Interview with Ingemar Lanevi, Treasurer, NetApp
Transcript: How do you do lease vs. buy analysis? |
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Interviewer: So, you must use weighted average costs of capital when you’re looking at discounting when you do your lease versus buyouts.
Ingemar Lanevi: Correct. And so, again, if we look at how we actually determine whether this is a good thing or a bad thing for NetApp and if the pricing makes sense from the lease structure point of view, I do make a comparison on the lease versus buy.
And the way that I typically look at that is, again, the cash purchase is pretty straight-forward. There is a fixed amount of money that I need to spend up-front. Let’s say it’s a million dollars, for argument’s sake. And for that I get a certain type of equipment.
I then look at the lease offer that I’ve received, and I typically also make sure that I build into my lease structures, certainty.
Again, the one big thing that people hate about leasing is uncertainty. You don’t know what’s going to happen in three years. You don’t know what the fair market value’s going to be.
Well, there are ways to protect yourself against all of that. And the way that I do that is I make sure that I get “not to exceed” buyout values in my lease deals up front with a leasing company so I know from the beginning when I sign the document to do the deal, I know what my worst-case scenario is.
I have a three-year, 36-month lease payment. I know what that is. I know after 36 months what my not-to-exceed fair market value is going to be. And, again, depending on equipment and manufacturer or whatever, it ranges typically from 20 to 30 percent, let’s say.
But with that knowledge I can now take the worst-case scenario; let’s say it’s 25 percent. So, 25 percent of the million-dollar purchase price, I know exactly what my buyout value after year three will be.
I take that number, I take my 36 monthly payment, discount it all back to today’s value at my weighted average cost of capital, and as long as that total sum is less than my cash purchase of cash, the million dollars being laid out today, as long as that number is lower, I have generated economic value to the firm by going the lease structure as opposed to the cash purchase.
That’s how I do a very quick and dirty analysis to determine economically whether I’m bringing value to the table or not.
Now, the naysayer will say, “Oh, wait a minute. You’re missing the point.” And the point that’s missing in that very quick-and-dirty analysis is in the purchase scenario, clearly I have retained the residual risk. I didn’t outsource my residual risk. I retained it.
And the naysayer will say, “Well, in three years you can take that asset and you can actually sell it in the secondary market and get some money back.” And it’s absolutely true. I could.
My argument with that is always, “OK, you tell me or you show me one IT organization that successfully has put a program in place that aggressively does that activity at the end of every single three-year period.”
When you’re done depreciating the asset, show me that they actually have a process by which they can take the equipment out of the data center, clean it up, list it on eBay or whatever service they want to use, and sell it and generate value and take into consideration all the costs that went into that exercise of pulling it out, cleaning it up, packaging it up, taking the time of putting it on eBay, watching the bidding, agreeing to the price, and all of that stuff.
My argument is, the cost of doing that is going to outweigh the amount of money that you’re actually going to earn on it. And, again, my basic premise is no IT organization will ever do that successfully on a equipment-by-equipment basis.
They might get lucky on one deal, on two deals, but it never, ever happens. Why? Because it’s not their job. Their job is to manage the data center, keep the data center up and running at all times, make it as efficient as possible.
They’re not measured on being able to take an old piece of asset out of the data center and generate value out of it.
Instead, what happens is it gets pulled out, pushed into the corner, and it sits in the corner until they need that space for something else. And then they toss it in the bin, effectively. That is the reality of what happens.
So when I’m doing my quick-and-dirty analysis of ignoring the whole residual of the purchase, I agree I’m sort of fudging the numbers a bit in terms of the analysis, but in reality, that is really the comparison that needs to be done.
Because I don’t think anybody really generates value out of the owned residual risk that a cash purchaser is taking on.
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