Walt Disney Company’s Yen Financing

Daniel Chavez, JJ Henn, Young Park, Scott Perreault, and Chris Root

Background

• An unrelated Japanese firm began operating a Tokyo Disneyland on April 15, 1983
• Disney receives royalties, in Yen, from the Japanese firm to license Disney brands
• 1984 royalty receipts just over $8 billion Japanese Yen
• Disney is worried about its Yen exposure regarding these loyalties
• The Yen is down 8% from the previous year
• Royalties are expected to grow 10%-20% over the next few years
• Potential loss would grow significantly if Yen continues to depreciate

Disney’s Yen Exposure (Royalties)

Should Disney Hedge?

• Depreciation in Yen would have huge negative impact on Disney’s financials
• Negative impact on Nominal Profit
• Disney should hedge to remove uncertainty and exchange rate risk
• As a MNC, Disney derives value by removing uncertainty pertaining to its cash flows
• Disney is concerned with removing downside risk (Yen Depreciation)

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What is a currency swap?

• Cross-currency swap
• Counterparties agree to exchange for a specified time period:
• Principal amount of a loan in one currency and the applicable interest
• Corresponding amount and applicable interest in a second currency
• Uses
• Exchange fixed interest rate payments on debt for floating-rate payments
• Offsets both exchange rate and interest rate risk

What is a Eurobond?

• Bonds issued in a currency that is different than the domestic currency of the issuer
• E.g. In June 2015, Apple issued $2 billion in yen-denominated bond
• Uses
• Issuers can choose better interest rates in other currencies
• Issuers who are not able to access debt in local markets can use domestic investors to provide local currencies
• Resident investors are able to get exposure to foreign investment

What is ECU?

• Predated the Euro we know today (1979-1999)
• Artificial currency made from a basket of currencies of member countries in the European Economic Community (precursor to the EU)
• Only an electronic unit of account with no coins or notes

How will they hedge?

Disney has access to a variety of hedging techniques moving forward

• To determine the best course of action for Disney, we looked at the following strategies to help remedy their foreign exchange risk.
• Options
• Forwards
• Futures
• Swaps
• Term Loan
• Goldman’s ECU/Yen Swap

Hedging Strategies: Futures, Options and Forwards

• Pros
• Forwards and Futures lock in the exchange rate so that forecasting cash flows would be easier
• Options give Disney the right but not the obligation to exercise at a certain exchange rate

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• Cons
• Liquid markets for options and futures - only maturities of two-years or less
• Long-dated FX forward would be considered as a part of total exposure to banks and tie up valuable credit lines.

Hedging Strategies:

Currency Swap

Pros:

• Reduces Disney’s exposure to Yen depreciation and interest rate risk
• Reduces Disney’s dollar denominated debt
• Allows Disney to match Yen receipts with Yen payments

Cons:

• Hedge would only be short-term
• Attractive Yen swap rate for maturities less than four years were hard to find
• Would not provide any additional cash to reduce short-term debt

Hedging Strategies: 10-year Bullet Loan

Pros:

• Disney would be able to pay back debt with royalties from Tokyo Disneyland
• Provides funding to pay off short-term debt
• Provides a 10-year hedge

Cons:

• High interest rate for foreign firm in Japanese market
• Principal repaid at end of the 10-years which creates another hedging problem/opportunity

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10-Year Bullet Loan

Loan Terms

• 15 billion yen principle

• .75% Upfront Fee

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• 7.50% interest, paid semiannually

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• 10 year term, 20 periods

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IRR

• Semiannual: 3.804%

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• Annual: 7.753%

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Hedging Strategies:

Proposed Goldman Sachs Deal

• Disney issue ten-year sinking fund ECU Eurobonds to be swapped into a yen liability
• Disney effectively creates a Yen liability at a favorable ECU rate, due to French Utility’s Company’s credit rating
• Disney receives yen equivalent of ECU proceeds from issuance, and makes payments in Yen to IBJ
• Pros
• Disney would be fully hedged for 10-years
• More favorable rate than Bullet Loan
• Cons
• Counterparty risk exists with French Company

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ECU/Yen Swap

Details

• ECU 80 million loan
• Coupon rate 9.125%
• Expenses = $75,000
• Price = 100.25%
• Fees = 2.00%
• Dollar/ECU Rate = 0.7420

IRR

• Semiannual: 3.446%

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• Annual: 7.010%

Recommendation

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Disney should take the Goldman Deal

• Much lower rate than the Bullet Loan
• Allows Disney to be fully hedged for 15 years
• Counterparty risk is low (French Company has AAA rating)
• Source of non dollar financing for Disney

QUESTIONS?

Suggested Questions

Should Disney hedge its yen royalty cash flow? Why or why not? If so, how much and over what time frame?

Assuming a hedge is desirable, what hedging techniques are available to the treasurer and what are the pros and cons of each?

In light of the various techniques for hedging FX exposure, why does a market for currency swaps exist? Who benefit and loses in such an arrangement? Can a swap really create value for a company, and if so, where does the value come from? What risks does a swap carry for the various parties involved?

Evaluate Goldman’s proposal for an ECU bond issue accompanied by an ECU/Yen swap. How does its “all-in” yen cost compare to that of the proposed yen term loan? Is it superior to hedging using forwards? (Note: “all-in” cost generally refers to that discount rate which equates the present discounted value of future debt payments with the financing proceeds less front-end fees, expressed as annual rate)

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