A lot of people seem to be missing the fact that they plan to sell the building and then rent it back, turning an already paid CapEx into an OpEx.
Zynga seems to be really good at the CapEx/OpEx game. Back before they went public, they did everything on Amazon, so it was all OpEx. Then they built the ZCloud, which converted OpEx to CapEx, which investors liked.
What a lot of people don't realize is that they have been slowing dismantling ZCloud and going back to AWS (converting previous CapEx to current OpEx).
Beyond CapEx and OpEx considerations, the ability to extract cash to offshore (via loans from offshore companies to entities offshore) allows both tax avoidance (legally) and transfer of wealth to executives (legally, since ownership of the various companies is diluted with other executive "co-conspirators"). I know this because I worked at companies where they kept reselling and reselling the skyscrapers over and over again - so they could keep maximizing their ability to make themselves richer while avoiding taxes.
Companies are rated on equity to liability ratios for creditworthiness.
Assets = Liability + Equity
Let's say my company has:
50 million in non-real estate assets (cash, IP, etc)
25 million in liabilities (loans, accounts payable, etc)
25 million in equity
50 million in a building paid by a loan (both an asset and a liability)
If I own the building:
Assets (100) = Liabilities (75) + Equity (25)
Equity/Liabilities = 1/3
If I sell it, pay the loan, and lease it back to myself:
Assets (50) = Liabilities (25) + Equity (25)
Equity/Liabilities = 1
I appear much more credit-worthy.
This sounds like a bug - a business is not clearly safer or less safe a credit risk doing the movement described. Perhaps a business opportunity there.
There are lots of accounting bugs like this. The challenge is Accounting isn't as cut and dry as people think.
For example - how long do you depreciate (write down the value of) an asset that you buy? If you depreciate it too slowly, it might make it seem like you're more profitable than you really are.
Another example - If you buy a financial product to hedge a risk vs to speculate, the accounting treatment is different. (In the latter you need to mark it to market more frequently)
One more... If you're a bank, and you make a loan which you intend to hold until maturity, the accounting treatment (mark to market) is different than if you intend to sell the loan.
Accounting is more than just consistent rules followed by the green eyeshades. :-)
There are two immediate existing business opportunities:
1) Accounting companies (E&Y, Deloitte, etc) help execs understand all these rules. Their advisory (what can you do?) work is more profitable per partner than their audit (what did you do?) work.
2) Investment funds do detailed analysis of accounting statements to make "Apples to Apples" comparisons of companies, then analyze their equity and debt valuations to see if they are properly priced. Sometimes this goes by the name of "Relative value" or "Long/short".
People think accounting is just sums -- it's not. It's the interpretation of sums. Balance sheets and P&L statements don't follow some law of nature; they are careful crafts that try to convey specific concepts about how a company views itself and how it thinks other people should view it. Like all things written by humans, these documents can lie, misdirect, and bend the truth to an agenda. It takes skills to craft them and to decipher them.
Accounting is "just sums" in the same way being a playwright is "just writing". It's a shame that formal education seems to fail at communicating this to the general public; Western society is based on capital but few people understand where and how this capital actually is.
The failure you speak of is by design, I think. Discovering that there aren't hard and fast standards for how to declare everything and that balance sheets can be made to lie is rather shocking to most people.
Hard and fast standards would just re-incentivize gaming the system on the operations side. Accounting is very, very difficult. The best answers often include subjective decision making.
Consider; your project managers claim to be done with 80% of a project. You've billed and been paid for 50%. One lone ranger claims the project is only 30% done. At completion, the project will require a an expensive piece of hardware from you to launch. You have three of these pieces of hardware in stock; the first two you bought cost $50k. The last one cost $150k. The market value is $100k, and the customer will pay $100k at launch.
There is no one answer as to how to book this. You have three choices for the inventory booking (FIFO, LIFO, AVCO) -- the first one will at launch book you a net profit of $50k, the second a loss of $50k, and the last one a profit $17k or so. And, you may decide to book the expense of the hardware now, depending on the contract, so it might look like an expense until you actually launch.
If you are accrual basis, you have at least two ways to book your current revenue; 80% or 30%. Depending on your internal personnel costs, that may yield a profit or a loss. Of course, if some of the project time has been spent on things that could yield benefit to the company later, you may move some of it over to an R&D budget,...
The decisions go on. They are neither trivial nor are they unlinked from reality -- answering the questions like 'did we make money on this project?' and 'how much should we sell the hardware for?' are basic questions that yield 'it depends' type answers.
So, yes, people lie on balance sheets, all the time. But, truth is often hard to achieve for even a very solid financial officer and good management team.
It is by design but there is no way to come up with a truly 100% objective system. There are real reasons to have judgment involved. (Hard and fast rules in any subject always create strange exceptions)
>For example - how long do you depreciate (write down the value of) an asset that you buy? If you depreciate it too slowly, it might make it seem like you're more profitable than you really are.
It isn't supposed to be ambiguous, though it sometimes is (and that's a problem). At least in Canada, we have relatively straight-forward rules to follow for allowable capital depreciation rates, as seen here:
Bit of a tangent, but this makes me think about how personal credit scores are calculated. I find infuriating the exact formula isn't public knowledge.
> a business is not clearly safer or less safe a credit risk doing the movement described
Yes they are? The reason you're thinking of the building as completely safe wrt to credit risk is that, if the company finds it can't pay the loan on the building, it can sell it and hope to pay the loan that way. But that might not work! In the second scenario, that's already been done, which eliminates the risk of being unable to sell the building for an amount that will cover the loan.
Sort of, but another way to look at it is Zynga is not a real estate company and shouldn't be valued based on its real estate. Decoupling the real estate and the Real Business lets investors properly value both (when bankers say this they mean the two parts will be worth more than they are now as one).
In a sense it's a question of vertical versus horizontal integration. (Figuratively and literally) Do you want to concentrate just on what you're good at, or the whole stack? There's not a right and wrong answer, but it's best not to have too much value tied up in something that you're not focusing on.
That's a common thought on Wall Street. Activist investors frequently push companies to separate from real estate holdings (and frequently succeed).
This particular deal makes a lot of sense, the type of investor who wants real estate is not usually the same type that is interested in a struggling tech company.
But it may be way more profitable. Because profitability is not the amount of dollars earned, but the ratio of earned dollars per invested dollar.
Also, it makes sense for most healthy companies to borrow money and pay out a stock dividend at the same time. You need to pay interest on the borrowed money. But that interest can be deduced from the taxes you'd have to pay otherwise. The trick is to find the correct ratio.
The earnings to invest ratio goes up and everyone is happy.
Whilst what you say is true, it should, however, be noted that this is done mostly for liquidity considerations rather than beefing up any accounting ratios. Obviously it’s impossible to tell without seeing the actual legal documents, but the upcoming guidance on lease accounting will most likely require that this type of sale and leaseback transaction to be shown on the balance sheet. So any benefit of turning this into an off-balance sheet lease would only be for the next few years.
True - if not on the balance sheet, definitely in the footnotes.
I think there is something to be said for extracting the value of the illiquid asset. Retailers like Sears and Target were valued primarily based on their real estate until real estate went South and all that was lost.
I didn't word it well, but basically instead of buying more servers (increasing CapEx) you spend more OpEx instead, but not all at once. So it's better on the balance sheet because less is being spend up front (Even though it's more overall).
If you mean the building, it's because they can take advantage of the gains and add that to their balance sheet and then slowly spend it back down.
>So it's better on the balance sheet because less is being spend up front (Even though it's more overall).
A balance sheet balances, so every asset matches a liability. A sale like this doesn't alter the sheet, they are merely swapping one asset (a building) for another (cash).
Actually, I think the balance sheet is affected because they're realizing a profit on the sale.
The profits probably haven't been accrued in past P&L's have they?
So the amount of profit will be a credit to equity and a debit to cash, improving the leverage of the balance sheet.
But that's beside the point, any good analyst would have already adjusted their balance sheet to take account of the value of real estate.
My best guess is that they are planning a round of lay-offs and will use progressively less space in the building. I'd wager that they plan to move headcount to lower cost areas. They also view the real estate market as peaking and want to get out at the top instead o ending up with a depreciating asset. These are just my wild guesses though, no analysis to back it up.
The asset should be worth it's market value in the balance sheet, so when they realize that asset that just get the value in the balance sheet, less any loan against the building.
The CapEx versus OpEx game doesn't make as much difference with depreciating assets because you balance the initial expense against the asset value you are depreciating and so you spread the cost in your P&L over the time it takes to depreciate the value down to 0. So the balance between OpEx and CapEx is more which is better value for the business.
Appreciating assets like building of course have a different affect on the P&L, but then so do the loans you take out to finance them.
Zynga seems to be really good at the CapEx/OpEx game. Back before they went public, they did everything on Amazon, so it was all OpEx. Then they built the ZCloud, which converted OpEx to CapEx, which investors liked.
What a lot of people don't realize is that they have been slowing dismantling ZCloud and going back to AWS (converting previous CapEx to current OpEx).