Obama is Bush part 3

Caterpillar's Troubling Bond Issue

There have been a lot of articles in trade publications, and a few academic articles written, about the problems of analyzing companies with "captive finance subsidiaries".

Consider an extreme example:
CAT goes and makes a bulldozer for $60K, and "sells" this to the finance subsidiary for $100K, booking a $40K "profit". The finance subsidiary goes and borrows the $100K at 6% (lets say we are looking at this before the credit crisis), and depreciates the bulldozer over 10 years, or $10K per year. The finance subsidiary tries to lease the bulldozer out for at least what it costs them to finance it. Lets look at the case where they are unable to lease it first:

So year one, the accounting books show:
machinery and engines: $40K profit
Finance $16K loss ($10k depreciation + $6K interest)

And CAT as a whole reports a $24K "profit" even though they didnt sell anything.

If the finance subsidiary manages to lease the bulldozer for $18K per year, they would make 2% ROA (which would actually be well above average for financing deals). In this case the accounting books say:
machinery and engines +$40K
Finance +$2K

This is roughly speaking what CAT's books are showing right now, which is why some people **think** CAT is a bulldozer company... most of the earnings **appear** to be coming from machinery, with only a small amount coming from finance.

But what happens if the home builder industry collapses and the finance division cannot lease the bulldozer for all 10yrs? What happens if the cost of financing goes up by more than the lease?

It quickly becomes obvious that the $40K "profits" on the machinery side is nothing more than an **advance** from the finance division. The actual profitability of producing the bulldozer is completely dependent on how well the financial division can finance their assets vs liabilities.

In other words, CAT is a bank