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reduce your investment completely, and you don™t tinues to make his payments to the bank, which, in
recognize anything until that investment is covered.” turn, reduces Comdisco™s discounted lease receiv-
ables.
...




So has Comdisco made money? Well, it has
To better understand the accounting, consider a paid $100 for a computer and borrowed $85 from
typical transaction, which in itself is no simple mat- the bank, to be paid off in ¬ve years by the user™s
ter. The “tax-advantaged” leases, in order to get by rental payments. That leaves a $15 net investment.
the IRS, often involve layers of companies. And the But it™s also received $17 cash from the investor,
shuf¬‚ing of papers in sale-leaseback transactions and then shuf¬‚ed papers so that an $83 note from
can, in short order, obscure the economic realities of the investor is exactly offset by lease payables of
the deals. $83. Comdisco also retains the right to share the
But here are the basics. proceeds of re-leasing the computer in years six and
838 Case: Comdisco, Inc. (B)




108 Part 4 Additional Cases




seven with the investor. The bottom line is this: the pro¬ts are attributed to tax-advantaged transac-
$17 in cash offsets the $15 net investment. Com- tions.”
disco is $2 richer. About 80%“90%?
“I wouldn™t say 90%,” says Vosicky. “It depends
So the income statement shows $2?
on how you want to slice the pie.” Pro¬tability, he
Not likely. All those high-paid lawyers and
points out, depends on the allocation of general
accountants on staff argue the $17 cash payment is
and administrative expenses. And Comdisco ¬nan-
a “fee””for, among other things, putting the deal
cials do not break out this information.
together. Clearly the $17 is theirs; they don™t have to
“I think it would be correct to say,” continues
give it back. So in many cases Comdisco takes the
Vosicky, “that the primary reason for the earnings
entire fee as pro¬t. It shows earnings of $17, even
increase is because of tax-advantaged transactions
though it has only $2 in the cash register.
or ¬nancial services.”
Where™s the other $15? The difference between
The bulk of the increase rather than the bulk of
the reported pro¬ts and the actual cash sits quietly
earnings?
on the balance sheet”in “leased computer equip-
Comdisco (B)




“Yes.”
ment” or sometimes in “net investment in sales-type
In other words, the big leap in pretax earnings
and direct ¬nance leases.” That™s the amount Com-
from $21 million in 1981 to $53 million in 1982 is
disco hopes to recover from re-leasing the computer
primarily because of the tax-advantaged deals?
in years six and seven. But by booking the entire
$17, it has effectively taken this assumed residual “Yes. I think that would be fair to say.”
value into earnings on day one. And if all fees had been reduced by the amount
of investment in the equipment, how much less
Now if in years six and seven, Comdisco re-
would ¬nancial services revenues have been in
leases the computer for, say $20, it can report a $5
1982?
pro¬t. If the re-leasing brings in only $15, Comdisco
“A lot of that revenue came from safe harbor
has broken even. It has simply replaced the $15
leasing transactions where we don t have any invest-
paper asset on the balance sheet with a more
ment . . . .”
spendable $15 in cash. But what if re-leasing brings
in only $5? That presents a nasty problem”indeed, But if the investment in equipment on all the
that means that Comdisco is looking at a $10 write- other leases in 1982 was netted out, how much
off. would ¬nancial services be reduced?
“It would probably be cut in half,” replies
...




Vosicky. “I would think at least cut in half.”
And so this year, with no safe harbor leases,
Nor is the way “fees” are treated an idle, theo-
netting out all the investment in equipment would
retical matter. It is vitally important to Comdisco™s
cause an even greater drop in ¬nancial services?
bottom line. For such fees comprise the bulk of the
“Yet, it would.”
company™s “¬nancial services” revenues. And
Insofar as Comdisco reports pro¬ts now from
although revenues from computer sales and rentals
the equipment leased”and leaves residual value on
are two to three times greater, the company™s big
the books to be recovered later”it increases its
pro¬t center is clearly ¬nancial services. Peter Labe,
exposure to obsolescence. And as of September
an analyst at Smith Barney, a ¬rm that has done
1982, the date of the most recent balance sheet with
investment banking for Comdisco, claims in a recent
full footnotes, that exposure was considerable, at
report that ¬nancial services “account for the bulk of
least in comparison with the company™s net worth.
corporate pro¬ts.”
Comdisco doesn™t dispute it. “No question,”
...




says Comdisco™s Vosicky, “a large percentage of the
839
Case: Comdisco, Inc. (B)




109
Part 4 Additional Cases




EXHIBIT 3
Letter to Comdisco, Inc. Shareholders
October 12, 1983
Dear Stockholders:

As I™m sure most of you know by now, the October 10, 1983 issue of Barron™s
includes an article about our Company. I believe the article and its subsequent impact on
the price of the Company™s stock entitle our stockholders to a clari¬cation of the facts
underlying the key issues raised. The article emphasizes four main areas: (1) The Com-
pany™s accounting; (2) competition from IBM Credit Corporation; (3) our tax advantaged
investment program; and (4) sales by insiders.

Accounting




Comdisco (B)
The article raises questions concerning the Company™s accounting policy with respect
to the investment risk taken on leased equipment and implies that our policy with respect
to payments from tax advantaged leases could result in an overstatement of income.
Under the Company™s depreciation policy, our leased equipment portfolio as of June 30,
1983 will be depreciated to a net book value at lease termination of $112,000,000. The
estimated fair market value of this equipment at lease termination (as provided by inde-
pendent forecasts from International Data Corporation, a highly regarded equipment
valuation expert) was in excess of $279,000,000, a coverage ratio of nearly 2.5 to 1. The
facts demonstrate that the Company™s policies are conservative, and have created a
potential signi¬cant source of future earnings. The speci¬c ¬nancial implications of our
policies are as follows:

(1) Equipment Values
While generally accepted accounting principles require varied accounting treatments
for different types of leases, the central issue is the same for all of the Company™s leases:
Is the Company™s depreciation policy reasonable, thus eliminating the likelihood of a
future write-off? The answer is that our depreciation policy is reasonable, and, in fact,
produced book values of leased equipment which are substantially less than the values
estimated by independent industry experts, as shown by the table below:

Total Lease Portfolio at June 30, 1983 (000™s omitted)

Estimated Fair
Net Book Value at Market Value at IBM List
Lease Type Lease Termination Lease Termination* Price

Operating leases $92,000 $208,000 $876,000
Sales type and direct ¬nancing
leases 20,000 63,000 847,000
Other ” 8,000 60,000
$112,000 $279,000 $1,783,000

*Source: International Data Corporation


As shown above, fair market value estimates prepared by International Data Corpo-
ration provide a substantial margin over the Company™s net book value at lease termina-
840 Case: Comdisco, Inc. (B)




110 Part 4 Additional Cases




tion. This is still true even if the equipment is sold under a tax advantaged transaction.
Since most tax advantaged transactions are structured so that the equipment will have a
zero net book value by the time any tax advantaged investor shares in the fair market
value proceeds, this sharing will not have a signi¬cant effect on the margin of fair market
value available to the Company over the net book value at lease termination.
Another method of evaluating our depreciation policy is to review the operating lease
portfolio (which comprises 82% of the total lease portfolio) by comparing, by year of ter-
mination, net book value at lease termination to estimated fair market value at lease ter-
mination. The following table illustrates this comparison:
Operating Lease Portfolio at June 30, 1983 (000™s omitted)

Estimated Fair
Fiscal Year of Net Book Value at Market Value at Estimated Excess
Termination Lease Termination Lease Termination Fair Market Value
Comdisco (B)




1983 $ 16,000 $ 22,000 $ 6,000
1984 30,000 53,000 23,000
1985 19,000 50,000 31,000
1986 14,000 46,000 32,000
1987 13,000 37,000 24,000
$ 92,000 $208,000 $116,000


Our auditors, Peat, Marwick, Mitchell & Co., review and agree with the Company™s
depreciation policies.
Referring to the foregoing table, it should be noted that 71% of the Company™s oper-
ating lease book value is represented by leases which terminate by September 30, 1985.
This short time period increases the reliability of residual value estimates. Equally as
important, the Company has historically realized more from the remarketing of leased
computer equipment than the value carried on its books, resulting in additional pro¬t at
the point of remarketing.

(2) Revenue Recognition
The sale of leased equipment in a tax advantaged transaction is separate from the
underlying user lease transaction and results in payments to the Company from the inves-
tor. Revenue is recognized from these transactions in accordance with one of two basic
methods:
(a) For all equipment where the underlying user lease term is ¬ve years or longer, and
generally for all 308X mainframe transactions, these investor payments are ¬rst
applied to reduce the Company™s investment in the equipment. Any excess over the
investment is recorded in the period in which the tax advantaged transaction occurs.
During ¬scal 1982 and the nine months ended June 30, 1983, the Company gener-
ated $83,160,000 of such payments. The Company™s investment in the equipment
was reduced by $43,890,000 and the difference, $39,270,000, was recorded as
¬nancial services during this period.
(b) For equipment where the underlying user lease term is less than ¬ve years (except for
308X mainframe transactions) these investor payments are recognized in the period
in which the tax advantaged lease transaction occurs. This accounting treatment is
appropriate since the Company™s depreciation policy results in net book values at the
841
Case: Comdisco, Inc. (B)




111
Part 4 Additional Cases




end of the initial user lease term (typically 2“3 years) that already is less than fair
market value estimates. To further reduce the Company™s net book value for such
equipment would materially understate current income and overstate future income
by reducing or eliminating depreciation charges against future rental income.

Competition from IBM Credit Corporation
IBM has been Comdisco™s single largest competitor for the entire 14 years Comdisco
has been in business. Through its direct lease and rental programs, IBM has always been
the dominant force in the computer leasing industry. IBM™s increasing emphasis on gener-
ating equipment sales, however, is re¬‚ected in its withdrawal from the direct leasing busi-

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