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Nova Chemicals received an unsolicited offer of $160.0 million for the Industrial Products Division (IPD) from United Chemicals. The purpose of this memo is to evaluate the offer, and consider the implications of the sale or retention of IPD on the 5-year

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Introduction

Summary & Recommendations Recently, Nova Chemicals received an unsolicited offer of $160.0 million for the Industrial Products Division (IPD) from United Chemicals. The purpose of this memo is to evaluate the offer, and consider the implications of the sale or retention of IPD on the 5-year financing needs of Nova. We recommend the following actions: * Negotiate with United Chemicals for a selling price of $185.0 million, which is in the middle of a valuation range of $164 - $208 million, and in line with the market's valuation of IPD * Assuming the sale of IPD, Nova should raise $185 million of equity to meet residual funding needs * If IPD is retained, Nova should issue $90 million of debentures and raise $252.4 million of equity to fully meet the financing needs of the next five years Evaluation of the Sale of the Industrial Products Division (IPD) Nova Chemicals consists of two specialty divisions and IPD, a basic chemicals division. The specialty divisions expect high growth, and therefore require investment in new product facilities. In contrast, the commodity nature of basic chemicals has led to low margins for IPD, while the cyclical nature of the industry suggests a weak outlook. ...read more.

Middle

and interest coverage ratio (EBIT to interest expense) of each of these alternatives. We examine the following three options in detail: $100 Million Bank Credit Agreement We feel the first option-issuing $100 million on a 2-year bank credit agreement-is prohibitive because the company would still need to raise another $85 million, while meeting several requirements. The most prohibitive is that a maximum ratio of total debt (short-term and long-term) to net worth of 1.0. Because the company currently operates with a 1.0 total debt to net worth ratio, the company would need to raise an additional $100 million in equity. In our analysis, this gives the company a WACC of 10.99% (slightly higher than the current cost of 10.83%), but also lowers the interest coverage to 2.24 significantly below the 3.0 desired by the Board. $200 Million in 15-Year Debentures at 11.25% The second option to raise $200m of 15-year debentures at a coupon rate of 11.25% is handicapped again because of the same restrictions as in option 1. Because of the 1.0 total debt to net worth restriction, this again results in the need to raise $100 million in debt along with $100 million in equity. ...read more.

Conclusion

A summary of these options is presented in Table 2. Table 2: Summary of Financing Options, Assuming Sale of IPD Five-Year Financing Plan Assuming Retention of IPD If the Board chooses to retain IPD, Nova will need to raise $153.4 million, $324.1 million, $342.4 million, 340.3 million and 316.5 million respectively from 1990 to 1994. As a result, none of the three options considered above can alone meet the peak funding need of $342.4 million in 1992. However, if Nova raises funds with new equity, it will have the ability to issue debt as well. To preserve an interest coverage ratio of 3.0, the maximum amount of debt that Nova can raise at a rate of 11.50% is $90 million. Thus, in this scenario, we recommend that Nova raises $252.4 million of equity capital, and simultaneously issues $90 million of 15-year debentures at the 11.25% rate. This will increase the cost of capital to 11.47%, although the debt-to-equity ratio will fall to 0.72, while interest coverage will be maintained at 3.0. Exhibit 1: Valuation of IPD Exhibit 2: Five-Year Estimate of Funding Needs ?? ?? ?? ?? 1 ...read more.

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