The world's most innocent mouse, Mickey, is pairing up with cartoon history's most devilish mouse, Itchy, in an unlikely pairing as Walt Disney's (DIS) purchase of Twenty-First Century Fox (FOXA) assets. 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 or Epcot in the next few years. Honestly, Avatar 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 so many years ago. Beyond anti-trust concerns, which I don't feel will amount to much, the greatest concern outside of integration of paradoxical assets (dark vs. family friendly) is the deal structure. Disney is spending $52.4 billion for FOXA assets via a distribution of 515 million shares. Despite being dilutive, using shares as currency in return for income producing assets is a long-term win for companies. Dilution used sparingly and for cash flow, is far more attractive than spending cash or using debt. And it's that latter part 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 debt along with the assets.
Debt: An Ugly Word
Debt. It's an ugly word. And tossing around a nine-figure bomb like $13.7 billion will grab some headlines providing 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 the purchase, Disney held a debt-to-equity ratio of .61 (short-term plus long-term debt divided by total equity).
- The $13.7 billion all rolls into the debt number and Disney acquires a conservative 80% of Fox's $16.3 billion debt;
- Disney is collecting $52 billion in assets (as valued by the purchase) along with $13.7 billion in debt.
Under that scenario, Disney's new debt-to-equity measure will reach approximately .72.
This continues a disturbing trend that began back in 2014 when Disney's debt-to-equity began rising. In 2013, it measured .31 and has climbed every year since that time. It currently measures 2x what it did in 2013 and will increase 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 here to consider. Disney's $9 billion in net income flowed to investors last year. The company paid $2.5 billion in dividends, a rate equivalent to 28% of its net income, so secure and well-covered. The company repurchased $9 billion in shares, the entirety of its net income. That did mean it dipped into borrowing for $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 Disney's existing debt.
Disney May Not Even Need to Make Major Changes
It's interesting to note that Disney may 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. For now, let's disregard that and focus on Fox.
Disney has added that the acquisition will boost the bottom line two years after closing, which is anticipated to occur in 12-18 months, so some time in 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 the 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.
There's one consideration I haven't seen discussed in the potential for currency diversification. Disney will acquire 39% of SKY along with Star India. Already a global brand, Disney will have direct access to subscribers in Europe plus one of the jewels of India media. The collection and recognition of revenue from these assets could be structured in a format to permit Disney more diversification between the dollar, euro, and rupee. While it may 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 bottom line impact on the plus, but 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. The integration potential of Fox's assets, although somewhat polar opposite to Disney's current assets, offer top and bottom line growth for the long-term. Disney using its shares as currency, then repurchasing them on the open market as it sees fit is exactly how I want to see company's use stock. And while some may 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. If you're a seller of Disney based on this deal, then 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 to double again in another four years, but I do expect shares to be north of $150 when the Fox assets start producing a boost to earnings in 2021.
(This column has been revised to reflect additional information. It originally appeared at 2:59 p.m. ET 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.)