Mickey Mouse -- The world's most innocent rodent -- is pairing up with cartoon history's most devilish one, Itchy from The Simpsons, thanks to plans by Walt Disney Co. (DIS) to by much of Twenty-First Century Fox (FOXA) for $52.4 billion. The Simpsons and Mickey Mouse under the same roof! Perhaps, we can have an Itchy and Scratchy Land after all.
In the same breath, the Avengers are now teamed with X-Men, Avatar and Deadpool. I'm sure no one can wait to see what kind of Deadpool-themed attractions are coming to Disney World or Epcot Center in the next few years. Honestly, the Avatar franchise and its upcoming films will slide in perfectly for Disney theme parks, but Deadpool, The Simpsons and Planet of the Apes are a far cry from the Disney I knew in my childhood.
Irony aside, the acquisition of assets from Fox repositions Disney as a media powerhouse, like it was so many years ago. Beyond antitrust concerns (which I don't feel will amount to much), the greatest issue outside of integration of paradoxical assets (dark themes vs. family friendly entertainment) is the deal's structure. After all, Disney will be paying for Fox's assets via a distribution of 515 million shares of stock.
But while that's dilutive, using shares as currency to buy income-producing assets is historically a long-term win for companies. Dilution used sparingly and for cash flow is far more attractive than spending cash or using debt to buy things.
But it's that latter part of the equation that has put questions into the deal. Disney has already said it plans to repurchase $10 billion in stock to help offset the dilution. However, the company will absorb $13.7 billion in Fox's debt along with the assets.
Debt: An Ugly Word
Now, debt is an ugly word on Wall Street, and tossing around a nine-figure bomb like $13.7 billion will grab some headlines -- providing Disney bears with fodder. But this is worth a deeper dive, because the headline number feels misleading.
Disney pulled in roughly $9 billion of net income over the past year, so in comparison to net income, the debt figure is large. But the bigger question becomes: Is it serviceable?
Before this announced purchase, Disney already had a debt-to-equity ratio -- short- and long-term debt divided by total equity -- of 0.61.
- Fox's $13.7 billion of additional debt all rolls into number;
- Disney acquires a conservative 80% of Fox's$16.3 billion of equity and $52 billion in assets (as valued by the purchase).
Under that scenario, Disney's new debt-to-equity measure will reach approximately 0.72. That would continue a disturbing trend that began back in 2014, when Disney's debt-to-equity began rising. It measured just 0.31 in 2013, but has climbed every year since then. The company's debt-to-equity ration currently measures 2x what it did in 2013 and will increase even more after this deal closes.
On the surface, that's a big enough yellow flag to back some folks away from the "buy" button. But there's more than debt to consider here.
After all, Disney's $9 billion in net income flowed to investors last year. The company paid $2.5 billion in dividends -- equal to 28% of its net income -- so the dividend is secure and well-covered. The company also repurchased $9 billion in shares, the entirety of its net income.
It dipped into borrowing $3.7 billion to cover this -- but with an effective rate of 2%, the company bet on itself with the share repurchase. Despite tepid share results, the stock is up 6% year-to-date and every repurchase outside of the spring of 2017 has been a net winner.
The company could simply slow the rate of repurchase and cover its existing $385 million in interest payments on existing debts, plus the estimated $275 million to $350 million in added interest charges it will absorb annually from the Fox debt (assuming it can be financed at a similar rate to that of Disney's existing debt).
Disney Might Not Even Need to Make Major Changes
It's interesting to note that Disney might not even need to make major changes, as the company anticipates a cost savings of $2 billion from the merger. Net of new interest charges, this pockets Disney $1.65 billion per year, or close to half of what it borrowed last year. Furthermore, given the company paid a 32% tax rate on its taxable income in 2017, there is the potential for another bump to the bottom line.
But for now, let's disregard that and focus on Fox. Disney has said that the Fox acquisition will boost the bottom line two years after closing, which is anticipated to occur in 12 to 18 months. So, some time around 2021, Disney will experience bottom-line growth.
Conservatively, I'd estimate that the Fox assets will deliver $500 million to the bottom line beginning in 2021, in addition to the $2 billion in cost savings. The combination of those two items alone is enough to maintain the current dividend, maintain the $10 billion buyback, decrease borrowing and cover the current interest expenses. Furthermore, I believe the synergies between Avatar and Disney theme parks plus the Marvel franchise and X-Men will create blockbuster attractions and continue the run of super-hero movies and shows for another decade.
And there's one consideration I haven't seen discussed in the potential for currency diversification. Disney will acquire 39% of Britain's Sky TV, along with Star India. This means that Disney -- which is already a global brand -- will have direct access to Sky subscribers in Europe, plus one of Indian media's crown jewels.
The collection and recognition of revenue from these assets could be structured to give Disney more diversification between the dollar, euro and Indian rupee. While that might not have a direct impact on the bottom line, it could create more stability moving forward in a world economy. Disney would have the potential to smooth big moves higher or lower in any of those currencies. Managed properly, it could have a positive bottom-line impact, or at the very least it offers a positive for the business and support of the acquisition.
There's Top and Bottom Line Growth for the Long Term
Overall, I have zero concerns with the debt Disney absorbs with this deal. After all, the integration potential of Fox's assets, although somewhat a polar opposite to Disney's current assets, will offer top- and bottom-line growth for the long-term.
DIS is also using its shares as currency and then repurchasing them on the open market as it sees fit -- exactly how I want to see companies use stock. And while some critics might point to the doubling of the debt-to-equity ratio of the company since 2013, they should also note the stock's price has doubled during that same time.
The bottom line: If you sell Disney based on this deal, it should be for a reason other than debt. I see little that will change and little reason that anything has to change. I don't expect Disney's stock price to double again in another four years, but I do expect shares to be north of $150 (from around $111 currently) once the Fox assets start producing a boost to earnings in 2021.
(This column originally appeared Friday, Dec. 15, on Real Money Pro, our premium site for active traders and Wall Street professionals. Click here to get great columns like this even earlier in the trading day.)
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At the time of publication, Timothy Collins had no position in the securities mentioned.