Walt Disney

Group
Ajay (537)
Ashutosh(596)
Rizwan(578)
Rohit(592)
Sampat(594)
Ujjwal(588)
 About the Company Dividend Decision
Our Story
Mission Strategies
Philosophy Hurdle Rate
Products and Services Investment Returns
Key Achievements Optimal Mix
Investment Opportunities
Corporate Finance Closing
Investment Decision Summary
Focus Financial Decision Questions and
Answers
  To look at different decision factors for the company
and take investment , financial and decision aspect
of Disney and how it affect the total valuation of the
Walt Disney group.
Objective –  Main objective - Maximizing stock price

Decision  Investment through analysis

 Financial Analysis
Analysis  Dividend Analysis
 Valuation effect because of decision
  Hurdle Rate
 Risk-free Rate

Investment  Regression Beta

Analysis  Default Spread

 Investment Analysis
 DCF Model
  Benchmark for break even
 Hurdle rate = Riskless Rate + Risk Premium
Hurdle rate  Risk = Danger + Opportunity
 Risk – Deviation from actual returns around an
expected return
 Risk – Hurdle rate and Beta
 There are two types of risk
 Market specific risk
 Firm specific risk
 California adventure theme park is a firm specific
risk ,all the firm risk can be ignored if the portfolio
is diversified enough.
 Market risk = Risk added by any investment to
market portfolio
 Beta of asset is relative to market portfolio
 Marginal investor in company is well diversified
 Lot of institutional investors are here and those
investors are diversified hence we can minimize
the risk
 Riskfree Rate
 By CAPM model we need to know the Riskfree
rate
 10 year maturity , default free bond will
effectively be a pretty good risk free rate
 Riskfree rate must be in the same currency that
the cashflows are estimated
 In case of no bonds are available we can use
different currency but use have to know the
default spread
 Disney with multi continental business will be
required business by business analysis for
different currency in different markets
 For simplicity we will use the risk free rate of
2.25% of USD
 Equity Risk premium
 All AAA rated countries have same equity Country Rate Default
risk premium rate Spread
 However Disney is a different case, because US 5.50% 0
Disney business is diversified and spanning Canada 5.50% 0
different countries India 8.30% 3.30%
China 5.90% 0.90%
 We take weighted average of these to come
Germany 5.50% 0
up with our equity risk premium rate
UK 5.60% 0.60%
 We will use the consolidated market where France 5.60% 0.60%
Disney operates and take the weighted
average of the country it runs in by revenue.
 Betas
 Slope of the regression of 1.25 is beta
 Regression parameter are always calculated with
error.
 In case of Disney its 0.10
 With 95% confidence we can say that the beta of
Disney lies in the range of 1.05 – 1.45
 R squared = 73%
 73% of the risk at Disney comes from Market sources
 27% of the risk comes from firm specific sources
 Firm specific risk is diversifiable
Expected Return of Disney and cost of
equity
 Disney Beta = 1.25
 Risk free Rate = 2.75% (US 10 year T
Bond)
 Risk Premium = 5.76% (Based on Disney’s
Operating Exposure)
 Expected return = Riskfree Rate +
Beta*Risk Premium
 2.75 + 1.25*5.76 = 9.95%
 From investment point of view 9.95% is the break
even rate for Disney
 2.75% is the risk free rate and hence Disney is a risky
investment it needs to make at least 9.95% on
investment
 Managers at Disney need to make at least 9.95% for
their equity investors to break even
 This is the hurdle rate for projects, when the
investment is analysed from an equity standpoint
 In other words Disney’s cost of equity is 9.95%
 Investing in any project less than these will make the
stock price drop and managers might be replaced
 Unlevered Beta
 Average across entertainment industry is 1.35 which is
greater than the Disney’s
 Complication arises due to less fixed cost of Disney in
comparison to industry average and hence lower beta
 Unlevered beta – beta of business you are in
 Levered beta – Equity beta
 These are connected by debt to equity ratio
 The regression beta of 1.25 is levered beta(based on
stock prices)
 Debt to equity ratio = 19.44%
 Unlevered beta = 36.1%
 Financial Breakdown of Disney
 Disney is a multi billion $ business, when it looks
at an investment , that investment doesn’t cut
across business’s, its in a single business
 In case of a business project with return on
equity of 9.5% will be funded or not, since the
business individual cost of equity is 9.92% it
does not make sense to invest in this business or
fund this movie
 In case if you accept the project , Disney will
become riskier business since other individual
business is required to fund the losses made in
movie business.
 Cost of Debt and Cost of Capital
 Contractual Obligation  Cost of Capital = 9.95(0.8842) +
 Tax Deductible 2.40(0.1158) = 8.1% (approx)
 Loss of control in case of non payment.
 The hurdle rate or cost of capital is 8.1%
 Disney cost of Debt according to S&P is 3.75%
 Disney is a large cap, developed company and its actual  Any investment that makes less than 8.1%
rating is A is not worth the trouble
 Tax rate in US = 36.1%
 After Tax cost of debt = 2.40%
 Cost of Capital = 9.95%
 Market value of Equity = $121,878 Million
 Equity/(Debt + Equity) = 88.42%
Investment Returns – DCF Model
 Any project can be invested in after a
careful analysis of the time weighted ,
incremental cash flow analysis (IRR ,NPV)
 The rio project , magic kingdom project
undertaken by Disney group has their
cash flow analysis done with respect to
time
  Financial Mix

Dividend  Trade off

Analysis  Capital Approach

 Financial Type
Disney Economic Profit
 Financial Decision and Trade off
 The right kind of debt for Disney and right
mix of Debt and equity to fund its
operation
 Optimal Mix of Debt to maximize the firm
value
 Right kind of Debt to match the tenor of
Disney’s Asset
Debt V/S Equity
 Fixed Claim vs Residual Claim
 Tax Deductible vs Not Tax Deductible
 High Priority vs Low Priority
 Fixed Maturity vs Infinite
 No management Control vs Management
Control
 Debt has 2 advantages and 3 cons
 Tax Benefit
 Added Discipline
 Expected Bankruptcy Cost
 Agency Cost
 Loss of flexibility
The Debt capacity of a company depends upon where it is in its lifecycle
 Disney is a large cap , Mature Company
 It would be most benefitted from high tax rate in US (36%)
 The added discipline will be good for Disney due to clear separation of
ownership and management
 Expected Bankruptcy cost will be lowed due to its more diversified nature
 Agency cost will be higher in broadcasting and movie business lower in
theme park
 The flexibility needs should be lower for Disney since it is mature and has
well established investment needs
 Cost of Capital Approach
 The right mix of debt and
equity is the one which
minimizes the cost of
capital
 Unlevered beta for Disney
is 0.9239 using the bottom
up approach as shown in
investment analysis
 Cost of equity = 2.75% +
levered Beta * 5.76%
 The lowest cost of capital
occurs at 40% debt
 Optimal Debt where cost
of capital is optimized
 The right financing
 The biggest advantage of using debt is tax benefits and
the biggest advantage of using equity is flexibility

 Right financing is best mix of debt and equity

 Long term project for a company require long term

debts too, in 1990’s Disney was among the two
companies to issue 100 year bonds the other one was
Boeing

 Disney has multiple business entity and each business

needs are different and hence require different type of
financing based on its product life cycle.

 The debt issued should be long term with and should

have a duration of 4 to 5 years (as a group)

 18% of Disney’s revenues comes from outside US

market and hence a lot of floating rate debt for Disney
in foreign currency (Euro floating bond ,Asian currency
exchange debt)
  Measure of Dividend Policy
 Assessment , Action & Follow up
 Valuation
Dividend  Growth
Analysis  Terminal Value
 Value of Control
 Relative Valuation
 Dividends and Measure of Dividend
Policy
 Dividend Payout = Dividend / Net income
 If you cannot find investments that make your
minimum acceptable rate, return the cash to owners  How much of the earning has been put up into the company
 How much cash you can return depends upon current  Dividend Yield = Dividend per share/ Stock price
& potential investment opportunities
 Measures the return that an investor can make from the dividends aloe
 How you choose to return cash to owners will depend
on whether they prefer dividends or buyback
 Dividends tend to follow earnings, a company with low
earning cant afford to pay the dividend, change in
dividend is also largely dependent upon the earnings
 Tax rate also affect dividends
 More and More firms are tending to buy back stocks
rather than pay dividends - this is a direct result of
globalization and increased competitions as well less
regulated sectors, very few of the sectors are now
protected by company cartel or government
Assessment - Dividend after 2008’s
crash
 Disney returned more cash than it could
have
 Disney returned about 1.5 Billion dollars
more than 18.1 Billion dollars it had
available as Free cashflow to Equity with
a normalized debt ration of 11.58%
Action and Follow up for the Disney
 Between 1994 & 2003, Disney generated $969 million in Free cash flow to Equity and paid
out $639 million in stock buyback each year
 It was holding back cash – it had 4 billion dollars at the end of 2003
 In this period Disney underperformed, its stock delivered 3% less than the cost of equity
 Underperformance has been post 1996 ( Capital cities acquisition)
 Between 2004 to 2008 its stock price performance improved
 After the crash in 2008 it started accumulating cash again with dividend and buyback
amounting to 2.6 billion dollars
 Post 2013 Disney financials started looking healthy , its stock price increased , it seems like
it has come out of the effect of stock market crash of 2008
 Valuation – Cash flow & Growth Rate
 Since Disney’s Debt ration changes over time, free cash
flow to equity become cumbersome to estimate.
 Discount free cash flow to the firm can be used
 Disney is used to investing a lion share of its earning into
back to its operation or acquisition
 This increased the future prospect of a company
 Since the cash is not outflowing from the company in
form of dividends , interest etc.
 Disney Return on Capital has also grown a lot gradually
over the 200’s and has levelled off in 2008-14 but started
improving again thereafter
 Growth rate is based on reinvestment rate of a company
and increase in cash flow
 Since Disney has been diligently reinvesting in itself and
return of capital is increasing on larger picture , its
valuation keep on increasing.
 Operating income (adjusted for leased of the real
estate) = 10,032 million dollars (rough estimate of
2014)
 Effective tax rate = 31.02%
 Capital Expenditure (including acquisition) = $5,239
Million
 Depreciation & Amortization = $ 2,192 Million
 Change in non cash working capital = 103 Million
Dollars
 Free cash flow to Firm = After tax operating income –
net capital expenditure – change in working capital =
6920 -3629 -103 = 3188 million dollars
 Reinvestment = 3629 + 103 = 3732 Million
 Reinvestment rate = 3732/6920 = 53.93%
 Valuation – Terminal Value
 Though the company is expected to go on forever but the cash flows
cannot be approximated after a certain time and hence the terminal
value is needed

 Terminal value is the total value of the firm at the end of the cash flow
prediction and it’s the total value of the company at that point

 Valuation of a company is dependent upon market size, excess cash ,

competitive advantages and length of high growth period

 Terminal value of the Disney group is in excess of 74 Billion Dollar ( one

of the highest valued company in the world )

 There are still the period of stable growth after high growth period and
that is why companies have a going concern prosperity

 The growth rate forever is assumed as 2.5% in US market for Disney

but its still less than the risk free rate of 2.75%

 At this point every thing like cost of capital etc. have to be recalculated
Growth Factors in valuation
 Due to diversified nature and a conglomerate style of
business operation of Disney, it remains well diversified
and quite shock resistant
 The market size of the group is compounded by the fact
that it is showing almost high growth in each segment
 Due to its policy of reinvestment and stock buyback and
dividend policy it has excess amount of cash
 Long period of growth has been recognized by the some
of the expert in financial world
 Competitive advantage of Disney stretches out due to the
fact that it has some of the most recognized brand names
in the world right now
Value of Control
 Assumption – in future Disney will continue to
grow at high growth till 2020 and then hit the
transition phase and will go to stable growth
phase
 Control is not always worth the investment
 Sometimes dilution of control in pursuit of
increasing shareholders value can go a long
way
 Historically none of the companies have
survived infinitely
 Dilution of share might be a good idea in
declining phase of a company
 Relative valuation of Disney
 A study of relative valuation of
Disney with its contemporary it
seems Disney is overpriced
 Its PEG ratio is greater than the
median
 Its growth is lower than the
median
Final thoughts - Summary
Thank you
QUESTIONS?