- Assuming that the Gannett acquisition goes through, estimate CCI’s short-term (1.5 years) and long term (4.5 years) funding needs. How much of each funding need must be met through external financing?
The dollar amount for Cox’s pending acquisitions is estimated to be $10.419 billion. This amount should be sufficient to cover CCI’s funding needs over the next 3 to 5 years (4.5 yrs). Immediate funding amounts (1.5 years) for these transactions can be estimated by the out flow from investments (Exhibit 8D $3.778 billion + $3.986 billion =7.764 billion) with $2.7 billion being used for the purchase of Gannett (mix of equity and debt). CCI’s funding needs over the next year and a half will reach $7.764 billion. They have already committed to 7 billion in acquisitions for this year and the full cash 2.7 billion needs for the purchase of Gannett will not be fully vested in the next 1.5 years. The amount of funding that will be needed from external sources to cover the next 1.5 years of funding needs is 4.772 billion dollars (the average of the 1999 and 2000’s cash from financing activities, and multiplied by 1.5) (total cash from financing 99-2000 equals 6.363 billion). The amount of funding that will be needed from external sources between 2000 and 2003 is (1.283 billion) due to anticipated cash inflows from business operations which will subsequently be used to repay external financing, it is difficult to estimate the repayment of Cox’s obligation however historically Cox has been somewhat conservative regarding debt. In addition the sale of “non-strategic” interests in companies like Sprint PCS and others, will inject additional cash into Cox’s operations.
- What constraints does Clement face in satisfying CCI’ funding needs? You may assume that CEI has mandated a 65% floor on their economic stake.
One constraint that Clement faced in issuing equity was to meet the financial objectives set forth by the Cox family. These included doubling the size of the company every five years, and preserving the economic ownership of the Cox family (65% floor). In addition, Clement was faced the time constraint of issuing equity before Charter’s IPO. Clement feared that if they did not issue their securities before their rival (Charter), investors would be less attracted to the Cox securities. Other factors to consider were the direct costs of an equity issue such as underwriting fees and expenses which were estimated to amount to 2-3% of the total amount raised. The “market impact” of a large equity issue was yet another constraint that Cox faced. As studies have shown, traditionally, issuing large blocks of equity can result in an additional 3-4% reduction in the price of a firms stock.
Constraints that Clement faced in issuing bonds included the Cox family’s conservative attitude about the issuance of debt, and the pressure to maintain investment grade rating. By maintaining investment-grade-rating CEI may be able to have easier access to credit lines in the future. Transaction costs are also a constraint that would amount to less than two percent of the total debt issuance. According to academic studies the “market impact” of issuing debt was estimated to be around 1%-2%. These constraints reinforce the necessity to diversify sources of capital for financing the aggressive acquisition plans. It is clear that Clements will be required to incorporate the issue of equity, debt and hybrid securities in order to meet cash flow needs.
- Analyze the solutions presented in Exhibit 8. What is a FELINE PRIDES security? What are the advantages/disadvantages to firms using this security? Decompose this security into its debt and equity components. What, economically, is a firm doing when it issues FELINE PRIDES?
Exhibit 8A contains the Pro Forma Cash Flows for Cox Communication if it did not purchase Gannett, but if other proposed acquisitions were undertaken. In this Exhibit, the most outstanding feature is the depreciation in the equity interests of the Cox family. This is due to the dilution of the amount of equity, which is one of the major concerns that the Cox family intended to address.
Exhibit 8B shows a high leverage ratio due to the increase in issued debt. The ratios show significant incremental increases over the next four years which contradict the Cox families target Debt/EBITDA of no greater than 5.
Exhibit C is a pro forma based on an all equity issue to finance the up coming acquisitions, as demonstrated this method significantly lowers the Cox Family Economic Equity, the leverage ratios in this exhibit are significantly lowered, but the loss of equity interest eliminates the feasibility of Exhibit C.
Exhibit D is a combination of debt, equity, and PRIDES. This pro forma indicates a balanced approach to the financing acquisitions. In following a diversified approach management can effectively keep within the constraint considerations. One may notice that the Cox Family Economic Equity falls below the 65% threshold in 2002 and 2003, this in minimal and can be regained with additional capital restructuring, repurchase of PRIDE equity shares or other outstanding class A voting shares.
Hybrid equities such as FELINE Income PRIDES are an alternative means of capital financing. FELINE PRIDES are units consisting of (a) a contract under which the holder is obligated to purchase common stock from the company approximately three years following the closing of the offering and (b) beneficial ownership of either dividend-paying capital securities or debentures issued by a business trust subsidiary of the company or U.S. treasury securities. Proceeds from the offering will be used to repay outstanding indebtedness under the company's bank credit facility and for general corporate purposes, including potential future acquisitions. Essentially this issue of a hybrid security like a PRIDE has both the characteristic of debt and equity and functions as such in a company’s operations, the debentures are disregarded for accounting and (generally) regulatory capital purposes, allowing the issuer to present the trust preferred securities as equity-like securities on its balance sheet.
The issue of a hybrid security has advantages and disadvantages, firstly the issue of such securities provides a profitable tax savings, and payments in interest are treated as tax deductible. Secondly, the issue of PRIDES securities is treated as equity for financial reporting purposes due to the obligation of the holder to purchase equity in the future. As a result the firm maintains a desirable debt equity mix and is able to maintain economic and financial control and stability. FELINE PRIDES also come at a price; the issue of these securities is costly because the firm must create a separate entity (trust), this will result legal costs. Hybrid Securities can also disadvantage investors because the higher the stock price in three years, the smaller the number of shares that the income PRIDES holder would receive.
The structure of equity and debt for a FELINE PRIDE is a circular 7 % debt coupon and 7 % preferred equity payment. $720,000,000 million will result in the issue of 14, 400,000 FELINE PRIDE securities. At a rate of 7% (assuming monthly compounding) the resulting payment per PRIDE is $11.57 for three years. This would amount to an estimated $166,608,000 in interest expense over three years. The returning coupon payments into the trust (assuming annual payment) $10.5 over three years, would total $151,200,000 in coupon payments. This is a difference of $15,408,000. The holders of the PRIDES would then be able to transfer this modified debt instrument to pure Class A equity.
By issuing FELINE PRIDES the firm is able to create cash inflows with a deductible interest expense, $166,608,000. The economic impact is that the firm can convert its debt into equity after the demand for immediate cash for planned acquisitions. The incurred costs are for the initial issue and the interest expense.
- Which solution in Exhibit 8 seems to satisfy the financing constraints determined above and why?
Exhibit 8D which includes a combination of debt, equity and PRIDES creates the most efficient mix of debt and equity resulting in a debt leverage amount within the parameters set forth by the management we feel that this is the parameter with the highest importance and economic impact. This approach also maintains the 65% Economic Equity requirements for the Cox family (we believe that the reduction in 2002 and 2003 is temporary or that it can be avoided all together with slight changes in capital structure, i.e. repurchase of some class A shares etc). Exhibit D it also maintains an effectively high Voting Equity share. This is the only exhibit that includes the use of PRIDES; these hybrid securities have some strong advantages for Cox’s present financial needs. A diversified mix of debt and equity is generally the most efficient means to meet capital demands.
