The Walt Disney Company’s Yen Financing

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The Walt Disney CompanysYen Financing
2
Whats the problem?

• JPY royalties from Tokyo Disneyland had increased
  significantly during the last year, and Disney
  foresaw further growth in the years ahead.
• The JPY had recently depreciated against the USD.
• Disney had no use for JPY and required USD (or
  perhaps other foreign currencies) for
  construction and expansion of entertainment and
  recreational complexes, production of motion
  picture and television features, and development
  of real estate projects

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How serious is the problem?

• During 1984, JPY royalty receipts had been just
  over JPY 8 billion (almost USD 34 million _at_
  average 1984 exchange rate of 237.30 JPY/USD) and
  were expected to grow at 10 to 20 over the next
  few years.
• This was 11.58 of 1984 operating income before
  corporate expenses (33,712,600/291,033,000), a
  percentage which is likely to grow, since Disney
  itself will probably not grow as rapidly as its
  JPY royalties.
• A depreciation of the JPY could disrupt Disneys
  financial plans for its large, long-term
  construction, expansion, production, and
  development projects.

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How likely is the problem?

• The JPY depreciated against the USD from the 2nd
  quarter of 1984 through the 1st quarter of 1985
  however, it has appreciated in the quarter since
  then.
• Forward rates indicate that the JPY is expected
  to appreciate against the USD over the next 10
  years, and U.S. inflation has exceeded Japanese
  inflation for the past 5 years.
• Disney probably does not need to be concerned
  with a depreciation of the JPY however, Disney
  may have to forecast its cash flows so precisely
  that appreciation lower than expected could
  affect the execution of its plans.

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Unsatisfactory Hedging Alternatives

• Liquid markets for options and futures contracts
  existed only for maturities of two years or less.
• Disney obtained quotes for ten years on
  long-dated forward contracts, but bid-ask spreads
  were large, reflecting conservative bank pricing.
  The contracts would be considered part of the
  banks total exposure to Disney, tying up
  valuable credit lines.

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Debt Structure

• As of 3/31/85, Disneys debt included 19.75
  unsecured borrowings under revolving line of
  credit and bank term loans, 41.22 commercial
  paper, and 17.56 notes with a maturity less than
  2 years.
• Only 21.47 of its debt had a maturity greater
  than 2 years, USD 50 million of which is a yen
  term loan due 2/1/93.

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Money Market Hedge

• New long-term JPY debt would 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 Disneys debt.
• Disney is unable to issue Euroyen bonds under the
  current Japanese Ministry of Finance guidelines.
• Disney can take out a term loan from a Japanese
  bank.

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Swaps

• Disney has already swapped into JPY, USD 50
  million of its USD 75 million Eurodollar notes
  due 3/15/89.
• Disneys USD 150 million Eurodollar notes due
  1/10/87 are too short-term to have attractive
  swap rates and to provide much of a hedge and
  would provide no new cash to pay off short-term
  debt.
• Because of a recent Eurodollar note issue and
  Disneys high debt ratio, longer-term Eurodollar
  debt swapped into JPY had been ruled out.
• Goldman-Sachs is suggesting an ECU Eurobond issue
  swapped into JPY.

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JPY Term Loan Terms

• JPY 15 billion principle
• 10-year term
• 7.50 annual percentage rate
• .75 front-end fees
• Bullet loan - semiannual interest payments and
  principle paid at maturity.

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JPY Term Loan All-In Cost

• Time 0 Cash Flow 99.25 (100 less .75 front-end
  fees)
• Time 1-19 Cash Flows -3.75 (7.50/2)
• Time 20 Cash Flow -103.75 (100 plus final
  interest payment)
• Semiannual All-In Cost 3.80423
• Annual All-In Cost 7.75319 ((1.0380423)2-1)

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ECU Eurobond Terms

• ECU 80 million principle
• 10-year term
• 9.125 annual percentage rate (applied to the
  beginning of the year balance)
• Issued at 100.25 of par
• 2 underwriting fees
• 75,000 additional expenses
• Annual interest payments and ECU 16 million
  sinking fund each year 6-10.

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ECU Eurobond All-In Cost

• Time 0 Cash Flow 78,498,922 (80M x 1.0025 - 80M
  x .02 - USD 75,000 / .7420 USD/ECU)
• Times 1-5 Cash Flows 7,300,000 (80 million x
  .09125)
• Times 6-10 Sinking Fund 16M Times 6-10
  Interest 7.30M (80M x .09125), 5.84M (64M x
  .09125), 4.38M (48M x .09125), 2.92M (32M x
  .09125), 1.46M (16M x .09125) Times 6-10 Cash
  Flows 23,300,000, 21,840,000, 20,380,000,
  18,920,000, 17,460,000
• Annual All-In Cost 9.47267

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Bondholders
Bondholders
Swap Structure
ECU
JPY
JPY
JPY
French Utility
Disney
IBJ
6-Month USD LIBOR
6-Month USD LIBOR
ECU
ECU
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Swap Cash Flows
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Swap Cash Flow Analysis

• Disney makes semiannual JPY payments that the IBJ
  passes through unchanged to the French Utility
• The French Utility makes annual ECU payments to
  the IBJ. These are 50K greater for years 1-6 and
  40K, 30K, 20K, and 10K greater for years 7-10
  respectively than the amounts the IBJ pays to
  Disney. This is how the IBJ earns its fee.
• The debt swapped by the French Utility is
  existing therefore, it doesnt pay or receive
  anything at time 0. Disney converts the ECU
  proceeds of the bond issue into USD to pay off a
  portion of its short-term debt.

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Comparative Rates

• The all-in cost computations show that Disneys
  cost of JPY debt is 7.75391 and cost of ECU debt
  is 9.47267
• The schedule of its publicly traded Eurobonds
  shows that the French Utilitys cost of JPY debt
  is 6.83 (the yield-to-maturity of its 1/95
  Euroyen bonds) and cost of ECU debt is 9.37 (the
  yield-to-maturity of its 1/95 EuroECU bonds, the
  ECU bonds with a comparable remaining life.

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Economic Rationale

• The French Utility has an absolute advantage in
  both currencies debt, but Disney has a
  comparative advantage in ECU in that it has less
  of a disadvantage.
• Iff Disney borrows in ECU and the French Utility
  borrows in JPY, they pay less combined interest
  than if Disney borrows in JPY and the French
  Utility borrows in ECU.
• This reduction in total interest can be shared by
  Disney and the French Utility.

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What makes the swap work in the ECU market?

• 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 bonds principle.
• Three-quarters of ECU Eurobond issuers are
  European, and European sovereigns and state
  agencies, including the French Utility, were
  often perceived by the markets as borrowing ECU
  too frequently and wearing out their welcome
  among the retail purchasers of ECU bonds.
• Disney has worldwide name recognition.

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What makes the swap work in the yen market?

• Disney debt is rated single A, and the French
  Utility debt is rated AAA.
• What the case does not say is that Japanese
  government regulations made public issuance of
  unsecured JPY debentures by foreign companies a
  slow and cumbersome process and available only to
  the highest quality debtors.
• This is the reason Disney was ineligible to issue
  Euroyen bonds and also the reason Disney was
  ineligible to issue Samurai Bonds, which are
  foreign bonds issued in the domestic Japanese
  bond markets.

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Disneys Benefit

• Disneys proceeds from its bonds, ECU 78,498,922,
  are worth JPY 14,445,057,631 at the current
  exchange rates of .7420 USD/ECU and 248 JPY/USD.
• We can regard this as the JPY benefit that Disney
  will receive in exchange for the JPY payments it
  will be making.
• The IRR of these cash flows, 7.01034, is
  Disneys cost of JPY debt as a result of the
  swap.

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French Utilitys Benefit

• If we view the JPY payments the French Utility
  will be receiving as the payments on a JPY debt
  at its current 6.83 cost of JPY debt, then the
  face value of this hypothetical debt would be JPY
  14,591,732,744.
• This is the present value of the JPY benefits the
  French Utility will be receiving, which is equal
  to ECU 79,296,000 at the current exchange rates
• We can regard this as the ECU benefit that the
  French Utility will be receiving in exchange for
  the ECU payments it will be making.
• The IRR of these cash flows, 9.34981, is the
  French Utilitys cost of ECU debt as a result of
  the swap.

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Swap Summary

• Disney reduces its cost of JPY debt from
  7.753129 to 7.01034, 74.28 basis points. This
  is a substantial benefit.
• The French Utility reduces its cost of ECU debt
  from 9.37 to 9.34981, 2.02 basis points. This
  is a very tiny financial benefit, so there must
  have been other reasons why it entered into this
  swap.
• IBJ gets ECU 50K per year for 6 years, and then
  ECU 40K, 30K, 20K, and 10K for the next 4 years.
  This is a low fee, but it was co-lead manager for
  Disneys ECU Eurobond issue.

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What did Disney do?

• Disney did issue and swap the ECU Eurobonds. The
  deal was sufficiently well received that it was
  followed by a second ECU note offering in 12/85.
• Disney subsequently issued 10-year CHF notes and
  3-year AUD notes and swapped them into JPY.
• In 4/88 Disney discounted an undisclosed amount
  of its JPY royalties (representing most of its
  JPY income for the next 20 years, according to
  its 1988 annual report) for USD 723 million.

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Should Disney have hedged?

• In 1985, there was ample evidence (based upon
  purchasing power parity) that the JPY was
  overvalued, and it had already begun to
  appreciate.
• Disney may have made an overly conservative
  response to the preceding depreciation of the
  JPY.
• BUT the point of hedging is to insure against
  unexpected exchange rate movements, and the
  expected appreciation of the JPY should have been
  reflected in the rates at which Disney swapped.
  Perhaps Disney was so dependent upon the cash
  flows from Tokyo Disneyland financing its other
  projects, that it couldnt risk any shortfalls
  from their expected values.

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