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Comcast Eyes the Eisner Discount

Editor's note: This is a special bonus column for readers. Arne Alsin's commentary regularly appears on, where this column appeared on Feb. 26. To sign up for RealMoney, where you can read his commentary every day, please click here for a free trial.

Buying a great franchise that generates cash -- as evidenced by the stream of free cash flow -- is considered good investing. Wal-Mart (WMT), Home Depot (HD) and McDonald's (MCD), for example, generate surplus free cash every day in every quarter, year in and year out.

But it's not enough to invest in great franchises that generate a lot of cash. You need to take it one step further and analyze management's ability to allocate capital. In my view, a CEO's single most important function is allocating capital. Over seven to eight years, on average, a CEO will allocate all of his or her company's capital.

Numbers Don't Lie

Disney (DIS) Chairman and CEO Michael Eisner, who leads one of America's great franchises, is busily lobbying shareholders to keep his job as "Allocator-in-Chief" of Disney's capital. However, if he's talking to shareholders who understand financial statements, he has a problem. Numbers are not malleable. Parse through 10 years of Disney's financial statements and the numbers tell the cold, stark truth about Eisner's capital-allocation record:

  • Nominal earnings have barely budged over a 10-year span. Annual earnings have increased from about $1.1 billion to $1.3 billion. Adjusted for inflation, there has been no growth.

  • The capital base was $8.3 billion 10 years ago; it now stands at about $37 billion. Despite deploying four times as much capital, Disney generates roughly the same amount of nominal earnings!

  • Debt has ballooned from $2.8 billion to $13 billion in 10 years.

  • Revenue growth has been paltry to nonexistent (adjusted for inflation) for many years, despite the four-fold growth in the capital base.

President John Adams said, "Facts are stubborn things." The same is true for numbers. Sophisticated investors know that a CEO can increase earnings by swelling the capital base -- e.g., taking on debt, making acquisitions, etc.

Here's an example. Assume Disney expands its capital base by issuing debt to buy a profitable $1 billion company. The only requirement of this newly acquired company is to earn more than the cost of borrowing $1 billion. If that happens, Disney's earnings will increase accordingly. It's an easy way to provide a bump to earnings, although shareholders may not appreciate the extra debt burden.

But when the incremental return on the extra capital is sub-par, it harms shareholders. For the past decade, not only has Disney's performance on incremental capital been sub-par, but the return is barely above zero.

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