If ever there was a business which has found the magic formula for making profits it is Disney’s theme park division. Last year alone it generated 69.6% of the media giant’s $12.9 billion operating income on just 36.6% of the revenue. It is partly thanks to a controversial trick tucked up Mickey’s sleeve.
On the face of it, theme parks have a simple business model. According to the International Association of Amusement Parks and Attractions (IAAPA), between 55% and 60% of revenue comes from entry tickets with 25% to 30% coming from dining and merchandise and the remainder generated by licensing, sponsorship and special events.
Crucially, the entry tickets tend to be loss leaders meaning that they often don’t cover the parks’ colossal energy and staffing costs. However, the loss made on the tickets is more than outweighed by the profits made by the on-site shops and restaurants. Once guests are inside the parks they are a captive audience so have little choice but to eat there whilst gift shops are often cunningly-placed outside the exits to the rides to subliminally tempt them to buy merchandise when they are at their happiest.
Food, beverage and merchandise have the highest margins so the more guests who stream through the turnstiles, the higher the profit for the park operator. So far, so simple however that is just the start of the story for Disney. One of its resorts pays it just for opening its doors and last year its dues rose by 32.2% to a record $166.5 million (€156 million).
The resort is Disneyland Paris which, ironically, is seen as being one of Disney’s least profitable outposts. It is actually anything but that.
Disneyland Paris is Europe’s most-visited tourist site and attracted 15.3 million visitors in 2022 according to the Themed Entertainment Association’s latest Global Attraction Attendance Report. It has had a magic touch on its bottom line.
As we recently revealed in The Guardian, the resort’s parent company Euro Disney Associés (EDA) surged from a $50.1 million (€47 million) net loss in 2022 to a $171.8 million (€161 million) profit last year as revenue hit a record $3.1 billion (€2.9 billion).
The complex on the outskirts of Paris comprises seven on-site hotels, two convention centers, a 27-hole golf course and two theme parks – the fairytale-inspired flagship Disneyland Park and the movie-themed Walt Disney Studios which yesterday announced that it plans to change its name to Disney Adventure World.
The change is due to coincide with the opening over the next few years of a new land themed to the hit animated movie Frozen. It is part of a $2.1 billion expansion which we revealed in November 2017 in British newspaper The Express. It was officially announced in February the following year by Disney’s chief executive Bob Iger and French president Emmanuel Macron.
Although Disney is funding the expansion, its investment is almost equivalent to the dues that the media giant has received from Disneyland Paris. As the graph below shows, since Disneyland Park’s ornate iron gates swung open in 1992, EDA has paid Disney the blockbuster total of $1.9 billion in royalties and management fees.
The origin of these spellbinding payments stretches back to before the opening day. When Disney was looking for a site in Europe it requested a plot of land a fifth the size of Paris in order to maintain its exacting standards in the area surrounding the parks. Disney got its wish but it came with a catch.
As we have reported, the French government was only prepared to allocate such a large plot of land to a foreign company on condition that it entered into a public-private partnership.
Disney incorporated Euro Disney SCA which became the resort’s parent company and was listed on the Paris Euronext exchange. Only 49% of it was in Disney’s hands making it the private party in the partnership. The majority of the shares were owned by the public and this made it difficult for Disney to pour money into the business as it has done with its parks in the United States which it wholly-owns.
Instead, the resort funded its construction with $1.8 billion (€1.7 billion) of bank borrowings and Disney followed suit by lending it even more money. Surprisingly, that wasn’t the most essential asset that Disney handed over.
As Euro Disney wasn’t wholly-owned by Disney it needed a license to use the company’s characters, movies and other intellectual property. This was essential as the vast majority of the attractions in its parks are based on Disney’s IP.
That license agreement is still in force today and although the details of its contents are not widely known, they can be found deep inside documents that Euro Disney filed when it was floated.
They state that “on February 27, 1989, the Company was granted a license to use any present or future intellectual or industrial property rights of TWDC [The Walt Disney Company] that may be incorporated into attractions and facilities designed from time to time by TWDC and made available to the Company. In addition, the license agreement authorizes the sale, at the Resort, of merchandise incorporating or based on intellectual property rights owned by, or otherwise available to, TWDC.”
Payment comes in the form of royalties and, as the documents reveal, they “represent amounts payable to an indirect wholly-owned subsidiary of TWDC under a license agreement. This license agreement grants the Group the right to use any present or future intellectual or industrial property rights of TWDC for use in attractions or other facilities and for the purpose of selling merchandise.”
The documents add that under the license agreement, Disney receives “10% of gross revenues (net of taxes) from rides, admissions and related fees (such as parking, tour guide and similar service fees) at all Theme Parks and attractions; 5% of gross revenues (net of taxes) from merchandise, food and beverage sales in or adjacent to any Theme Park or other attraction, or in any other facility (with the exception of the Disneyland Hotel), whose overall design concept is based predominantly on a TWDC theme; 10% of all fees paid by participants (net of taxes); and 5% of gross revenues (net of taxes) from the exploitation of hotel rooms and related revenues at certain Disney-themed accommodations.”
In addition to the royalties, EDA paid management fees to a Disney subsidiary but both payments were repeatedly reduced and waived when the resort fell on hard times. The very structure which got Disneyland Paris off the ground ended up bringing it to its knees as the finance charges on its debt dragged down its bottom line. As the graph below shows, the resort’s parent company has only made a net profit 12 times over the past 32 years with total losses coming to a staggering $3.9 billion (€3.7 billion).
In just its second year, Euro Disney hit a recession and burned up a net loss of $868.2 million (€813.6 million) putting it at risk of bankruptcy. Saudi investor Prince Alwaleed brought some much-needed magic by investing around $430 million which funded new attractions and in 1995 the company made its first net profit of $18.6 million (€17.4 million).
It began a seven-year run of net profits which peaked at $47.2 million (€44.2 million) in 1998. Like every good Hollywood story there had to be a sequel so Euro Disney gave the green light to building the studios park which opened to coincide with the resort’s tenth anniversary in 2002.
Financed by borrowings and a capital increase, the studios park was meant to cement Euro Disney’s standing but bad luck struck again. The huge overheads of running two parks swelled operating costs just as the tourism downturn hit following 9/11.
By 2005 the company needed a $266.8 million (€250 million) rights issue, backed by Alwaleed. With its new finance, Euro Disney pulled out all the stops and spent an estimated $106.7 million (€100 million) on the Tower of Terror, a freefall ride set inside a 180 feet art deco tower which opened in April 2008. It brought an immediate glow to Euro Disney’s bottom line.
In 2008 the company made its first net profit in six years and finished $1.8 million (€1.7 million) in the black. Attendance rose 100,000 to an estimated 15.4 million in 2009 and it seemed the Mouse had finally come of age. However, there was another twist to come and debt was the villain of the piece.
The interest and repayments on Euro Disney’s bank loans fuelled losses and left the company with little profit to invest. In 2009, on one of its busiest days of the year, staff protested against a pay freeze by striking and marching through the Victorian-themed Main Street at the heart of the Disneyland Park. It caused the first-ever cancelation of its daily parade and sparked three years of protests.
Undeterred, in 2010 Disney signed an amendment to its agreement with the French government which increased the area at its disposal, extended its duration to 2030 and planned for further developments including a third theme park and three convention centres.
Trouble continued to brew behind the scenes and in 2012 there was another strike. This time the embarrassing spectacle was watched by British broadcaster Jonathan Ross who tweeted to his 4.9 million followers: “We are at Disneyland Paris for the 20th anniversary. There’s a dispute and strikers march down Main st. Worst Disney parade.”
It grabbed Disney’s attention and six months later it replaced Euro Disney’s bank borrowings with a low-interest loan. In 2014 it followed this up with another rights issue as well as a $640.3 million (€600 million) debt-for-equity swap. The final act came in 2017 when Disney took full control of the company in a $2.13 (€2) a share offer. EDA became its parent company and Euro Disney was de-listed from the Euronext. It was far from a happy ending for the shareholders.
Activist investor CIAM owned a 1.4% stake in Euro Disney and ahead of the takeover claimed that Disney should reimburse the company more than $960.4 million (€900 million) of the fees and royalties it had received. CIAM argued that they were excessively high and brought dark clouds to Euro Disney’s bottom line.
In response, Disneyland Paris’ former vice president of communication Francois Banon rightly pointed out that there is nothing improper about the management fees, royalties or the payment structure itself. He added that CIAM’s allegations were “false and unfounded” and, testimony to this, its demands didn’t bear fruit.
Nevertheless, the payments are controversial because they reduce the profits of the company which hands them out. Quite simply, the payments are a cost and the higher the costs, the lower the profit which is why they angered CIAM. However, this isn’t the only consequence of the payments. The lower the profit, the less tax is paid so the payments are also a perfectly legitimate way for a company based in a high tax jurisdiction to reduce its bill.
Known as transfer pricing, this process involves the owner setting up another company in a lower tax jurisdiction which then bills its counterpart for fees. Paying the fees drives up the costs of the company which usually has a high tax bill and this reduces its profit. In turn, its tax bill goes down whilst the fees it pays end up in a jurisdiction with a low rate. In summary, transfer pricing essentially involves the owner of a company moving money from its left hand to the right in order to pay less tax.
Crucially, the fees need to be charged at what are known as arm’s length rates meaning that they cannot be excessively high or it would reduce the tax bill by a disproportionate amount. While Disneyland Paris hasn’t fallen foul of this condition, it landed Disney’s French parent company with a bill of $94.3 million (€88.4 million).
News agency Bloomberg lifted the curtain on Disney’s dilemma in November 2018 when it revealed that French tax authorities had raided its offices in Paris on October 5 2017 hunting for evidence of whether it had breached transfer pricing regulations. The inspections lasted for two days as documents and mailboxes were seized by the authorities.
The Mouse didn’t take it well and lodged multiple lawsuits arguing that the raids were illegal. Amongst other things, Disney claimed that the tax officials had breached professional secrecy by providing Disney’s IT chief with the salaries of staff members which appeared alongside their names on a list of the computers they wanted to investigate. A judge ruled that while this disclosure was “regrettable” it was limited and didn’t justify invalidating the raids so Disney’s lawsuits were tossed out.
The authorities believed that a Disney unit in the United Kingdom had overcharged the Walt Disney Company (France) for IP royalties and managing and coordinating its activities. In turn, this led to the company making lower profits and paying less tax in France. The authorities said that lumping together the IP royalties and management and coordination costs made it impossible to verify whether the transaction between the two Disney entities was correctly priced.
The amounts at stake were huge as the fees paid by the French company reportedly accounted for more than 90% of its operating profit in the first half of the decade. There was good reason for this. The UK had one of the lowest corporation tax rates in Europe at the time and reached a record low of 19% when the investigation began in 2017 whereas it came to 33.3% in France.
The investigation came on the back of a tax audit of Disney’s French unit and the Mouse thought it would come out on top of that too.
The 2019 financial statements of the Walt Disney Company (France) acknowledged that that “the company is currently subject to tax audits covering the years 2013 to 2018. As part of this process, during the financial year the company received proposed rectifications for the 2013 to 2015 period which it disputes.” It added that a further “proposal for rectification relating to the 2016 financial year was received on December 30, 2019. No provision was recorded at the end of the financial year as the company believes it has solid arguments to justify its position.” This time Disney failed to work its magic.
Later filings revealed that “2021 was marked by the conclusion of a dispute between the tax administration and the company over the 2013 to 2018 years. As a result, an amount of €88.4m was recorded in the financial statements.”
Disneyland Paris has faced no such problems but nevertheless put the brakes on the management fees following the takeover by Disney. The royalties are still being paid and even continued throughout the pandemic, albeit at a much lower level than usual.
So although EDA’s $171.8 million net profit cast a powerful spell last year, it was only part of the story. Disney also pocketed $166.5 million of royalties giving it a total of $338.3 million from Disneyland Paris and that really is a happy ending.
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