Disney: Mickey Mouse Accounting
When we discussed operating leases we saw that as per current accounting rules, the debt shown on a company's balance sheet does not adequately present a company's true debt level. Unfortunately, off-balance sheet debt doesn't stop at operating leases. Consider The Walt Disney Company (DIS), which operates theme parks, owns a movie studio, and has an extensive media network (e.g. television stations).
Disney has strong, well-recognized brands, has great margins, and has a P/E under 10. Its stock has dropped from about $35 just a few months ago to its current price under $20! As a result, it has undoubtedly popped up on the radar screen for a few value investors with long-term outlooks.
A quick look at its balance sheet reveals equity of $32 billion and debt of $15 billion. Since nobody knows how long this (or any) downturn will last, a conservative capital structure is essential. In the near-term, people will cut down on their trips to Disneyland, and businesses will cut their advertising budgets for Disney's television stations. As such, it's of utmost importance that a company have manageable debt loads if it is to qualify as a long-term investment.
Digging a little deeper, however, reveals that Disney has agreed to purchase various non-cancellable broadcasting rights in order to bring its viewers action from the NFL, NBA, NASCAR and other sporting events. Capitalizing these obligations results in more than doubling the debt of $15 billion on the balance sheet to $37 billion! The D/E ratio changes from 46% to 115%!
But is this really how we should be treating these broadcast agreements, the same as how we treat debt? Absolutely. If Disney had "bought" these rights upfront, they would qualify as assets, and whatever they borrowed to pay for these would qualify as debt on the balance sheet. Just because the various sports leagues have agreed to effectively fully finance these rights does not change economic reality.
Furthermore, the debt we've just added on represents very real risk. If viewership goes down, or advertisers cut their spend, Disney would not make as much off of those games, but they would still owe every part of that debt. This is akin to a company buying a hard asset financed with debt, and not being able to generate the returns off that asset to cover the debts.
That's not to say Disney should be discarded. So far this year it has shown an ability to weather the storm. Furthermore, last recession it also managed to stay profitable. It is diversified across many segments and has strong margins which shows it owns differentiated products. However, investors must recognize that for all companies they consider, it is essential that they recognize all of a company's debts before proceeding with an investment.
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This article has 3 comments:
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riskyreward
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7 Comments
Nov 19 03:48 PM-
Saj Karsan
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39 Comments
My Website
Nov 19 03:58 PMNot at all. As you say, these should be considered assets as well as obligations (as alluded to in paragraph 5).
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media observer
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1 Comment
Dec 05 12:54 AMThese sports contracts are considered television programming that their networks will use over time. They probably don't start until some time in the future. Once the contracts become effective, Disney will carry the contracts as an asset (depending on the term, either short term or long term asset), and the contractual payments will show up as short and long term liabilities. In addition to the right to broadcast he sporting events, Disney gets the right to generate revenue through sponsorship and advertising. Aha.....yes, these rights are operating assets that will be amortized over time.
They will no doubt generate more cash flow and profits for Disney than all of their fiction and non-fiction programming combined. Would you feel better if Disney didn't have any sports programming contracts lined up?
It's the way the business works.