On value, investing, and everything in between

Sad Days Ahead at the House of Mouse

Feb 01, 2023

In our last article, we discussed the importance of capital allocation and the pitfalls of using good money to chase after bad ideas.  We dropped also some not so subtle hints that we were talking about the recent history of Disney.  In this article we are going to discuss how the changes have impacted Disney’s financials, and in our final post on the series we are going to talk about how to fix it.  


To start we need to look at the damage to Disney’s balance sheet.   One of the main metrics that an investor should care about is a company’s ability to cover it’s long term debt.  Specifically, we want to look at a company’s ability to pay off it’s debt using free cash flow.  The ratio of debt to free cash flow should be maximum 3 to 1.   This ratio effectively means a company can pay down it’s long term debt obligations in 3 years using the available cash flow.  Many company’s may actually sign debt covenants with financial institutions such as banks that ensure that a company’s operating income or free cash flow stays within a certain ratio of the debt.  If that ratio increases the company may be required to pay its debt early (see Figure 1)


Figure 1.  Disney’s covenants only require that EBIT is 3x the interest payments.  From the 2022 Disney 10-K

Additionally, the company may have its credit rating lowered which increases its borrowing costs and reduces its flexibility.  Indeed, this is what happened to Disney as a result of borrowing money to buy the assets from Fox (see Figure 2)

Figure 2. From Disney’s 2022 10-K


So what does all this mean?  Disney is at least safe from the debt being called in for the moment since it’s operating income ($6.7B) is 3 times larger than its interest expenses ($1.4B)


Despite their being no immediate threat to Disney, the consequences of the debt are that Disney has closed many doors with regards to cash usage.  First, between 2015 and 2019 cash flow ranged between $7.1 and $9.8B.  Since 2020 the company’s free cash flow has averaged $2.2B

The decrease in its free cash flow is largely due to the very expensive foray into streaming which has cost the company a great deal ($6B in EBIT per year) (see Figure 3)

Figure 3.  From the Trian Disney Presentation


The end result of all this fiscal recklessness? Disney used to spend $2.9B in dividends every year to shareholders which is no longer tenable.   Additionally spent between $6B and $9B per year between 2016 and 2019 for share repurchases.    In 2019-2022 Disney issued shares that reversed nearly a decade of share repurchases.  


To summarize, Disney has invested nearly $162B in capex, M&A, and content spend over the last 3 years.  What does it have to show for it?  No dividend, a higher share count, free cash flow down by nearly 90%.    So what to do?  Tune in next week and we will go through potential options for Disney to right the ship.  


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