Finance decision analysis
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Finance decision analysis

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Finance decision analysis Finance decision analysis Presentation Transcript

  • Presented For Presented BySagar Sen Md. Mainul Haque 09 (45 E)Lecturer Poonam Barua 100Institute of Business Administration 1 Farhan Imtiaz 112 Copyright Information goes here Company Proprietary and Confidential
  • Background of the company• J.H. Stone & Sons, a cardboard container and paper products manufacturer – was founded by Joseph Stone in 1926• After World War II, it reincorporated as Stone Container Corporation• In 1993, it was the paper and forest products industry’s leading producer of containerboard and corrugated containers.2Copyright Information goes hereCompany Proprietary and Confidential
  • Background of the company3Copyright Information goes hereCompany Proprietary and Confidential
  • Background of the companyGrew significantly through acquisition. Paid for its acquisitions either entirely in cash or borrowing funds with early repayment. In 1947, it became publicly-owned, issued its first 250,000 shares of stock After its first IPO, the company began acquiring even more to better diversify itself in the paper industry. 4 By 1987 Stone had quintupled its production Copyright Information goes here Company Proprietary and Confidential capacity, borrowed heavily to do so
  • Background of the companyStone Forest Industries was created to relieve some ofthis debt $3.3 billion of debt in 1989 when it acquired Consolidated-Bathurst Inc In 1993 Stone Containers future was a shaking one- $4.1 billion of debt. 5 Copyright Information goes here Company Proprietary and Confidential
  • Background of the Industry Price Cyclicality Capital intensive Industry Most products in the paper • The industry is very much capital industry have exhibited intensive. pronounced price cycles • It requires to incur huge amount of fixed costs. • Therefore, operating leverage of Unbleached Kraft Paper (1987 dollars) the companies in the industry is $550.0 $525.0 high by the nature of the business. $500.0Price per ton $475.0 $450.0 Price/Ton $425.0 $400.0 $375.0 $350.0 Year 6 Copyright Information goes here Company Proprietary and Confidential
  • Background of the IndustryOperating leverage • A magnification of profits (EBIT, or net operating income) that results from having fixed operating costs in the cost structure of the company. • Operating leverage increases as the ratio of fixed costs to variable costs increases. • With a high ratio of fixed costs to variable costs, a small percentage change in sales will lead to a large percentage change in operating profits. In other words, the percentage increase in EBIT is magnified.7Copyright Information goes hereCompany Proprietary and Confidential
  • Background of the IndustryDegree of Operating leverage (DOL) • Degree of operating leverage is defined as the percentage change in EBIT divided by the percentage change in sales • It measures to what extent operating profit will vary with the given change in sales for a given level of fixed costs • The higher the DOL, the higher the volatility in EBIT due a given change in sales. • A change in sales may result from external factors such as price movements, state of economy etc. • The higher the DOL, the higher the business risk – the chance that external factors may be unfavorable causing decreasing sales.8Copyright Information goes hereCompany Proprietary and Confidential
  • Background of the competition Competitor AnalysisCompany ProductsStone Container Corporation Container board, corrugated containers, kraft paper, bags, sacks, newspaper manufacturing products, wood pulpWillamette Inds.Chesapeake Corporation Commercial tissues, kraft paper, corrugated containersUnion Camp Corporation Pulp, uncoated white papers, paper bags, corrugated containersWestvaco Corporation Paperboard, Containerboard9Copyright Information goes hereCompany Proprietary and Confidential
  • Expansion strategy of the companyAcquisition A corporate action in which a company buys most, if not all, of the target companys ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a companys growth strategy whereby it is more beneficial to take over an existing firms operations and niche compared to expanding on its own. Acquisition turned out to be a profitable technique for Stone because-  They acquired the plants during industry ‘troughs’ which allowed them to expand at low cost and with greater speed. 10 Copyright Information goes here Company Proprietary and Confidential
  • Expansion strategy of the companyVertical Integration The process in which several steps in the production and/or distribution of a product or service are controlled by a single company or entity, in order to increase that company’s or entity’s power in the market place.  When a manufacturer owns its supplier, it’s a backward integration.  When a manufacturer owns its distributor, it’s a forward integration. One of Stone Corporation’s acquisition objectives was to form strong backward integration. Stone acquired plants and/or companies that produce its raw materials - • Mills producing jute linerboard and corrugated medium-raw material for corrugated containers. • Producers of kraft linerboard – raw material for containers. • Canada’s fifth largest pulp and paper producer, Bathurst. 11 Copyright Information goes here Company Proprietary and Confidential
  • Expansion strategy of the companyConglomerate It is a combination of two or more corporations engaged in entirely different businesses All corporations called subsidiaries - fall under one corporate group called parent company Often, a conglomerate a multi-industry company E.g. Beximco group in Bangladesh. This conglomerate has subsidiaries such as Beximco Synthetic Ltd. (textile), Beximco pharmaceuticals Ltd. (pharmaceuticals), Shinepukur Ceramics 12 Ltd. (ceramic), Independent Television (media) etc. Copyright Information goes here Company Proprietary and Confidential
  • Expansion strategy of the companyConglomerate Conglomerate has businesses in various industries. Therefore, its risk can be well diversified It can enjoy the benefits of vertical integration However, it may lose its focus on its core businesses and not be able to manage unrelated businesses equally well 13 Copyright Information goes here Company Proprietary and Confidential
  • Expansion strategy of the companyHorizontal Integration The acquisition of additional business activities that are at the same level of the value chain in similar or different industries.  E.g. Acquiring a competitor entity is a horizontal integration Stone Corporation acquired Light corrugated box company in Philadelphia – a competitor in the region – to expand the business beyond Chicago. 14 Copyright Information goes here Company Proprietary and Confidential
  • Current situation of the companyFinancial Leverage The company made many highly leveraged acquisitions. This made the financial leverage of the company very high.• The use of debt funds in a profit-making and tax-paying business improves the equity returns (ROE).• Financial leverage is the effect that the use of debt funds produces on returns• Financial leverage refers to a firms use of fixed-charge securities like debentures in its plan of financing the assets. 15 Copyright Information goes here Company Proprietary and Confidential
  • Current situation of the companyFinancial Leverage Financial leverage is a double-edged sword.  It magnifies returns and  Increases their volatility as well.  Increased volatility implies greater financial risk – the chance that the company may not be able to meet its debt obligation and go bankrupt.  The higher financial leverage, the more it magnifies profits as well as losses.  It is measured by Debt to total capital ratio or by Debt to equity ratio 16 Copyright Information goes here Company Proprietary and Confidential
  • Current situation of the companyDegree of Financial Leverage (DFL) It measures to what extent net income will vary with the change in operating profit (EBIT) given a certain level of debt. It is calculated by dividing %change in net income by %change in operating profit. The higher the DFL, the higher the impact of financial leverage, and the more it magnifies profits as well as losses 17 Copyright Information goes here Company Proprietary and Confidential
  • Current situation of the companyDegree of Combined Leverage (DCL) It measures the total impact of DFL and DOL. It is calculated by dividing %change in net income by %change in sales. The higher the DCL, the higher the impact of total leverage, and the more it magnifies profits as well as losses Companies with high DOL should maintain low DFL to reduce risk – so, companies which require to incur high fixed costs to carry out businesses should go for low level of debt 18 Copyright Information goes here Company Proprietary and Confidential
  • Current situation of the company Cross sectional comparison: year 1992 Financial Stone Chesapeake Union Camp Westvaco Willamette Ratios Corporation Corp. Corp. Corp. Inds. Return on (3.2%) 0.5% 2.5% 5.8% 3.4% sale (NPM) Return on total capital 3.5% 4.4% 3.2% 6.6% 6.0% (ROI) Return on (14.7%) 1.3% 4.1% 7.7% 7.0% Equity (ROE) Current Ratio 1.8 2.4 4.2 1.9 1.5 Debt to total 78.2% 51.1% 48.9% 37.8% 43.7% capital Interest 0.5 1.6 1.3 3.6 2.4 Coverage19 Earnings perCopyright Information goes here (2.50) 0.17 1.10 2.06 1.52 share (EPS)Company Proprietary and Confidential
  • Current situation of the company Cross sectional comparison 90.00% 80.00% 70.00% 60.00% 50.00% Stone Container Corp. 40.00% Chesapeake Corp. Union Camp Corp. 30.00% Westvaco Corp. 20.00% Willamette Inds. 10.00% 0.00% Return on sales Return on total Return on equity Debt to total -10.00% (NPM) capital (ROI) (ROE) capital -20.00%20Copyright Information goes hereCompany Proprietary and Confidential
  • Current situation of the company Time series comparison: Stone Container Financial Ratios 1992 1991 1990 Return on sales (NPM) (3.2%) 0.5% 2.5% Return on total capital (ROI) 3.5% 5.2% 10.6% Return on equity (ROE) (14.7%) (3.2%) 6.5% Current ratio 1.8 1.8 1.4 Debt to total capital 78.2% 73.1% 73.7% Interest coverage 0.5 0.8 1.4 Earnings per share (2.50) (0.78) 1.56 %change in sales 2.53% -6.46% %change in EBIT -35.49% -49.14% %change in net income -261.30% -151.47% DOL 14.01 7.6121 DFL 7.36 3.08 DCLCopyright Information goes here 103.15 23.46Company Proprietary and Confidential
  • Current situation of the company Time series comparison 90.00% 70.00% Return on sales 50.00% (NPM) Return on total capital (ROI) 30.00% Return on equity (ROE) 10.00% Debt to total capital -10.00% 1990 1991 199222 -30.00%Copyright Information goes hereCompany Proprietary and Confidential
  • Problem in Question • High financial leverage and high operating leverage with cyclical downward movement in prices of output • This situation left the company with the uncertainty on how to pay back the large amounts of debt that were due in the coming year. • Operating leverage cannot be decreased since high operating leverage is the essence of the business • Therefore, financial leverage must be brought down • They now face the problem of which of the 5 alternatives available to them is the best plan of action to take to arrive at a sound financial plan. • The goal of this plan was to relieve the immense debt that was plaguing them, help it get through the paper pricing trough, and also restore the company to its former glory of financial stability.23Copyright Information goes hereCompany Proprietary and Confidential
  • Option 1Loan restructuring• The borrower works with the same agreement.• The terms of the agreement are altered, such as extending the date by which balance must be paid off.• This means the borrower does not create a new account and continue to work with the same creditor as before.• restructuring equates to modification.• In the case of Stone Corporation, among the five alternatives, one was loan restructuring24Copyright Information goes hereCompany Proprietary and Confidential
  • Option 1• Loan restructuring – The terms on the bank loans could be renegotiated to extend their maturities and ease some of the binding covenants. Fees for this transaction would range from $70 to $80 million.• The effects of this would be $70-80 million in fees.• This option doesnt decrease the Stones familys interest in the company further• However, it doesnt involve any new inflow of fund.• It can be accepted.25Copyright Information goes hereCompany Proprietary and Confidential
  • Option 2• Assets or equity interest in a Stone Container Corporation subsidiary could be sold for a cash flow of $250 to $500 million.• Selling equity interest would decrease the Stone familys interest in the company further below 30%• Selling assets is not good for the future of the core business• However, it would bring in the funds needed to help decrease the companys debt• It should NOT be accepted26Copyright Information goes hereCompany Proprietary and Confidential
  • Option 3 & 4Loan refinancing• Borrower applies for a new loan and thus start working with a new lender.• Borrower may get better terms under the new contract, but does not alter the terms of the original loan.• Borrower uses the funds from the new loan to pay off the original debt.• refinancing equates to replacement.• In the case of Stone Corporation, among the five alternatives, two were loan refinancing27Copyright Information goes hereCompany Proprietary and Confidential
  • Option 3• Debt refinancing – The bank debt could be repaid by selling intermediate-term senior notes to the public. $300 million of 5-year notes bearing a coupon in from 12% to 12 ½% could be sold. – This is a bond that takes priority over the other debt securities sold by the company. If Stone were to go bankrupt, this debt must be repaid before other creditors receive payment. – This would replace the debt that was due in the coming year. The company would avoid a possible default • without losing its creditworthiness, • Without reducing Stone family’s interest in the company • Without selling any asset of the company28Copyright Information goes hereCompany Proprietary and Confidential
  • Option 4• Debt refinancing – The company could sell up to $300 million of convertible subordinated notes. The notes would have 7 year life, bear a coupon of 8 ¾%, and be convertible into Stones common stock – The other debt securities sold by the company take priority over this bond. If Stone were to go bankrupt, this debt would be repaid only after other senior creditors receive payment. – This would replace the debt that was due in the coming year. The company would avoid a possible default • without losing its creditworthiness, • Without reducing Stone family’s interest in the company • Without selling any asset of the company29Copyright Information goes hereCompany Proprietary and Confidential
  • Option 3 and 4 compared Loan annual Net Total EBIT Loan term interest EBT Tax amount interest income ROE interest (M) in yr rate (M) (M) (M) (M) (M) (M)Option 3 169.04 300 5 12.50% 37.5 131.54 46.04 85.50 7.10% 187.5Option 4 169.04 300 7 8.75% 26.25 142.79 49.97 92.81 7.71% 183.75 From the table above, • Subordinated notes offered the higher ROE and involved the lower amount of interest charges. • Additionally, subordinated notes had claim only after the claims of other senior debts were met. • Then, subordinated notes had longer maturity • Therefore, convertible subordinated notes should be preferred to the senior notes in this case 30 Copyright Information goes here Company Proprietary and Confidential
  • Option 5• Common stock of up to $500 million could be issued to the public which would produce net proceeds for the company of 95% of the offering price.• This option could potentially allow the company to put $475 million towards its debt.• However, this would decrease the Stone familys interest in the company further below 30%• It should not be accepted31Copyright Information goes hereCompany Proprietary and Confidential
  • RecommendationOption 1 – Renegotiating the terms of loans would allow the company more time to restructure its debt portfolio and give them a chance to depend less on an alternative that decreases the familys share in the company. – This option outweighs the alternative to sell equity in the company or its subsidiaries because there is no loss of family stake in the company.32Copyright Information goes hereCompany Proprietary and Confidential
  • RecommendationOption 4 – The shareholders of the company could earn good return on their equity. – This alternative outweighs the option to issue senior notes because the ROE is higher and the total interest paid is less – The longer life of this option would allow Stone to spread out its default risk farther than any of the other options. – This option would also keep the Stone familys interest in the company the greater than compared to option number five.33Copyright Information goes hereCompany Proprietary and Confidential
  • Conclusion• If Stone Corporation wants to stay out of bankruptcy it needs to restructure its debt.• The company had a long time standing of not needing debt or paid it off quickly but that changed because of large acquisitions.• Five debt reducing alternatives were presented to the company in order to – relieve the immense debt that is plaguing them, – help it get through the paper pricing trough, – help restore the company to its former glory of financial stability.• Two options offered the biggest rewards. – The company should restructure its loan terms and – issue $300 million in convertible subordinated notes34Copyright Information goes hereCompany Proprietary and Confidential