Flowers Industries is a large U.S. wholesale baking company that has grown through acquisitions. In the 1980s, it was seeking to raise $50 million to finance further acquisitions. It considered three financing options: issuing common stock, taking on straight debt, or issuing convertible subordinated debentures. Convertible debentures were identified as the best option because they would not immediately require capital, would yield the highest EPS, and would give the company better control over leveraging. The company's financial status in the 1970s-1980s was profitable with high sales and EPS growth outpacing competitors and the S&P 500 on average.

1. Flowers Industries, Inc
BMGT440 Financial Case Analysis
Xufei Xu
Yi Li
Sin Tung Chan
Xiaoqiao Wang
Minyi Xu

2. Introduction
 A largest U.S. wholesale baking company
 Based in Thomasville, Georgia
 Founded in 1919
 Produced baked food, snack foods, & convenience
food
 Goal : most profitable Least-Cost Producer
 1970s – 1980s: Grown through Acquisition strategy
which has served the company for many years

3. Flowers Industry, Inc.’s History
 1984 — Sales of $603 mil
 1985 — Became a Fortune 500 company
 Significant Sales Growth came from Acquisition
50-60% Sale Growth – from acquisition
100% Earnings Growth – from internal development
1974-1984 Industry S&500 Flowers
Compound 3% 8% 17%
Revenue Growth
EPS Decrease 6% 6% 17%

4. Anticipate Opportunities
 Marty Wood tried to find an opportunity to raise 50
million dollars to finance the company.
 Three alternatives:
1. Common stock issue
2. Straight debt issue
3. Convertible Subordinated debentures
- Not immediately require capital

5. Company’s Financial Status
 Financially profitable during 1974- 1984.
 Sales growth=17%
 S&P 500 average=8%
 High EPS growth

6. EPS Analysis
 Fact: Raise approximately 50 million dollars to
continue their acquisition opportunities
 Three ways need to be consider:
 Straight debt financing
 Common Stock
 Convertible bond

8. Step 1: Calculate Net Income

9. Step2: Calculate Number of Shares

10. Step3: Calculate EPS
However, the fully diluted EPS in the case of convertible debt adjusts for
the assumed conversion of the debt by adding back the after-tax cost of
debt which equals:
(Net income +new interest expense*(1-45%))/number of diluted shares outstanding
 Choose Convertible Stock!

11. Other Factors
• Financial Risks
• Flexibility
• Voting Control
• Timing of Financing

12. Financial Risk
Debt Financing:
Advantages
 Less risky for investor; therefore cheaper source
of capital than stock
 Tax deduction for interest results in lower after tax
cost to company
 Increase return to Stockholders (ROE)
Disadvantages
 High Financial Risk
 Payment obligations are enforceable under law

13. Financial Risk
Equity financing:
Advantage:
 No legal obligation to pay dividends if not making any
profit
 Low financial risk
Disadvantage:
 More risky for investors makes it more expensive form of
capital
 Require higher return for investing in stock

14. Flexibility
Debt Financing:
 Have specific monthly payment
 Potential to go bankrupt
Equity financing:
 Preferred; because lower regular cash payment
requirements

15. Voting Control
 Debt financing have more percentage of voting control
 Straight debt has no dilution on ownership at all
Best option from Voting control perspective

16. Timing
 When interest rate is high, the company will choose to
use equity financing method rather than debt financing.
 However, if the stock price of the company is high, the
company is willing to issue stock rather than debt
because the stock price is somewhat overvalued.
 Market interest rate is relatively low and the stock
market is not well, choose convertible stock!

17. When should the company call the
option?
3-step Analysis:
1. Price without calling the option
2. Term to call
3. Confirm that the term is fair to call

18. 1. Price without calling

19. 2.Term to call
 Dividend

20. 3. Is it a fair estimate?
 To confirm, we use two approaches:
1. Market value
2. Black-Scholes Value
 evaluating whether option contracts are fairly priced
 comparing the price of this instrument, the exercise
price of the option, the volatility of the instrument,
the time remaining until the expiration of the option
contract, and current interest rates

21. Market Price Valuation at year 4.31

22. Black-Scholes Valuation at Year 4.31

23. Recommendation and Decision
 Best choice: Convertible bonds
 Yields the highest EPS
 Better control over the leveraging process
 EPS growth was maintained at 15%
 Stock price went above conversion price in late 1987
and early 1988.
 Convertible bonds were called only in August 1992.

24. Questions?