13 —— Case Study: The Euro Disneyland Project roject sponsors need to address two basic questions early in the P planning stages for a project: 1. Should one or more separate legal entities be established to fi- nance, construct, own, and operate the project, and if so, how should each be organized? 2. What credit support arrangements will have to be put in place in order to attract the required capital? The Euro Disneyland Case Study illustrates how one major corporation addressed these issues, how financially restructuring a project can real- locate risk to other project participants and away from the original spon- sor, and how the sponsor can derive benefits from this risk reallocation. INTRODUCTION Euro Disneyland would introduce to Europe a theme park and resort concept that The Walt Disney Company (“Disney”) had developed— and seemingly perfected—in the United States and Japan over the is based on Bruner and Langohr (1994) and Euro Disney 8.C.A. (1990, 1993, 1994a, 1994b). 256PROJECT DESCRIPTION 257 preceding 35 years. ‘The first phase of the project (the “Euro Disney- land Project”) has been completed; other stages are scheduled to be completed through 2011. The complex financing structure Disney devised for the Euro Disneyland Project ultimately proved to be too highly leveraged. The high leverage created significant financial risk for a company that turned out to have relatively high operating risk. The financial suc- cess of the project depended importantly on the project entity's being able to develop and sell substantial real estate holdings at a significant profit in order to generate cash to pay down debt to a sustainable level. However, the real estate boom in France ended abruptly— principally because of a severe recession in Europe and an increase in interest rates. At the time the project financing was arranged, it was viewed very favorably. One article assessing Disney’s arrangement with the French government concluded that the Euro Disneyland Project will be “prof- itable. And .. . the wealth will be shared.”! A second article praised the structure and indicated that Disney had applied all the lessons it had learned from its other three theme parks in California, Florida, and Tokyo.2 In 1989, it seemed that Disney was well on its way to a huge success. PROJECT DESCRIPTION Disney planned to build the theme park and resort on approximately 4,800 acres of land located 32 kilometers due east of Paris. Disney chose this site based on availability, communications, and proximity to potential customers, after considering more than 200 possible sites in France and Spain. Approximately 17 million people lived within a 2- hour drive. More than 100 million lived within a 6-hour drive. About half of the developable land, 2,115 acres, would be devoted to enter- tainment and resort facilities. Another 1,994 acres would be set aside for retail, commercial, industrial, and residential purposes. The bal- ance of 691 acres would be used for regional and primary infrastrue- ture, such as roads and railway tracks. Upon completion, Euro Disneyland would be the largest theme park and resort development in Europe. It would be ideally situated at the hub of a vast transportation network, Euro Disneyland would be linked to Paris by the RER (regional express metro) suburban railroad258 CASE STUDY: THE EURO DISNEYLAND PROJECT system. It would be linked to the rest of France and Europe by the A4 motorway, and, in June 1994, by the high-speed train a grande vitesse (TGY) railroad network. The project would feature two separate theme parks. It would be built in phases. Phase I would include the Magic Kingdom theme park, which would be modeled after similar theme parks in the United States and Japan; six hotels; an entertainment center; the Davy Crockett Campground; and related infrastructure and amenities. Phase IA would consist of the initial investment in the Magic Kingdom theme park, the Magic Kingdom Hotel, and peripheral development. Disney planned to complete Phase IA and open the Magic Kingdom in April 1992. Disney expected Phase IA to cost FF14 billion.$ Phase IT would include a second theme park, the Disney MGM Studios Europe, based on Disney’s MGM Studios theme park in Florida; additional hotel de- velopment; a water recreation facility; offices; and industrial, retail, and residential developments. Disney planned to build a comprehensive resort facility containing more than 20 hotels (with 18,200 rooms). It would have six hotels (with 5,200 rooms) ready by 1992 when the Magic Kingdom would open. The other hotels would be added over a 20-year period. The resort facility would eventually include two golf courses, a water recreation area, campgrounds with 2,100 sites, and a large retail and entertainment complex. Disney's plans also included commercial development con- sisting of single- and multifamily residences, time-share apartments, more than 7.5 million square feet of office space, more than 8 million square feet of industrial space, and more than 1 million square feet of retail space. DISNEY Disney is a diversified entertainment company with headquarters in Burbank, California. Disney’s operations fall into three principal seg- ments: (1) the theme parks and resorts segment generated roughly 40 percent of the $8.5 billion in total revenue and 43 percent of the $1.7 billion in total operating income in 1993; (2) the filmed entertain- ment segment accounted for 43 percent of revenues and 36 percent of operating income in 1993; and (3) the consumer products segment accounted for the remaining 17 percent of revenues and 21 percent ofPROJECT OWNERSHIP STRUCTURE 259 operating income. Disney is acknowledged as the world’s leading theme park operator. In the 1980s, Disney management had set a 20 percent growth tar- get for the company. Expansion of theme park ‘operations was an inte- gral part of the strategy Disney had implemented to achieve that goal. With a well-penetrated American market, Disney realized that inter- national expansion was necessary to achieve the growth target. The first international expansion took place in Asia; the Tokyo Disneyland theme park opened in 1983. The project was successful from the out- set. This success prompted Disney to investigate other opportunities for international expansion. With the European Union taking shape, Europe seemed like an ideal site. PROJECT OWNERSHIP STRUCTURE The original plan called for Disney to build, own, and operate the Euro Disneyland Project in a manner similar to its operation of Walt Disney World (Disney’s Florida theme park) and Disneyland in Southern Cali- fornia. This ownership arrangement would ensure Disney 100 percent of the future earnings potential of the park. Disney management was de- termined not to repeat two mistakes of years past: (1) letting others build the lucrative hotels near the park, as happened at Disneyland in South- ern California, and (2) allowing another company to own a Disney theme park, as occurred in Tokyo (where Disney only collects royalties from the immensely profitable attraction). Although the ownership structure would enable Disney to retain 100 percent of the upside po- tential, it would also leave Disney with 100 percent of the risks inherent in such a tremendous financial undertaking. Disney’s then-current man- agement had transformed Disney from a company with $1 billion of rev- enues into one with annual revenues of $3.4 billion (in 1988), mainly through internal growth. The corporate managers felt they could find a more advantageous way to structure the project. Financial projections indicated expected profitability from the first year of operations (1992) amounting to approximately FF204 million on theme park revenues of FF4.25 billion and total revenues of FF5.48 bil- lion.4 Net income was expected to reach FF972 million on total revenues of FF10.93 billion in 1995. For the year 2001, Disney projected total revenues of FF22.43 billion and net profit of FF1.76 billion. With such260 CASE STUDY: THE EURO DISNEYLAND PROJECT impressive profit expectations, it seemed inconceivable that Disney would want to bring additional participants into the project. However, under the agreement Disney negotiated with the French government— the Agreement on the Creation and the Operation of Euro Disneyland en France (the “Master Agreement”)—Disney was required to sell a ma- jority stake in the project entity to European investors in order to “share the wealth.” In the spring of 1989, Disney set in motion a series of transactions that altered the ownership, management, financing, and control of the Euro Disneyland Project. Figure 13.1 illustrates the resulting owner- ship structure. Disney reduced its 100 percent equity interest in the project to 49 percent. The transactions initiated in the spring of 1989 would also reimburse Disney for FF1.9 billion of project development costs, increase the project’s leverage substantially, and result in the public offering of common stock by a company that had never earned any revenues. The change in project structure was made in part in re- sponse to the French government's request, but limiting the risk expo- sure of Disney's shareholders was undoubtedly another important consideration. Project Entities The primary participants alongside Disney included a bank consortium (consisting of about 60 banks), the French government, other creditors, and public shareholders. Ownership, however, was limited to two French “owner companies” provided for in the Master Agreement. 1. Euro Disneyland $.C.A. (EDSCA), one of the two owner com- panies, is organized as a société en commandité par actions (S.C.A.), which is very similar to a limited partnership. Disney would own 49 per- cent of EDSCA. The remaining 51 percent would be held by European investors after the public offering. EDSCA’s principal corporate pur- pose would be to develop and operate the Euro Disneyland Project com- plex. EDSCA would be managed by its gérant. 2. Euro Disney S.A, (EDSA), a gérant or management company, was established as a wholly owned subsidiary of Disney. EDSA but has no ownership interest in, EDSCA. Its sole responsibi S manage EDSCA in that company's “best interest.” EDSA would have, for the most part, broad discretion in managing the day-to-day affairs of the Euro Disneyland Project. EDSA would initially receive a base fee