 1990, Disney had turned to Japanese investors, who raised $600 million for film production before Japan's economy stumbled. Disney kept animated films out of that partnership, after regretfully sharing windfall profits with Silver Screen partners from five earlier animated hits.

According to one court exhibit, those five films "The Great Mouse Detective," "Oliver and Company," "Little Mermaid," "Rescuers Down Under" and "Beauty and the Beast" generated $1.75 billion in revenue in their first release. Disney calculated that the second cycle would generate $1.2 billion in revenue, which it didn't want to share with the Silver Screen partners.

Disney had the right to buy out the partners' interests in the films if they could agree on a price. Two of the partnerships allowed Silver Screen Management to seek other distributors for the films if it couldn't reach agreement with Disney about their residual value.

In a presentation to Eisner in September 1995, a team of Disney executives reported that Silver Screen intended to hire Allen & Co., an investment bank, as its appraiser. According to the document introduced as trial evidence, Allen & Co. put the "fair value" of the buyback at $1 billion.

Katzenberg has seized the Silver Screen buyout as a good measure of Disney's true calculation of the future earning power of the films he set in motion. Of the 66 films, 62 are among the "eligible product" on which his 2 percent bonus is based.

The Katzenberg legal team produced an expert witness who testified that that the Silver Screen buyout was "uniquely similar to the eligible product that we are seeking to value" in the Katzenberg contract.

The witness was Dennis Soter, a partner in Stern Stewart & Co., a New York consulting firm that specializes in independent valuations and fairness opinions. But in cross-examination, a Disney lawyer challenged his valuation as tilted heavily in Katzenberg's favor.

In its trial brief, Disney has contended that it owes Katzenberg about $140 million, or $438 million less than Katzenberg's valuation based on the Silver Screen model.

Katzenberg's lawyers, on the other hand, have made much of the fact that Disney destroyed nearly all of its internal documents on the Silver Screen buyback. Disney must have had something to hide, they suggest.

Heck, if Disney could make any deal disappear, it would be the Katzenberg contract that calls for the extraordinary 2 percent bonus.

But Disney is in the awkward position of not wanting to criticize the architect of the employment agreement: Frank Wells, the late Disney president who died in a 1994 helicopter crash. Wells was also largely responsible for the Silver Screen partnerships.

Some ghosts must be allowed to rest.

Kathryn Harris is a columnist for Bloomberg News.

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