Recently, there has been some gnashing of teeth about the possible impact on sale-leasebacks by a proposed change in the manner in which leases are accounted for under GAAP. FASB has put forward some changes which, if enacted, will effectively eliminate the distinction between operating and capital leases. For companies such as Walgreens and CVS, who heavily utilize sale-leasebacks, and typically structure the resulting leases as operating leases, this would means billions of dollars of lease liabilities would move from the footnotes to the balance sheet.While it's true that this change will be a headache for the accounting departments of both lessors and lesses (not the least of which due to its retroactive nature) it's impact onoverall sale-leaseback activity should be zero.
Here's why:
Sale-Leaseback Economics Don't Change Because of How You Account for Them.
The underlying economics of a sale leaseback need to work independent of how the transaction is accounted for. If the cost of doing the sale lease back isn't exceeded by the return obtained on the proceeds of the transaction than it makes no sense. How we record the debits and credits of such a thing is largely irrelevant.
It’s also not like operating leases are a secret on Wall Street. Analysts and those who follow these companies closely have already baked the operating leases into the debt loads of the companies. It’s common practice to take as much as 2/3 of the operating leases listed in the footnotes into consideration when conducting ratio analysis and comparing companies.
That being said, moving the obligations from the footnotes to the balance sheet is essentially a smoke and mirrors exercise although one would have to admit it does enhance transparency. Particularly so for companies who use the practice as a matter of course. It’s amazing how often you hear that Walgreens has no debt. Apparently, those who think so don’t read the footnotes.
While rationally, this change should be a non-issue to the investors in and conductors of sale-leasebacks, no one ever said people were required to act rationally....
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I completely agree with you, Jonathan.
ReplyDeleteTo add a bit of fuel to the fire:
1) Yes, opportunity cost or potential IRR of deployed capital is a key driver.
2) But also (and this is a bit of a pet peeve of mine), basically ALL traditional approaches to 'lease versus own' are wrong when applied to corporate single tenant property (as opposed to equipment, for instance): Just about every time, the analysis for 'own' assumes that the residual sale value will be equal to initial investment, or, even worse and more common, the value will increase at 1-2% per year. For corporate real estate, this is almost always WAY off, in that the property will almost certainly be sold vacant, and thus, with exceptions, at appr. 15-25% of initial investment.
Add opportunity cost to value destruction... that horrible sum trumps accounting issues.
RLP
ps: Our team at Lance came to that realization in the context of our TI funding business, where deploying corporate capital into assets with zero residual value really proves the point.