Capital is the lifeblood of any business operation. It helps organizations meet their daily and long-term financial needs, as well as signaling to stakeholders that the firm is on the right track. Companies raise capital through debt and/or equity. Usually, it’s a mixture of the two, which is referred to as the company's capital structure.
Analysts review the capital structure of a firm to gain insights about management's strategic relationship with and reliance on outside capital. A company with a strong growth strategy has a heavy reliance on outside capital, however, a mature company, such as Disney (DIS), can get away with a more conservative approach to capital structure and rely on cash flows generated from operations to propel itself.
- Disney’s capital structure remains heavily weighted toward using equity to finance growth, versus debt.
- This remains true even after the company more than doubled its debt load this year with the closing of the 21st Century Fox acquisition.
- Despite leverage ratios that are near decade highs, Disney—compared to its major peers—uses less debt and has a less levered balance sheet.
Capital structure varies based on industry and corporate financial strategy. Companies using more debt than peers may also be riskier since debt payments must be paid back even if earnings are negative or lackluster.
Equity, on the other hand, does not need to be paid back, but it generally costs more to raise equity capital than debt, particularly in periods of low-interest rates. This is why many companies, such as Disney, have used debt to increase its cash hoard over the past few years, taking advantage of low-interest rates.
Disney increased cash from $3.4 billion during the second quarter of 2014 to $6.7 billion in 2019. It also increased its long-term debt by $38.2 billion, from $14.8 billion in the second quarter of 2014 to $53 billion as of Oct. 2019. Disney’s debt load spiked during 2019 as it assumed the debt of Twenty-First Century Fox following the close of its acquisition of the media company.
Disney’s Debt and Equity Capitalization
Disney has a well-diversified portfolio of debt outstanding; however, debt isn’t the only component of Disney's capital structure. Equity, as measured by market capitalization, was $235 billion in Oct. 2019, up from $149 billion in Oct. 2014.
Market capitalization is calculated by multiplying the number of shares outstanding by the share price of the company. Since the number of shares outstanding at Disney remained relatively flat over the same time period, the change in capitalization must be due to an increase in the price of Disney shares. Indeed, Disney’s stock price increased from approximately $87 in Oct. 2014 to $129 per share in mid-Oct. 2019.
Disney’s Enterprise Value
Another way to measure capital is with the enterprise value. The enterprise value is calculated much like market capitalization, except it includes debt and cash. In other words, it takes market capitalization, adds cash, then subtracts debt.
Those companies looking to buy out other businesses as a growth strategy prefer enterprise value as a measure of total cost because it is considered a more accurate representation of the full cost of the business.
Since the market capitalization at Disney increased, it’s not surprising that enterprise value increased as well, from $163 billion to $286.3 billion during the five years from the second quarter of 2014 to the second quarter of 2019. The difference between a market capitalization of $235 billion and the enterprise value is debt, which is added, and cash, which is subtracted.
Capital is a tool used by companies to finance company operations and growth projects. Some companies prefer the use of debt, especially in low-interest-rate environments. Other companies prefer equity because it doesn't need to be paid back.
Most companies, such as Disney, strive to find some optimal balance between debt and equity to help grow operations without substantially increasing risk. Disney’s debt-to-equity ratio was 0.23 in the second quarter of 2019 and is now near 10-year highs.
The company’s addition of Fox’s debt to its balance sheet has now made the company debt-heavy, in that its debt-to-assets ratio is at a 10-year high of 27%. However, it’s worth noting that Disney’s capital structure is still in-line with major peers.
Disney's debt-to-equity and debt-to-assets ratios are low compared to Disney’s peer group (including the likes of Viacom, Time Warner Cable, and Comcast), which suggests that Disney’s capital structure does not present any risk to future company earnings. In fact, Disney’s capital structure could suggest that it is still conservative in its approach to debt.