Mickey Mouse is still Mickey Mouse, but Disney is no longer the company it once was. The icon of American culture, which in its heyday regularly steamrolled Wall Street's expectations as it churned out top-notch entertainment, is struggling to redefine itself as an evolving society threatens to make its core business less relevant. This five-part series, which runs through Friday, takes a look at the challenges facing Disney as it tries to reverse its recently flagging fortunes. For a look at the first part of the series, click here.

Disney's

(DIS) - Get Report

strengths haven't changed. Michael Eisner is still chairman. Roy Disney is still in charge of animation. Bran Ferren is still in charge of R&D at Imagineering. Mickey Mouse is still Mickey Mouse, and thanks to some quiet

lobbying last year, the company doesn't even have to worry about losing its copyright on him until 2023.

But none of that seems to matter right now. So what's wrong?

In explaining its problems to analysts and shareholders, the company has highlighted a couple of obvious sore spots, including its

ABC

television network, its live-action movie division and sales of its merchandise in Asia. Those trends aren't positive, but none should be impossible to fix, except maybe ABC's decline, which is both cyclical and a reflection of

secular problems in the network television industry.

Wall Street isn't exactly thrilled with those explanations. Since last May, when expectations for the company's profits began to tank, Disney's stock has fallen about one-fifth, while

Time Warner

(TWX)

has nearly doubled and

Viacom

(VIA) - Get Report

has risen almost two-thirds. But Disney still trades at close to 45 times its estimated fiscal 1999 earnings, a substantial premium to the average

S&P 500

stock, which trades at about 28 times expected earnings. The stock's relative strength in the face of sliding earnings is testament to the respect that most big and small investors still have for the company.

"They're the strongest, still, in family entertainment," says Ned Brines, senior research analyst at

Roger Engemann

, a Pasadena, Calif.-based money manager that owns 4.5 million Disney shares. "If I look out six months, do I see these businesses accelerating? Probably."

Disney could well see a bump in its business during 1999's second half, thanks to an increase in television ad spending for the millennium, as well as to the release of

Toy Story 2

, sequel to one of the most successful animated movies ever. Analysts are also hoping that digital video disc players, which are rapidly winning consumer acceptance, will boost the value of the company's film library by encouraging Disney-philes to buy DVD copies of videotapes they already own.

But beyond the short-term glitches, beyond the medium-term optimism, a close look at Disney's eroding profitability suggests that the company is facing a more fundamental problem, a problem that Disney isn't discussing and investors haven't yet realized.

Since Eisner became Disney's chairman 15 years ago, the company has become a worldwide entertainment giant, buying

ABC

and

ESPN

, spending billions of dollars to expand its theme parks and ramping up its live-action film business. But the heart of Disney's profitability still comes from its animated movies, which drive sales of home videos and licensed merchandise.

In fiscal 1998, for example, home video and consumer products sales accounted for roughly $2.2 billion in operating profits on $5.9 billion in sales, according to estimates from

Salomon Smith Barney

. (Salomon analyst Jill Krutick rates Disney an outperform; the bank hasn't performed any recent underwriting for Disney.) That's an operating margin of close to 40%. The rest of Disney was considerably less profitable, recording about $1.8 billion in operating income on $17 billion in sales, a margin of barely 10%.

Now, buried inside Disney's earnings statements, there's evidence that the company's animation business has peaked.

Disney accounts for its video and merchandise sales under its "Creative Content" division, which also includes its film and television studios. (The other divisions are Broadcasting, including ABC and ESPN, and Theme Parks.) And it is Creative Content that has taken the biggest hit in the last year. Cash flow at Creative Content fell to $1.4 billion in fiscal '98 from $1.7 billion in fiscal '97, a 17% drop. In the December quarter, the skid worsened. Cash flow in Creative Content fell 39% to $430 million from $700 million a year earlier.

The company has largely explained this drop by pointing to problems in its live-action film business. In his letter to shareholders in Disney's annual report, Eisner explained that "1998 was a tough year for us

in live-action film ... We're glad fiscal '98 is over in this area."

But a close look at Disney's results suggests that there's more to the story. In fact, Disney had several hit movies last year, including

The Waterboy

and

Enemy of the State

. For all of 1998, Disney grossed more at the U.S. box office than any other studio. And the pattern has continued into 1999. With a boost from

Miramax

, its in-house "independent" film division, Disney has dominated the American box office in the first three months of this year, raking in roughly 30% of total U.S. movie admissions, or about $350 million. That total is almost double Disney's take in the same period last year.

Yet the company's strong live-action results haven't helped Creative Content. The company said Tuesday that the division's operating income was $163 million in the March quarter, down from $339 million in the year-earlier period, a drop of more than 50%. That decline overwhelmed small increases in the company's other two divisions, causing Disney's overall net income to skid more than 40% from its year-earlier level.

The numbers may seem complex, but the underlying explanation is simple: Disney's problems aren't limited to ABC or live-action film. The company's franchise in animation, the core of its profitability, is under siege.

Those who study and market to kids, as well as those who produce entertainment for children suggest that -- even if Disney stops its slide this fall -- the company faces a challenge as serious as any it has confronted since Eisner became chairman in 1984.

The challenge stems from a trend even Disney can't control: Childhood is changing.

Coming tomorrow: The change that's bigger than Disney.