Saturday, October 30, 2010

Things I Don't Understand

A little piece on an odd decision Adidas by Mike Rogoway

Adidas America wants to sell its north Portland headquarters to raise money for operations, then lease back the property in a long-term deal.

This confuses me. Long-term interest rates are at historic lows, so how is it that this is a good way to raise capital? Either Adidas should be able to borrow directly or at the very least should be able to use the property to secure a very low interest loan against it.

But I am not a finance guy...still I wish someone would explain this to me.


The Oriole Way said...

First, the most basic of accounting identities: A balance sheet has two sides, assets and capital (which is, basically, liabilities + equity). For every dollar in assets, there must be corresponding dollar in capital.

Capital, like everything else in life, is not free. Since Adidas owns it's real estate, the firm carries the asset on its balance sheet along with a corresponding dollar amount of capital. If the company does not sell its building in order to invest in new projects, it must raise new capital, thus increasing the size of its balance sheet. This new capital could be equity (and thus dilutive of current shareholders) or debt (and change the risk profile of the firm's capital structure). There could be covenants on existing debt that prevent the firm from taking on new liabilities (because of debt/equity ratios, interest coverage, etc).

Alternatively, it could be some sort of tax play, since lease payments are fully deductible operating expenses while capital payments on debt are not (though depreciation on the assets would be). Especially if we are near the bottom for prices of commercial real estate (meaning that market value and book value of the assets either represents a loss on the sale to Adidas or at most a small gain), this could be a reasonable hypothesis.

Patrick Emerson said...

Ahhh...this last hypothesis makes a lot of sense.