The last training of 2014 took me to the big city Los Angeles and Beverly Hills area to train an executive group at the A + E Network. The first day of the two day course was a day of rain for the first time in months. So of course we were lucky because it turned out to be a great day for finance!
I had small group which was great because the class became as much discussion as lecture. I did cover the basics – Income Statement, Balance Sheet and Cash Flow but we were able to hit a lot of side bars with this small group.
One topic that always comes up with this group is A + E’s interesting structure. The company is an LLC that is owned by Walt Disney Co. and the Hearst Corp. These partners each own 50% of A + E. In 2012, the current owners bought out a minority partner NBCU and paid them slightly more than $3 billion dollars for their 15.8% share. Based on that price the total value of A + E networks at the time was $19.2 billion. That might seem like high value for a LLC partnership but A + E is a great business.
This group was particularly interested in the fact that A + E borrowed most of the money for this buy out by adding long term debt to this business. This changed their balance sheet dramatically by replacing equity (the NBCU stake) with debt. This took the debt to equity ratio for A + E from well under 1.0 to over 1.0. This means that the balance sheet after the deal had more debt than equity on it.
When students see their business adding debt to replace equity it often makes them worry about their business. We all learn that debt is a bad thing and as individuals we are all trying to get out of debt. On the other hand for a business adding low interest debt is a great strategy for a profitable/cash flowing business like A + E. Since after the deal Disney and Hearst own the business 50/50 they get a larger share of the profits when the business performs well. Interest on the new debt is nowhere near the benefit these owners get in increased returns. In fact after this deal was done A + E more than doubled its return on equity for its partners even though margins (profits as a percentage of revenue) only slightly increased.
The lesson here is that for business leverage is a good thing as long as the business can easily make the interest payments on the debt. In today’s environment using debt in place of equity to finance a business is a good move.
By the way on the second day it was another typical sunny Los Angeles day but surprisingly enough it was still a great day for finance. 🙂