Disney's castle in the air: Of mice, men and mounting losses. Gail Counsell tells how the Disney dream has faded as Mickey's magic failed to charm the Euro market

THE intelligentsia may have dubbed it a cultural Chernobyl, but the world has Euro Disney to thank for one thing; without the struggling theme park we would never have known that Walt Disney was really a Frenchman.

In the mid-1980s, when the giant Walt Disney company first mooted the idea of building a European version of its famous theme parks, it became evident that the French authorities would stop at nothing to persuade the group to locate the resort and its 12,000 jobs in the depressed agricultural region of Marne la Vallee, 20 miles east of Paris.

The 1980s were a time of rising unemployment in France; the socialists needed the jobs as well as the prestige that Euro Disney would bring. And Marne la Vallee, designated a new town in the 1970s, had run out of steam part way through its anticipated expansion. Accordingly no stone was left unturned in the attempt to persuade the Americans that Paris, despite its poor weather and high prices, was the place to be.

Money was no object. Around 5,000 acres of land were offered to the company at 1971 prices; road and rail links were promised; tax breaks and pounds 420m of loans at under 8 per cent for 20 years were thoughtfully pressed on the Americans.

Such were the sweeteners that Christian Cardon, who rejoices in the title of Delegue Inter Ministeriel au Projet Euro Disneyland en France, calculates as much as one in every nine francs spent on the development to date has come from the French public purse.

Other inducements were subtler. French enthusiasm for the deal started at the very top, and Francois Mitterrand, the country's regal president, stooped to press the French cause personally. But what showed the French were serious about Euro Disney was their acceptance of a claim to French ancestry for the Disney patriarch.

THE unlikely tale offered a double source of Gallic satisfaction, beginning as it did with the celebrated crushing of the English by the French in 1066.

As the story goes, Guillaume de Normandie was ably assisted in this task by two French soldiers, Hugh d'Isigny and his son, Robert. Natives of the Normandy village of d'Isigny-sur-Mer, the d'Isignys decided to remain on English soil following the great victory over King Harold.

Naturally, in the course of the next few dozen generations, the family name mutated into Disney. A brief sojourn in Ireland later, and Arundel and Robert Disney, Walt's forbears, embarked for New York. The year was 1834 and the rest, as they say, is history, albeit American not French.

Whether it was the financial blandishments or the cultural ones that did the trick, Main Street, Marne la Vallee, duly defeated the 240 other European candidates in the race to host the fourth Disney theme park, joining the then existing trinity of California, Florida and Tokyo.

Yet the pact with the French authorities had Faustian elements not appreciated in the balmy days of 1987, when Disney signed an outline agreement with the authorities covering the development of the resort.

This was supposed to take place in three stages spanning the years to 2017 - when Mickey Mouse, who reaches retirement this year, will have attained the grand old age of 90. By then, the Magic Kingdom and associated developments were to cover an area a fifth the size of Paris.

Such was the dream. The reality has foundered on the rocks of the European recession. So far, less than a third of the land allocated to Euro Disney has been developed; and for more than a year the losses have mounted alarmingly. Last week, the grinding of the ship on the bottom was almost audible as the company admitted that it would have to shelve indefinitely plans for phase two of the park, the centrepiece of which was to have been an 85,000 square metre theme park based on the MGM film studios.

To the shock of the French authorities, who had assumed the second stage was in the bag, and to the company's management, Euro Disney's American parent declined to give the expansion the go-ahead.

Plans had been made; an announcement was due to be made tomorrow. But it was not to be. The Legion d'Honneur given to Michael Eisen, Disney's US president, last year to mark six months of the park's operation, proved to little avail.

Mr Cardon, for the French authorities, declared himself 'surprised and disappointed'. Philippe Bourgignon, Euro Disney's chairman, spoke obliquely of his 'regret'.

Euro Disney had seen the second phase as the solution to one of its key problems - pitifully low hotel occupancy levels at the resort. The company view was that expanding the park's attractions and making them last more than a day, would mean visitors would have to stay overnight, so boosting the resort's revenues.

But the Americans, who would have had to back the FFr5bn ( pounds 580m) borrowings needed for the FFr9bn expansion, were less sure, fearing it might end up being part of the problem. Instead, they said, they wanted to complete a thorough review of Euro Disney's financial and development strategy - a task unlikely to be finished before spring next year. In the meantime, they conceded, they would finance the struggling group's funding needs.

The immediate cause of this decision was the mounting losses faced by the resort as it entered its supposedly busiest season - FFr500m between April and June, on top of just over FFr1bn in the previous six months - and the uncertainties dogging the project as European economies moved deeper into an unpredictable recession.

The number of British people visiting Euro Disney has halved as the value of the pound has plummeted against the franc following the withdrawal of sterling from the Exchange Rate Mechanism.

Both the Spanish and the Italians have been put off by high French prices, as their currencies have also weakened. Overall attendances at the park are down on last year. Aggressive marketing has meant some lost visitors have been replaced by French holidaymakers, but they have been reluctant to spend as heavily as Euro Disney would have hoped.

So the second park will have to wait while the Americans and their troublesome European offspring go back to the drawing board to try to work out how to make money from the resort.

Mr Bourguignon has been putting on a brave face, declaring the prudent approach in the light of the deepening French recession was to put the second park on hold for the time being.

But he, like other Euro Disney executives, will be aware that the review underway is about much more than timing issues. Reality has begun to dawn in Never Never land.

It has all been rather tough on those Euro Disney shareholders who have stayed with the company since its 1989 flotation. One of the most popular attractions at the Paris theme park is a near-reality experience called Star Tours, in which visitors are invited into a space craft, bombarded with sound and images, and tossed around as the the vehicle apparently lurches sickeningly out of control.

A small notice declares, with typical US attention to the niceties of litigation, that the violence of the movement means pregnant women are forbidden to ride aboard.

As one shareholder drily pointed out last week, bankers SG Warburg should have taken note when they prepared the 1989 prospectus for the company's flotation; it could usefully have included a similar warning.

The shares have ridden a roller coaster as the depth of the problems at the park have gradually emerged. It has been a trip very unlike that experienced by Disney shareholders in the US, whose investment has seen a steady appreciation.

It is this difference that hints at the roots of Euro Disney's difficulties. Conceived in the 1980s, the project originally envisaged early profits and funds for expansion could come from the sale of the five hotels built on the site in the first phase.

It also over optimistically aimed to raise money through developing commercial and residential property in and around the resort - a grand design scuppered as the Paris property market crashed a couple of years ago. Such property profits were supposed to generate almost a third of the 1993 revenues originally projected at the time of the company's flotation.

But such errors were only part of the problem. The real seeds of Euro Disney's difficulties lay in the structure of the deal drawn up by the Americans in 1987 with the French authorities, which in effect forced the Americans to give up half their share in the project.

French laws on inward investment stipulated Euro Disney would have to be controlled from within the Community. Disney was thus compelled to set up a public holding company, Euro Disney SCA, and to offer 51 per cent of the shares for sale to the public in a heavily promoted dollars 1bn ( pounds 670m) flotation.

But the Americans were unhappy at the prospect of 'giving away' half the resort's expected earnings, in this fashion.

This was a touchy area for the Americans. Michael Eisen, Disney's chairman, was under considerable pressure from his shareholders to secure what they considered to be the group's 'rightful' share of Euro Disney's anticipated profits.

Since the rules meant Disney could not achieve this by making Euro Disney a wholly owned subsidiary, the group sought instead to secure its position by loading costs on to the public company.

So the resort is managed by a wholly owned subsidiary of Disney, called, just to confuse things, Euro Disney SA. To it, the public company must pay management fees of at least 3 per cent of its revenues, as well as, in certain circumstances, management incentive fees, royalties, and a share of any capital gains.

The upshot of which, as analysts like Nigel Reed of brokers Paribas were swift to notice, was that the benefits of any improvement in trading went disproportionately to Disney US. Assuming things went well and the park managed 16 million visitors a year, it would make profits of FFr2.3bn, he pointed out.

The lion's share of this would go to Disney, however; Euro Disney would pocket barely FFr800m. Yet shareholders in Euro Disney have only limited voting rights. Dislodging Disney as manager of the park is virtually impossible, even if the American stake in the holding group falls to nothing.

The situation is further complicated by the fact that a second company, Euro Disney SNC, was created with the aim of making the project as tax-efficient as possible.

This is the operating company that technically 'owns' the resort's assets - the Magic Kingdom theme park, the hotels and other elements of the development - which are leased back to the public company for 20 years. At the end of that time, for a nominal sum, their ownership reverts to the public company.

Most of Euro Disney's hefty debts lie in this operating company, which in its turn is owned by a mixture of French institutions and Walt Disney, which has 17 per cent stake. Such an arrangement left little flexibility when Euro Disney's revenues began to fall woefully short of target.

There have been other restrictions too. Since the French authorities in effect 'bought' the jobs that came with Euro Disney, the company operates with staff levels some analysts consider to be more than 10 per cent higher than necessary.

But the main problem has proved Disney's original reluctance to deal with the issue of its charges. The hotels are a fact of life. They cannot be unbuilt and they have to be made to pay. But the high fees have created a vicious circle. Payments to Disney mean Euro Disney must in turn charge high prices. Yet high prices are one of the most off-putting aspects of the resort.

Europeans proved less eager to pay to queue for hours in the rain to ride the Euro Disney roller coaster, when lower US prices meant they could fly to Florida or California for almost the same amount, and wait in the sunshine.

Those that did go proved more careful with their finances than the Americans expected. Few wanted to splash out FFr30 ( pounds 3.60) on milkshakes made with unpleasant sterilised milk, when they had already paid FFr25 ( pounds 30) an adult or FFr15 ( pounds 18) for each child to enter the park.

Last week, the most common sight to be witnessed in the sweltering heat was that of families carefully refilling their water bottles at the park's taps - drinking fountains in the park are free.

Aggressive marketing, cutting entrance fees to the park after 5pm and promoting it to the local French population raised visitor levels to within spitting distance of the 11 million or so a year that the company originally bargained on. But such visitors have not wanted to make use of the hotels, which remain at least as expensive asequivalent hotels in central Paris, barely 40 minutes away by RER, the overland rail link. Ironically, the superb infrastructure installed by the efficient French government, which next year will include a TGV high-speed train link, has proved part of Euro Disney's undoing. Occupancy rates are running at only 68 per cent in peak season, and around 45 per cent for the year; a figure that compares dismally with the near 100 per cent in the United States. As Paul Slattery, an analyst with brokers Kleinwort Benson, points out: 'The assumptions were all wrong. Disney looked at how much they were charging in the US and compared that with similar leisure spends in Europe. They found European leisure prices were higher and multiplied up for Euro Disney.'

Disney, however, has proved reluctant to face this issue. Despite a mounting chorus of complaints, the most the Americans have so far agreed to, and this grudgingly, has been the temporary deferral of its fees. Waiving them, or altering the structure to give Euro Disney a financial breathing space, has been out of the question, at least until now.

Disney's attitude has historical roots. By 1989, when the project was finalised, Disney's three theme parks were contributing more than two-thirds of the company's annual revenues of dollars 3.4bn.

Yet Disney felt short-changed. In 1955, when the maestro himself had opened the first theme park at Anaheim in California, the success of the project was measured in thousands, not millions of dollars.

So the company secured only a modest area for development - the park takes up about 75 acres in all. Surrounding landowners, who saw the value of their plots soar, were thus able to cash in on the Disney magic.

When Disney World, the Florida resort opened in 1971, Disney made sure it had room to expand - the site then covered 11,000 acres. But once more, others were quicker than Disney to anticipate what turned out to be a virtually insatiable demand for hotel space. Again Disney felt others were benefiting unfairly from its efforts.

However, it was the Tokyo theme park that really upset Disney shareholders. Disney has no equity in the Japanese version of Disneyland, which opened a decade ago at a cost of dollars 625m. The only income it receives are royalties, to the tune of 10 per cent of gross earnings on rides and admissions and 5 per cent on food and merchandising. The land, finance and construction of the park were the responsibility of Oriental Land, a Japanese company.

After a rocky beginning, the Tokyo park has turned into a raging success. The last thing Disney wanted with Euro Disney was a repeat of Tokyo. This time, the Americans wanted to be sure they gained fully from what they confidently believed would be an equal success story. Euro Disney is paying for the success of its forebears.

None of this would have mattered if the resort had hit its ambitious revenue targets. Unfortunately it did not. Things started going sour for Euro Disney from the opening of the park in April last year. Attendances were initially disappointing. More visitors were attracted by special deals. But though this increased the number of people going to the park, it ate into revenues. Now the future looks uncertain; while no one believes the (highly profitable) Disney corporation would allow its newest progeny to fail, the shape of the company is uncertain.

This uncertainty has been exacerbated by yet another regrettable side effect of Disney's Japanese experiences, which has meant that to step through the gates of Euro Disney has been to enter a fantasy world in the board room as well as the amusement park.

Because of the sluggish initial performance of the now highly successful Japanese park, the reaction to the poor performance of Euro Disney has been to smile fixedly and re- iterate that, if only investors would be patient, the tide would turn. Unfortunately, before it did so, the ship was already beached.

(Photographs, graph and map omitted)