Interview with Ingemar Lanevi, Treasurer, NetApp
Transcript: WACC or Cost of Debt: which do you use for leasing? |
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Ingemar Lanevi: And, again, another way that I’m looking at the comparison of a purchase versus a lease is really the one big piece that I think a lot of people are missing when they do the analysis, that in a cash purchase nobody really (or, I shouldn’t say nobody), very few companies recognize that there is a cost of funds in a cash purchase as well.
So if I spend a million; the way I’m looking at it, the lease and the purchase; they’re identical. There are two components in both of them. There’s a cost of funds and there’s a residual.
In the cost of funds, in the purchase you need to look at your weighted average cost of capital. That’s just because, again, you’re using the capital of the firm to expend on a purchase because you need that piece of equipment to do something for you.
But there is a cost inherent to that, because you got that from somewhere, either through your earnings or raising more stock or from issuing debt … whatever. In some mechanism; you brought the capital into the company and now you’re spending it to buy a piece of an asset.
So, there is a cost to that equation which is typically completely ignored by most corporations in the world. Very few are sophisticated enough to take that into consideration.
And, again, NetApp’s the same way. We don’t really look at the fact that there’s a cost of that; I’m trying to instill that discipline, but again, that’s something that doesn’t come natural to people.
The residual aspect of it, again, you take on all the risk on the residual side by buying the piece of asset. So, you retain all the risk on the residual. Technical obsolescence, etcetera, etcetera. You have taken all that on yourself by buying the asset.
In the lease scenario, same two components: There’s a cost of funds involved. Now, with a lease, typically that is your cost of debt.
Because the leasing company will look at you as a creditor and see what is your debt rating and what is your risk from a credit point of view, and they will assign you a cost of debt, which, again, in all corporate theory that you will get your hands on, cost of debt will always be lower than your weighted average cost of capital. Because cost of equity in most cases has a higher cost than cost of debt.
So, purely from the cost of funds layer in the analysis, leasing is a better alternative because it has a lower cost of funds.
Interviewer: So, you could spend your cash, your precious cash on buying another company to bring shareholders returns…
Ingemar Lanevi: Correct. That’s exactly it.
Interviewer: …or you can spend it on equipment, which depreciates.
Exactly. So, you make the choice. Where do you drive the most value to your shareholders? By buying a piece of plastic and metal that will depreciate over the next three years when you’re going to use it and have virtually no value or very limited value after a three-year period?
Or, do you want to use that million dollars to go buy back your stock, if nothing else is available in terms of investments, and generate a certain amount of return to your shareholder by giving him or her the ability to take that money and invest it somewhere else where it can generate a 20, 25 percent return.
That’s the decision-making process in the lease-versus-buy analysis that most people need to go through.
And, again, just to finish off my last thought here in terms of the lease-buy analysis. On the lease side and the residual one are all; we talked about that; that residual piece is outsourced. That’s the whole beauty of it. You pushed that whole thing off to the leasing company. You don’t have to worry about it anymore.
One less headache for you to worry about. This is why I favor a lease structure: Lower cost of funds, outsource the residual, and I’m better off at the end of the day economically speaking, I think.
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I am glad to hear Mr. Lanevi’s view on using WACC as a measure for making the lease/buy decision. I believe it is the proper measure and have been trying to convince equipment users of that for years, now. It is a tough concept to accept for many CFOs, though, for whatever reason, even if it is theoretically sound.