DDIM 09/10. Massey Ferguson Case. Lenders. Group 9

Transcription

1 DDIM 09/10 Massey Ferguson Case Lenders Group 9

2 Massey-Ferguson, a multinational producer of farm machinery, industrial machinery and diesel engines, was founded in In 1980, Massey is the largest producer of farm tractor (17% of world market share) and the largest supplier of diesel engines, registering total assets of $ mln US$, annual sales of $ mln US$ and a loss of mln US$. Figure 1 shows Massey s sales in the previous 10 years. It is evident that the company registered a high growth rate until During the 1960s and 70s, Massey had an ambitious program of expansion. But in the last 70s, it faced huge problems with sales. The macroeconomic situation was changing: the price of oil drastically increased and the farm price and income in North American market dropped down. (Figure 2) Massey s difficulties: Current Lenders situation At the beginning of the fiscal year 1981 the company presents outstanding debts for 2.5 bln US$. The short term debt accounts for 43% of the total amount (1.075 bln US$). In 1980 the D/E ratio is 214%, which is relevantly above the average level of the competitors. It is thus evident that our position as lenders results particularly risky since the company won t be able to repay the debt due by the 1 st November. Indeed, the growth of the company was massively financed by short term debt, whose impact in terms of the interest rate expenses deteriorated the credit-worthiness of the company. The interest expenses are, indeed, 10% of the total ones and the percentage is expected to increase reaching 300 mln US$ in 1980 with a growth rate of 125%. (Figure 3).As a result of this financing strategy the company would unlikely have sufficient financial resources to cover both the short and the long positions. Our lack of trust towards the company is confirmed by the behavior of the shareholders who seems to have lost their confidence because of the critical situation of Massey and of the general economic environment. One evidence of it is that that the Argus Corporation, the largest shareholder, lost interest in further investing in Massey and postponed the issue of preferred stocks. Massey needs extra investment to improve the operation and financial difficulties, which is about mln US$ in the next five years while it lost its major source of equity funding. So as lenders, our choice is critical for the future survival of the firm. Alternatives to face Massey s difficulties and alleviate its financial problems Given the current situation of the firm, four possible alternative scenarios can be considered: a. Claim the debt As long as the company will be in default on several loans on November 1, lenders will be able to use the Cross-default provision, which allows them to cut off credit and secure their loans. As a consequence, the firm will be obliged to stop its activity and start the pay-off phase, implying assets sale and massive worker layoffs. Pursuing this alternative would mean minimizing the risks assumed by the lenders, ensuring them a partial return on their loans and would also represent a way out from an unhealthy company. However, they would report a loss deriving from the discount on receivables (968.2 mln US$) before maturity, on the non-current assets (721.3 mln US$) sale in order to obtain liquidity in the short term and on the inventory (988.9 mln US$) dismissal. Indeed, this amounts discounted plus the cash currently held (56.2 mln US$) does not cover the 2.5 bln US$ of outstanding debt reported at the beginning of the fiscal year Not claiming the debt would mean betting on a recovery of the company financial situation but also 2

3 increasing the probability of having back the total amount due. How can Massey survive and repay its debt-holders? We use Dupont Analysis to tackle this question. Dupont Analysis: Comparison with competitors PM=Net Income/Sales; TAT=Sales/Assets; EM=Assets/Equity. We compare every indicator of Massey with that of the other two companies: International Harvester and Deere & Com (Figure 4). Massey-Ferguson s ROE performs worst among the three companies. We can attribute this to the poor performance of its PM and EM. Interest rate is more than 10%, but ROE and ROA within this industry are both below this rate. Therefore high D/E or high equity multiplier is a disadvantage for the company, which reduces earnings or expands losses. Before interest rate drops and operating efficiency and asset use efficiency improve to the extent that ROA surpasses interest rate, Massey should keep the debt portion within capital structure at a low level comparable with others. Finally we arrive to the conclusion that in order to develop in the long run, Massey-Ferguson has to reduce the debt percentage in the capital structure. b. Equity Issue The company could improve its D/E ratio by issuing new shares and raising money on the capital market. The funds raised could be used to cover the short-term debt while the higher equity level would reduce the risk exposure for the portion of the debt still due. Given the current market price of 5 US$ per share and assuming as fair an under-pricing of 20% the price of the issue should be 4 US$ per share. To cover the short term debt of bln US$, millions of shares should be issued. This option seems unfeasible for two main reasons: current shareholders would never accept such a dilution on their voting power and the market would be unwilling to finance such an indebted company. c. Debt conversion into equity The lenders evaluated the hypothesis of converting part of the debt into equity to alleviate the financial leverage of the company but this option seems not convenient for the following reasons. We don t have any strategic interest and competence in the industry in which Massey operates and consequently the cost of information asymmetry and monitoring would be too high. Moreover, since the probability of default is and will likely be very high, becoming shareholders would mean loosing the priority in the pay-off phase. A possible conversion in preferred stock would solve the first problem. However, we would still loose our preferential position as lenders. An additional scenario could be figured out in the case of a public intervention by the Canadian Government. d. Government intervention The Canadian Government has a strong incentive in implementing a rescue policy in favour of Massey. Indeed, a massive reallocation of facilities in Canada has been planned and a halt of Massey s activity would imply a relevant loss in term of employment. The Government intervention would reduce the 3

4 default risk of the company and guarantee our position. Since public equity participation is not in line with the Government intentions, the only viable solution would be a long-term loan provided by the Government at a preferred interest rate. This loan should cover the short term debt, alleviate the pressure of interest expenses on the total cost structure and finance the recovery plan, guaranteeing the company s solvency in the long term. Chosen Option: Government intervention or Claim of the debt Among these scenarios the last one seems preferable in the lenders interest since having the Government, as a counterpart, would make our loans safer. If this would not occur, our position is that of claiming the debt in two weeks. With such a premise we approached the financial advisors of the company and the government to reach a negotiated solution. Negotiation Results All the three parties involved in the negotiation agreed on the intention of rescuing the company. Indeed, on our side a pay-off procedure would not allow to cover even 50% of the total debt position. We agreed on renegotiating the terms of the loan contract while the government accepted to guarantee the solvency of the company and the financial advisors, on the behalf of Massey s managers, fixed a reduction of the company s risk profile. A detailed description of the agreement follows. 600,000,000 US$ of the short-term debt are paid in two weeks thanks to a bridge loan by the Government. The remaining portion of the short-term debt (475,000,000 US$) has been subject to restructuring. The deadline for the payment has been postponed in 5 years. This time should be sufficient for the company to implement a recovery plan to restore the profitability level and reduce the default risk. The market interest rate adjusted to the inflation will be applied. This adjustment seems reasonable given that the current economic crisis lowers the opportunity cost of money. This agreement is particularly satisfying to us because the government accepted to guarantee the total amount in case of the company insolvency. This means that our short term position would be covered independently from the future results of Massey, eliminating our risk. Our priority position in case of default is still preserved in spite of the entrance of the Government as new lender. The financial advisors of the company committed to a fixed target of D/ (D+E) of 45%, which is aligned with the competitors level in exchange of our availability to postpone the payment date. At the moment we were not available to accept the advisors proposal of converting debt into equity. However, we are open to renegotiate this point in three years if the recovery plan results would be satisfying. A point in which the management seemed open was the possibility of adding a put option to the converted shares in order to make our way out from the investment easier. 4

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