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 some 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 Walt Disney Company (NYSE: DIS), can get away with a more conservative approach to capital structure and rely on cash flows generated from operations to propel itself.
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 come in negative. 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, increased cash and total debt over the past few years. Disney increased cash from $3.4 billion in September 2014 to $4.0 billion in September 2017. It also increased its long-term debt by $6.5 billion, from $12.6 billion in September 2014 to $19.1 billion in September 2017.
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 $172 billion in October 2018, up slightly from $165 billion in December 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 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 $90 in mid-December 2014 to $116 per share in mid-October 2018.
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 market capitalization at Disney increased, it’s not surprising that enterprise value increased as well, from $180 billion to $196 billion. The difference between a market capitalization of $172 billion and the enterprise value is debt, which is around $19 billion, and cash, which is approximately $4 billion.
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 0.51 in Q2 of 2018, tracking close to the firm's median debt to equity ratio of 0.47 over the past fifteen years. Disney's debt to equity ratio also happens to be low compared to Disney’s peer group, which suggests that Disney’s capital structure does not present any risk to future company earnings. However, Disney's capital structure suggests that it may actually be too conservative in its approach to debt. Some analysts may even say that the company is leaving cheap money on the table.