Walt Disney Yen Financing I_Group 8

The Walt Disney Company’s Yen Financing

Prepared By – Nitin Gupta

(A024)

Ayush Gupta (A025) Manica Gupta (A026)

The Case Summary The Walt Disney Company, a diversified international company headquartered in Burbank, California, operated entertainment and recreational complexes, produced motion pictures and television features, developed community real estate projects, and sold consumer products. The company was founded in 1938 as a successor to the animated motion pictures’ business established by Walt and Roy Disney in 1923. The company operated the Disneyland amusement theme park in Anaheim, California, and the Walt Disney World destination resort in Orlando, Florida. In addition to the domestic entertainment and recreation revenues from Disneyland and Walt Disney World, the company received royalties, paid in yen, on certain revenues generated by Tokyo Disneyland, owned and operated by an unrelated Japanese corporation. Tokyo Disneyland was opened to the public on April 15, 1983. Consolidated revenues for The Walt Disney Company and its subsidiaries increased by almost 27% in 1984 to $1.7 billion. Total entertainment and recreation revenues, including royalties from Tokyo Disneyland, increased 6% to $1.1 billion in the fiscal year ended September 30, 1984. Net income totalled $97.8 million in 1984, an increase of 5% from 1983. Total assets grew 15% to $2.7 billion at the end of fiscal 1984. In early July 1985, Rolf Anderson, the director of finance at The Walt Disney Company, was concerned about possible foreign-exchange exposure due to Yen royalty receipts from Tokyo Disneyland which had increased during the last year significantly(￥8 billion), and Disney foresaw further growth (10% - 20%) in the years ahead. The current spot rate of JPY/USD is 248; a depreciation of almost 8% from the last year’s value of 229.70 is also a matter of concern. In order to mitigate the foreign exchange fluctuation risk, Walt Disney has two proposals. First, Disney was considering a ￥15 billion ten year bullet loan, with principal repaid at final maturity, which required interest of 7.50% paid semi-annually and front-end fees of 0.75%. Second, Goldman Sachs proposed to arrange for Walt Disney and a French Utility to enter into a swap, intermediated by Industrial Bank of Japan (IBJ), in which the utility would take on an ECU liability in exchange for future Yen receipts, and Disney would take on a Yen liability in exchange for future ECU receipts.

Q1. Should Disney hedge its yen royalty cash flow? Why or why not? If so, how much should be hedged and over what time frame? A1. Disney needs USD for construction and expansion purposes but not much exposure to YEN cash flow. As a result, Disney needs to transfer YEN to USD. Because the amount of money received in JPY is huge, a depreciation of the JPY could deeply disrupt Disney’s financial plans. Given the fluctuation of YEN/USD rate, this is a big exposure which needs to be hedged. Considering the long term trend, if the appreciation of JPY is lower than expectation, it will hurt Disney’s plan. Therefore, hedging comprehensively is the most optimal solution to cover future fluctuations in ￥/$. There are basically two alternatives – 1) Create a YEN liability - 15 billion ten-year bullet loan 2) SWAP solution offered by Goldman Sachs Alternative 1 JPY term Loan One of the viable choices was to create a Yen liability through a ten-year term loan of ￥15 billion from a Japanese bank with interest of 7.50% paid semiannually. It could hedge the JPY royalties, and the proceeds could be used to pay off some of the short-term debt and diversify the maturity structure of Disney’s debt. All-in cost of this JPY Term loan: IRR = 3.804% semi-annually (from Excel sheet Bank Loan) Annual all-in cost of the JPY Term Loan = (1+3.80423%)2-1 = 7.753% (From Excel sheet-Bank Loan)

Alternative 2 SWAP solution offered by Goldman Sachs ECU Eurobond Another alternative, suggested by Goldman Sachs, is that Disney issue ten-year ECU80 million Eurobonds that would be swapped into a Yen liability at a potentially more attractive all-in Yen cost than a Yen term loan. Using Exhibit 6 data from the Excel IRR=All-in Cost of the ECU Eurobond=9.47% (Excel sheet Swap) ECU/YEN SWAP After issuing the Eurobond, Disney needed to SWAP the ECU liability into YEN liability to achieve the goal to hedge the expected future YEN receipts. In finance, a swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream. Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the underlying prices. In this case, Disney tried to use SWAP to transfer the ECU liability to YEN liability with French Utility. SWAPs are popular and attractive, because they can benefit both counterparts of the contract. A swap could benefit both firms if the firms in separate countries have comparative advantages on interest rates. In such a case the party pays/receives fixed interest in currency A to receive/pay fixed rate in currency B for a term of T years. For example, you pay JPY 1.6% on a JPY notional of 1.2 billion and receive USD 5.36% on the USD equivalent notional of 10 million at an initial exchange rate of USD/JPY 120. These firms could swap to take advantage of the lower rates.

Loan rates for comparative-advantage:

Walt Disney (rated A) French Utility (rated AAA)

JPY Loan 7.75% 6.83%A

ECU Loan 9.47% 9.37%B

A – YTM of french Eurobonds in denominated currency of Yen of ten year maturity period(Exhibit 8) B - YTM of french Eurobonds in denominated currency of ECU of ten year maturity period(Exhibit 8)

From the table above, we notice that the French Utility has an advantage in both currencies’ debt, but Disney has a Comparative-Advantage in ECU. If Disney borrows in ECU and the French Utility borrows in JPY, they pay less combined interest (9.47+6.83=16.3%) than if Disney borrows in JPY and the French Utility borrows in ECU (7.75+9.37=17.12%). Therefore, it seems to be a good idea that Walt Disney and French Utility should involve in a SWAP to exchange their liability.

Q2. Assuming a hedge is desirable, what hedging techniques are available to the treasurer and what are the advantages and disadvantages of each? A2. The various hedging techniques available to Rolf Anderson are – 1. Liquid markets for options and futures contracts - Existed only for maturities of two years or less 2. Foreign-currency swap (JPY/USD) - Is short-term since Disney’s Euro dollar note issues matured in one to four years. Attractive yen swap rates for maturities less than four years were hard to find 3. Longer maturity Eurodollar debt - Disney issued Eurodollar notes recently and also the company has high debt ratio at present 4. Long term JPY debt - Hedge the JPY royalties, and the proceeds could be used to pay off some of the short-term debt and diversify the maturity structure of Disney’s debt 5. SWAP solution offered by Goldman Sachs - Disney has a comparative advantage.

Therefore we can conclude that there are various advantages of hedging: 1. The trend from years 1980 to 1985 indicates that yen has been depreciating against the Dollar (Exhibit 4 in Excel) 2. Walt Disney expects to earn higher revenues in future from Tokyo Disneyland 3. While revenues are earned in Yen, it has to repay its debt in Dollars 4. As per the past trend, if Walt Disney does not hedge and Yen continues to depreciate, it would translate lower dollars in the future and impact its debt serving capacity. Also, the option of SWAP seems to be the best option available, because at that time Disney would be only the second U.S. Corporation to access the ECU Eurobond market. Its bonds would be the first ECU bonds incorporating an amortization schedule to repay the bond’s principal. Moreover, Disney had worldwide brand recognition.