operating leases

7/26/2019 Operating Leases

1/20

Corporate Valuation Operating Leases

Advanced Valuation Issues: Operating Leases

Professor David Wessels

The Wharton School of the Universit of Pennslvania ! "##$%


2/20

Professor David "

Corporate Va uat on Operat ng Leases

&idden Assets ' Lia(ilities

) Co*panies have three

*a+or hidden assets:

, &ide assets ( using off-

(alance sheet financing

such as operating leases%

, ./pense0 rather than

capitali1e0 intangi(le

invest*ent 23'D4%

, &ide o5nership dilution

through historical

pooling%


3/20

Professor David 6


&idden Assets ' Lia(ilities

) Capitalize operating leases

, Many companies have moved financing off-balance sheet using

operating leases, rather than purchase assets outright.

) Capitali1e research ' develop*ent 7 advertising

, Toda0 *an co*panies pri*ar assets are intangi(le% We need to

develop a *ethodolog to value historical invest*ent in products0

(rands0 distri(ution net5or8s0 etc%

) Capitali1e intangi(le assets hidden ( pooling

, Although S9AS ; no5 re


4/20

Professor David ;


Understanding Leases 2Snthetic De(t4

Monmouth

Capital

Corporation(lessor)

Fed!

Corporation

(lessee)

use of asset for a

contracted period

periodic pa*ents

25hich cover interest and depreciation4

) Wh Lease>

% 9le/i(ilit has value to the lessee

"% Standardi1ation ( lessor leads to efficient costs

6% Depreciation ta/ shields can (e *ore valua(le to lessor 2avoid A?T4%

) A (usiness *a ac


5/20


6/20

Professor David B


Lease Tpes

According to 9AS0 a lease that *eets one or *ore of the follo5ing criteria0 *eaning it is

classified as a purchase ( the lessee 2S9AS 64:

24 the lease ter* is greater than $ of the asset=s esti*ated econo*ic lifeE

2"4 the lease contains an option to purchase the asset for less than fair *ar8et valueE

264 o5nership of the asset is transferred to the lessee at the end of the lease ter*E or

2;4 the present value of lease pa*ents e/ceeds F# of the fair *ar8et value of the asset%

Capital lease"

A lease for 5hich the lessee ac


7/20

Professor David


Operating Leases vs Capital Leases

) 3eported capitali1ed leases are s*all fraction of the present value of

operating leases% Got onl is toda=s total *uch s*aller0 (ut the gro5th

in capitali1ed leases is *uch s*aller as 5ell%


8/20

Professor David H


./plicit Capital: Capitali1ed Leases

) The good ne5s: Capitali1ed leases are alread included on the inco*e

state*ent and (alance sheet0 even though not e/plicitl% Details are

often hidden 5ithin the footnotes 25hich is O4%

Assets Liabilities & Shareholder Equity

Aggregated within PP&E: Aggregated within Long-Term

Aircraft 221 Unsecured debt 1,529

Package handling and ground

support equipment and vehicles 20 !apital lease obligations "22

#ther, principall$ facilities 1%

#ther debt, interest rates of &'(0)

to 9'9(), due through 201 &&

*ross !apitali+ed eases 5&5 -otal .ebt 2,01

ess accumulated amorti+ation /2&( ess current portion %0(

et !apitali+ed eases 29 ong/-erm .ebt 1,09

ource 3ede4 10/ ote ource 3ede4 10/ ote &

FedEx Cororation

6evenues 22,"(

#perating 74penses

alaries and emplo$ee benefits 9,(

Purchased transportation 2,155

6entals and landing fees 1,(0%

.epreciation and amort i+ation 1,%51

3uel 1,%"9

8aintenance and repairs 1,%9(

#ther %,1(2#perating ncome 1,"1

nterest, net /11(

#ther, net /15

ncome :efore ncome -a4es 1,%%(

!n"ome StatementFedEx Cororation


9/20

Professor David F


&idden Capital: Operating Leases

) The (ad ne5s: Operating leases

co*(ine depreciation and interest

pa*ents into a single ite* called

rental pa*ents%

) ?ore (ad ne5s: the present value

of operating leases do GOT

appear on the (alance sheet%

) We *ust find a 5a of

recapitali1ing the off-(alance

sheet ite* (ac8 onto the (alance

sheet%

6evenues 22,"(

#perating 74penses

alaries and emplo$ee benefits 9,(Purchased transportation 2,155

6entals and landing fees 1,(0%

.epreciation and amorti+ation 1,%51

3uel 1,%"9

8aintenance and repairs 1,%9(

#ther %,1(2

#perating ncome 1,"1

nterest, net /11(

#ther, net /15

ncome :efore ncome -a4es 1,%%(

!n"ome Statement

FedEx Cororation


10/20

Professor David #


Valuation Issues and Operating Leases

) The accounting treat*ent of operating leases 5ill distort

*an critical inputs for the valuation process% @iven its

de(t-li8e characteristics0 *an distortions follo5 directl

fro* the acade*ic literature on de(t%

, Co*petitive (ench*ar8ing and *easuring value creation

, The cost of e


11/20

Professor David


ote (' ong/-erm .ebt and !ommitment

Future Caital #erating Future Caital #erating$ear Leases Leases $ear Leases Leases

200" "" 1,%&( 200" &( %1(

2005 125 1,2(5 2005 &( 251

200& 102 1,192 200& 9% 1("

200 11 1,155 200 &( 1%&

200( 11 1,0"5 200( 11% 10"

-hereafter 2%( (,%"2 -hereafter 2"1 555

5%1 1",%( &51 1,5"(

%nited Par"el Seri"e

ote ease !ommitments

FedEx Cororation

) 9ro* the notes0 5e can collect infor*ation on operating leases:

Operating Leases: 9ed./ versus UPS

) 9ed./ uses operating leases heavil% &o5 5ill this affect co*petitive

(ench*ar8ing and value creation>


12/20

Professor David "


) Using the accepted *ethodolog of discounting operating lease

pa*ents at the cost of de(t 2B4 to ascertain the value of off-(alance

sheet assets0 9ed./ doesn=t loo8 as asset efficient an *oreJ

Distortion of Capital Turnover

%nited Par"el Ser&i"e

' o( ' o(

Line !tem ) *illions +e&enues ) *illions +e&enues

-otal 6evenues 22,"( 100'0) %1,22 100'0)

:ook PP;7 (,00 %(') 1%,&12 "%'5)

7stimated eases 9,9&9 ""'%) 1,21% %'9)Ad


13/20

Professor David 6


Distortion of 3OIC

) 3OIC *easures financial perfor*ance 5ithout regard to a co*pan=s

capital structure% If one fails to ad+ust 3OIC for operating leases0 3OIC

5ill (e sste*aticall distorted ( lease choice%

PV2Lease4-CapitalInvested

PV2Lease44823OIC3OIC3OIC dunad+ +=

After-ta/ lease

interest rate

3OIC 5ith no

operating

leases

3eported

capital


14/20

Professor David ;


The Cost of .


15/20

Professor David $


Mield to ?aturit and De(t 3atings

) Li*0 ?an0 ' ?ihov 2"##64 co*pare the i*pact of operating leases on de(t

ratings and the ield of ne5 de(t issues to that of (alance sheet de(t% The

argue rating have less sensitivit to leases0 (ut ields do not%

#/0 1egression of 2umerical Debt 1ating #/0 1egression of 3ield 0pread


16/20

Professor David B


Valuing Operating Leases

) In the #-0 5e can retrieve (oth

historical as 5ell as future

operating lease co**it*ents%

) There are three *ethods:

24 Su* the future discounted

operating lease flo5s ( the cost

of de(t 2S'P0 Da*odoran4%

2"4 Divide ne/t ear=s flo5 ( the

cost of de(t 2?ood=s4%

264 Divide ne/t ear=s flo5 ( the

su* of the cost of de(t and the

annual depreciation rate%

Future Caital #erating$ear Leases Leases

200" "" 1,%&(

2005 125 1,2(5

200& 102 1,192

200 11 1,155

200( 11 1,0"5

-hereafter 2%( (,%"2

5%1 1",%(

ote ease !ommitments

FedEx Cororation


17/20

Professor David


Valuing Operating Leases: An ./a*ple

) To understand ho5 5ell each *ethodolog 5or8s0 let=s (uild a hpothetical

leasing e/a*ple% In our e/a*ple0 5e assu*e the co*pan leases assets for

the first five of their ten-ear lives0 at an interest rate of $%

Assu*e asset

life of #

ears0 lease

for first $

ears

Assets have

(een gro5ing

at #

Cost of de(t

e


18/20

Professor David H


Valuing Operating Leases: An ./a*ple

) @iven (oth historical and future rental pa*ents0 ho5 can 5e separate out

interest and principal> i%e% re*ove interest pa*ent0

) &o5 can 5e deter*ine depreciation of the operating assets>

Su* of all asset

lease pa*ents

Onl the oungest

asset 5ill appear in

the final state*ent


19/20

Professor David F


Valuation ?ethodolog

) The *ost co**on *ethod0 discounted *ini*u* rental co**it*ents0

sste*aticall underesti*ates the operating leases% A si*ple perpetuit

*ethod 23ental e/pense 7 8d4 sste*aticall overesti*ates lease value%


20/20

Professor David "#


Wall Street ?ultipliers

) Toda0 the accepted Wall Street *ultiplier of rental e/pense is H/% This

is consistent 5ith toda=s #-ear corporate (ond rates and an average

asset life of "-ears%

operating leases

Documents