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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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November 26, 2007 12:01 AM ET
Edward Lampert's Sears Holdings would see a 22% jump in EBITDA.
U.S. generally accepted accounting principles currently allow companies to keep most leased assets and the corresponding obligations to make payments on them off their balance sheets. As long as the present value of the payments amounts to less than 90% of the asset’s value, and the term of the lease is less than 75% of the expected life of the asset, none of it has to go on the books. However, FASB and the International Accounting Standards Board, which are working together on the new rules, are widely expected to require within the next few years that most of those operating leases be capitalized and put on the balance sheet as both an asset and an obligation for future payments. “I’m expecting that virtually all off-balance-sheet leases will come onto the balance sheet,” said Georgia Tech professor Charles Mulford, who oversaw the research project. The numbers will be huge. Research by David Zion, an accounting analyst with Credit Suisse, found that at the end of 2005, 492 companies in the S&P 500 had obligations to pay $534 billion in future lease payments. At present value that amounted to approximately $396 billion. While the business community will likely fight the FASB and IASB proposal tooth and nail, because adding the assets and liabilities to balance sheets will reduce reported returns, Mr. Mulford’s analysis shows that it will also produce higher earnings before interest, taxes, depreciation and amortization. His study looked at a sample of the public filings of 25 companies that use EBITDA as a performance measure in financial covenants with lenders and/or in incentive compensation plans for executives, and calculated what the impact would be from capitalizing their operating leases. The average change in EBITDA for the group: an impressive 17.2% increase. The simple reason for the EBITDA spike is that lease payments, now accounted for as rent expense, would be replaced by interest expense on the capital lease obligation and amortization of the leased asset. The charges would likely be larger in the early years of the lease and smaller towards the end of it. But none of it would reduce EBITDA. The biggest boost among the 25 companies examined would be at Internet marketing firm 24/7 Real Media, where EBITDA would increase by 87%. The next four biggest increases would occur at financial planner Gilman & Ciocia (76.4%), music distributor Handleman Co. (47.7%), CKE Restaurants (39.6%) and greeting card manufacturer American Greetings (36%). The biggest company in the sample, retailer Sears Holding, controlled by its chairman, Edward S. Lampert, would see an EBITDA rise of 21.7% as $845 million in rent expense would be reclassified. Mr. Lampert doesn’t receive incentive compensation as a director at Sears, but four of the named executives in the company’s 2007 proxy did, including CEO Aylwin Lewis and three executive vice presidents. Payouts on both the annual and long-term incentive plans for those executives are based on EBITDA levels realized by the company. If Sears meets its EBITDA goal, executives get 100% of their target payout. At 90% of the goal they get a 60% payout and at 125% of goal they get a 200% payout. An accounting-induced boost of 22% in EBITDA would put them well on the way to a maximum payout. The proxy did state that the EBITDA measure was adjusted for accounting changes, which suggests that Sears’ compensation plans would not be affected by lease accounting changes. Other companies, however, may not have such clauses in their EBITDA-linked contracts. According to Mr. Zion, retailers and food companies would see especially large surges in operating income. Other industries that would likely see big impacts from any change in lease accounting include manufacturing and technology companies. But virtually every industry and large company would be affected by the rule changes. “The rules may not change until 2009 or even later, but EBITDA is used in a lot of long-lived agreements, including debt transactions and compensation arrangements,” said Mr. Mulford. “Financial managers need to be aware of the change when they write new contracts and possibly revise existing ones.” If they want to avoid confusion down the road, he suggested that they add rent to the equation now and make EBITDAR the performance measure. FW
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