Like many companies getting pummeled by the novel coronavirus, Disney (NYSE:DIS) went to the credit markets on May 12 to raise $11 billion in new debt. The move provides the company with significant liquidity. Does the financing make DIS stock a buy at slightly over $100, or is this the beginning of another leg down for the entertainment company?
That’s a good question. Before I delve into the answer, let’s consider the entire financing arrangement. As mentioned, Disney issued $11 billion of senior unsecured notes. The duration of maturities ranging from 2026 (six years) to 2060 (40 years). The interest rates payable between 1.75% and 3.8%.
Imagine if small businesses could get loans at these levels of rates. We wouldn’t have a small business crisis. But that’s a subject for another day.
In the meantime, let’s look at both sides of the argument.
Disney Is Building a Financial Fortress
The company finished its second quarter ended March 28 with $14.3 billion in cash on the asset side of its balance sheet. On the liabilities side, it had $55.5 billion in short- and long-term debt for a net debt position of $41.2 billion.
In the second quarter, it paid out $300 million in net interest ($365 million in interest expense less $65 in interest income). That was up from $143 million a year earlier. The amount was higher due to its acquisition of 21st Century Fox. Based on $55.5 billion in debt and $1.46 billion in annualized interest expense ($365 million times four), the average rate of interest was 2.6%.
It finished the second quarter with bank credit facilities of $12.25 billion, with none of it used. Subsequent to the quarter-end, it added a $5 billion credit facility. It now has access to an additional $17.25 million in cash. Let’s assume Disney draws dawn the entire amount. Then add $925 million in cash from 3.057% March 2027 fixed rate senior notes issued in April.
That means that as I write this, Disney would have $43.5 billion in cash and $84.7 billion in short-term and long-term debt for the same net debt of $41.2 billion at the end of the quarter.
The only thing that changes is the interest paid out goes up. Of course, it does plan to use some of the $11 billion raised to pay down some of its near-term maturities, but that’s just a shuffling of the deck chairs.
The most important thing is that it figures out how to cut enough expenses to keep the monthly losses from mounting. In the first six months of 2020, Disney’s cash provided by operations was $4.8 billion, 20% less than in 2019.
By Disney not paying more than 100,000 of its employees, it will save $500 million a month on this expense alone.
The Move Only Weakens the Situation for DIS Stock
Like AT&T’s (NYSE:T) acquisition of Time Warner, Disney’s purchase of 21st Century Fox only goes in the history books as a win if it can continue to operate its businesses, generate cash flow above its operational needs, and use that free cash flow to pay down its debt.
While the furloughing of its employees ought to save it $500 million per month, analysts estimate that it could lose $1 billion in earnings before interest and taxes (EBIT) every month its parks and resorts are closed.
In the second quarter, its Parks, Experiences, and Products segment, which includes its retail stores and parks, had a 10% decline in its revenue to $5.5 billion and a 58% decline in its operating income.
In the first month and a half of the third quarter, all its parks except for Shanghai Disneyland remained closed. This also applies to its retail stores, which are only just reopening in many U.S. states. Expect the third quarter to be even worse.
“We intend to continue doing work to refine this estimate, but we don’t have much to go on,” Bernstein analyst, Todd Juenger, wrote in a note May 13. “Disney did not provide nearly as much information as we had hoped with respect to the burn rate of Parks while they are closed, or the economics of opening at reduced capacity.”
So, the $1 billion monthly EBIT loss could be even worse. Further, it’s impossible to know when Disney’s parks will be able to return to 100% capacity. The truth is probably much longer than CEO Bob Chapek would care to admit.
The Bottom Line on DIS Stock
On May 5, Disney announced that it would forgo paying its July semi-annual dividend of 88 cents, saving the company $1.6 billion in the process
Given it’s furloughed more than 100,000 employees, there is no way it could have followed through with paying its dividend. The unions, not to mention its employees, would have gone ballistic.
Is Disney a buy or a sell after selling $11 billion in debt?
On the one hand, Disney is trading at levels it hasn’t seen too often over the past five years. Financially, its Altman Z-Score isn’t all that great at 1.80. It can’t afford to be in the same position a year from now with regards to its Parks business. They have got to be open or the debt load’s going to kill it.
If you don’t own Disney, but want to buy, I would wait until it’s in the low $90s. If you own Disney, I’d consider buying some more should it fall into the $90s. If you’re thinking of shorting its stock, I definitely would not. It’s as iconic an American business as there is. Its ability to sell $11 billion of debt demonstrates this fact.
We’re in tricky times. No investment decision is easy right now–not even regarding Disney.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.