Walt Disney Company's Sleeping Beauty Bonds

In July 1993, the Walt Disney Company issued $300,000,000 in senior debentures (bonds). The debentures carried an interest rate of 7.55%, payable semiannually, and were priced at "par." They were due to be repaid on July 15, 2093, a full 100 years after the date of issue. However, at the company's option, the debentures could be repaid (in whole or in part) any time after July 15, 2023 or 30 years after the issue date.

Beauty, the fairy tale princess and heroine of a popular Disney animated film, according to legend, slept under enchantment in a magic castle for 100 years. The Disney 100-year debentures were immediately dubbed the "Sleeping Beauties."

The issue caused a lot of comment among traders and portfolio managers.

"It's crazy," said William Gross, head of fixed-income investments at Pacific Management Company. "Look at the path of Coney Island over the last 50 years and see what happens to amusement parks."1

Scott Jacobson, head of fixed-income research at Piper Capital Management, felt that the bonds were too risky for his clients, but "if corporate treasurers can get away with it, why not?"2

Others interpreted the successful sale of the bonds as a vote of confidence in the Disney Company and U.S. economic policy. "It shows that people believe the Mouse will still be singing and dancing in 100 years," said Tom Deegan (head of corporate communications at Disney).3 And Alan Greenspan, Chairman of the Federal Reserve Board of Governors called the bonds "one of the more important indicators of the long-term inflation expectations that have so bedeviled our economy and financial markets seem to be receding . . . a very good sign."4

As long-term interest rates declined in 1992 and 1993, companies and investors began to show renewed interest in very long-term maturities. The Tennessee Valley Authority (a government-

owned hydroelectric power company) sold a 50-year bond in April 1992. Ford, Boeing, Texaco and Conrail followed with their own 50-year issues (irreverently dubbed "Methuselah" bonds) in 1993.

The Disney bonds were the first 100-year bonds to be issued since 1954, when the Chicago & Eastern Railroad (a subsidiary of Union Pacific) issued 5% bonds due in 2054. However, the award for longest lasting liability went to the Canadian Pacific Corporation, which was paying 4% on a 1,000-year bond, issued by the Toronto Grey and Bruce Railway in 1883, and due to be repaid in 2883!5

The idea for the 100-year bond came from an institutional investor. As reported in the Wall Street Journal, an institution approached Morgan Stanley with a request for a 100-year corporate bond to balance its short-term holdings and lengthen the duration of its portfolio. Thus, according to some observers, the 100-year bonds "were conceived by quantitative analysts tucked away in cramped rooms crowded with computer screens."6

The issue was priced on July 20, 1993 to yield .95% (95 basis points) over the benchmark 30- year Treasury bond. Analysts estimated that this was .15% to .20% more than Disney would have paid had it issued 30-year bonds. And Disney had the right to call the bonds after 30 years for 103.02% of face value. Thus 30 years hence, the company had the best of both worlds. If prevailing interest rates were low, it could call the bonds and replace them with a cheaper issue. But if interest rates were high, the bonds could remain out, continuing to pay 7.55%, for 70 more years!

The bonds were rated Aa3 by Moody's and AA- by Standard & Poor's. Demand was so brisk that the company doubled the size of the issue from $150 million of $300 million.

As co-manager of the Disney offering, Merrill Lynch perceived an overflow of interest for very-long-maturity bonds. According to Grant Kvalheim, a managing director at Merrill Lynch & Co., "We went to Coke and showed them the [Disney] bonds."7 Three days later Coca-Cola Co. went to market with its own 100-year issue of $150 million. The Coke 100-year bonds were priced to yield 7.455% or just 80 basis points over the benchmark Treasury, but, unlike the Disney bonds, were not callable.

The primary buyers of both the Disney and Coca Cola bonds were large institutions, especially insurance companies and pension funds with defined liabilities. There was also speculation that some Wall Street houses would find it advantageous to break up the bonds into their component parts and sell the pieces separately.

At the end of the week, professionals were still divided over whether the two 100-year bond issues were indicators of a trend and (as Greenspan claimed) evidence of confidence in the economy, or merely two novelty items that enlivened a dull week in July, before everyone headed off on vacation!

Questions

1. What are the cash payments associated with the Sleeping Beauties? Who gets how much and when, per $100 of bonds issued? Consider the following dates: the issue date, the delivery date, the date of the first, second, etc. interest payments, the maturity date. (Assume the bonds remain outstanding through 2093.)

2. Open the Sleeping Beauty Excel Workbook, which contains a number of worksheets. Double-click on the Basic Spreadsheet. It contains a list of years and payments made each year on the Sleeping Beauties. (For simplicity, we are ignoring the fact that U.S. debentures, by convention, pay interest semiannually.) The NPV function in Excel calculates values of cash flow streams for a given interest rate. Cell F15 in a box titled Present Value contains the formula, and shows the resulting price of the bonds. What interest rate was used to calculate the price? Was it higher or lower than 7.55%?

3. Suppose on the day after the Sleeping Beauties were sold, the prevailing interest rate increased one percentage point, i.e., from 7.55% to 8.55%.

a. What events might cause such a change?

b. What would be the new price of the Sleeping Beauties?

4. If the interest rate dropped by one percentage point, what would the price of the Sleeping Beauties become?

5. The next spreadsheet in the Workbook is called Interest Rates. Column D in the Interest Rates spreadsheet contains a list of interest rates, ranging from 2% to 20%.

a. Is this a reasonable range of interest rates to consider over a 100-year horizon?

b. Calculate the value of the Sleeping Beauties for each of the interest rates shown.

(Hint: Copy the NPV formula in Cell E6. Paste the formula in Cells E7 through E27. Note that the cash flow stream in the formula is "absolute," i.e., each cell reference is preceded by a $ sign.)

6. The next sheet in the Workbook is called "Maturity." The first three columns are identical to the Basic Spreadsheet. The next column contains cash flows for a bond that is just like Sleeping Beauty, but lasts only 10 years ("Napping Beauty"). Column F contains the same list of interest rates as in the Basic Spreadsheet. Columns G and H contain prices for the Sleeping and Napping bonds that correspond to the different interest rates. (You can check your answers to Question 5 against the values in Column F.)

a. Compare the prices of the Sleeping and Napping bonds at the initial interest rate of 7.55%. Why are they the same? What does this say about the expected price path of the Sleeping Beauties as time passes, if interest rates remain around 7.55%?

b. Suppose interest rates fluctuate wildly during the next two years and then stabilize again at around 7.55%. What do you predict would happen to the price of each of the bonds?

7. Compare the value of the Sleeping and Napping bonds for interest rates greater than 7.55%.

a. Which is worth more? Why?

b. Do the same for interest rates below 7.55%. Which bond is more sensitive to interest rate fluctuations? Why?

c. Flip to the next sheet of the Workbook to see the graphed values for the Sleeping and Napping bonds.

8.The next sheet in the Workbook is a Chart of the Sleeping and Napping Beauties prices as a function of interest rates.

9. In July 1993, the Walt Disney Company's common stock was trading in the range $36 to $41 per share. It paid dividends of $ .25 per share annually, on earnings of $1.80 (estimated for the fiscal year ending in September 1993).

a. What pattern of cash flows do holders of Disney common stock expect? How does this pattern compare to the Sleeping Beauties?

b. If Disney bonds pay 7.55%, what rate of return should one expect for holding Disney common stock?

c. How much must Disney's stock price go up this year to give an investor that rate of return?

d. How fast must Disney increase its dividends, to merit such an increase in its stock price?

10. Is Disney a good candidate for a leveraged recapitalization? Why or why not?