Lester has determined that merging with Shang-Wa will be a strong capital venture. Knowing the proper financing mix to optimize Lester’s capital structure will be key to their success. United Health Group has a wise Chief Financial Officer, who understands maximizing capital structure very well. Pat Erlandson, CFO for United Health Group stated, “successful capital management requires trade-offs and tough decisions. Always make connections between value creation and capital stewardship by the following: balance the requirements of delivering both current and future value, identify the key capabilities required, assess gaps existing and prioritize strategy clearly. (United Health Group, 2008)
Other areas for Lester to look at would be to “select high-risk projects” where the stockholders benefit at the expense of the bondholders when the high risk project is accepted. Another area to look are “Mergers” that are structured either as cash-for-stock transactions or as stock-for-stock transactions. Shang-Wa could very easily fall into this area. Another area would be ”Options” which are special contractual arrangements giving the owner the rights to buy or sell an asset at a fixed price anytime on or before a given date. Finally, “Corporate Securities” where almost every issue of corporate bonds and stocks have the option features. Capital structure decisions and capital budgeting decisions are viewed in terms of options. (Ross, 2005 p. 618)
Analyze Risk Associated with Investment Decision
In order to make an effective investment decision a number of business factors must be analyzed. Production, marketing, and logistics are just a few departments that have to be on board in making such a decision. The investment process begins with identifying a need, then clarifying the investment proposal, considering alternatives and developing cash flow projections. A four phase model has been created in order to guarantee the success of corporate investment. First the company must plan the project, then the project or capital must be evaluated, a status report need to be completed, and the project must undergo a post completion review (Weaver and Weston, 2002).
After a company has made all of its investment decisions the company can then determine the value of its assets. The company can also look into its capital structure. When the project first started the company might have raised the cash to invest its assets by issuing more debt than equity. Now that the project is completed the company might consider issuing more equity and buy back some of its debt. This financial decision can be made independently of the original investment decision (Ross, 2005).
Lester has many investment decisions that need to be made. Lester needs to determine the risks of merging with Shang-Wa in order to make a successful global company. Lester is currently involved with domestic sales and is falling behind all of its major competitors. With this merger the sales will then become international giving the other electronic companies competition in the field.
Lester can also look at the investment decisions that were made by Wells Fargo when merging with Wachovia or InBev with its merger with Anheuser-Busch. Lester could follow the lead of Wells Fargo and do a stock to stock trade in order to acquire the company and keep all of its shareholders happy or they could follow InBev and Anheuser-Busch and issue money in bonds in order to refinance the merger. Another company Lester needs to look at is K-Mart. K-Mart first started to revamp its image in order to save the company. The company closed several locations, lay off several employees, and developed a marketing campaign in order to save its stores. When this approach did not work they decided to merge with another widely known store, Sears, in order to give Wal-Mart some competition. A merger that just took place was Verizon Wireless with Alltel. This example is also very informative for Lester because Verizon partnered with a well known financial advisory group, Morgan Stanley, in order to determine the best method to acquire all of Alltel’s debt. The companies decided the best financial option was to use bridge financing. With all of these choices Lester should be able to determine what method is best in acquiring Shang-Wa and become a global leader in the electronics field,
Evaluate Dividend policy on Wealth Maximization
According to Ross, Westerfield and Jaffe, dividend usually refers to a cash distribution of earnings,” (Ross, ed. 2005). There are several types of dividends but the most common is the regular cash dividend. This process is usually done about four times a year. Paying a cash dividend reduces the corporate cash and retained earning shown in the balance sheet. Another type of dividend is paid out of stock, which is referred to as stock dividend. This type of divided is not considered a true dividend because no cash actually leaves the company. This process increases the number of shares outstanding which reduces the value of each share. A stock split can also take place. This is considered when a firm increases the number of outstanding shares. The price of the stock should fall because each share is now entitled to a smaller percentage of the firm’s cash flow. When the company decides to pay a dividend it is distributed to the shareholders on a specific date. After it has been declared it has become a liability of the firm and cannot be easily rescinded by the company (Ross, ed, 2005).
An alternative to paying out dividends is a company may repurchase shares of its own stock. This can be done in three ways. First, a company can repurchase its own stock, just as anyone would buy shares of a particular stock. If a company chooses this method, the company does not have to reveal itself as the buyer. The next method if the company can institute a tender offer. This occurs when the company announces to all of its stockholders that the company is willing to buy a fixed number of shares at a specific price. The last method generally used is the company may buy the shares from a specific individual. This option might be chosen because one stockholder can be bought out at a price lower than that in a tender offer. The fees in this method can also be at a lower rate (Ross, ed. 2005).
One company that saw an advantage of purchasing stock was Wells Fargo when the company merged with Wachovia. This process helped both companies in acquiring cash in order to make the purchase. This is also one option for Lester to acquire Shang-Wa. Lester needs to find a way to maximize the company’s total wealth. Choosing this method will help the company see some profit by purchasing shares at a lower rate.
Recommended Offer to Lester Electronics
Lester is looking to identify the best way to secure the future of the company. Should the company lose its long-standing contract with Shang Wa, it would mean a significant loss of revenue over the next several years. Aiming to avoid this detrimental future, the company has considered a possible merger with Shang Wa. As discussed in the previous paragraphs, there are many things to consider when looking into this option. However, after careful examination of the concepts previously discussed and examination of the options available for Lester, it is recommended that the company merge with Shang Wa. This move is the best decision when looking at the long-term state of the company. Investing in other options, such as the selling of stock to raise capitol may provide Lester with some additional capitol, however, in the long run, it would not be enough to make up for the loss of revenue if Lester should remain independent and lose its contract with Shang Wa.
Individual Company Synopses
CitiGroup by Catherine Huhn
Today, in these tough economic times, holding banks like CitiGroup have fallen below the regulatory margins that are demanded to maintain a minimum level of capital, which protects depositors against loses. CitiGroup, based in New York, had stock, retained earnings, and preferred shares in 2007 equal to a weighted-average-cost-of-capital ratio of 10.7 percent of its risk-weighted assets. That was down from 12.2 percent in 2005 (Pittman, 2008). In contract, of the 66 largest bank-holding companies, the weighted-average-cost-of-capital ratio was 11.63 percent. The important thing to remember about capital ratios is that they are minimums. Ralph Sharpe, a lawyer at Venable LLP in Washington and director of OCC’s Enforcement and Compliance division stated, “In good times everybody looks good, but when the tied goes out, you see who is not wearing their bathing suit” (CitiGroup, 2008). At the end of 2007 CitiGroup owned $552 billion of securities weighted at zero risk and $523 billion at 20 percent. It also held $320 billion in risk with weightings of 50 percent and $881 billion at 100 percent according to Federal Reserve.
To maintain the ratio of 10 percent when a $100 million AAA security is dropped to BBB, a banks needed capital would raise to $10 million for $2 million. The institution can raise the $8 million by selling stock or preferred shares. This is what Lester will need to do into order raise the capital to purchase Shang-Wa. Lester as well as CitiGroup can also compensate by selling the security, or cutting back on other lending. Lester can go into negotiations with some known information like what their WACC is which will lend to better decision making on all parts of management.
CitiGroup has so far been the biggest seeker of capital, generating $30.4 billion through the sale of shares, preferred stock and bond convertibles into equity, stated CFO Gary Crittenden however CitiGroup has not faired the storm well. As of January 16, 2009, CitiGroup posted a $8.29 billion loss in its fourth quarter and will divide the company in an ongoing effort to restructure the company for management purposes and split into two separate businesses, CitiCorp and Citi Holdings (CitiGroup, 2009).
United Health Group by Catherine Huhn
“An effective finance organization is a faithful steward of the general financial health and direction of a company but more specifically, of its financial capital” as stated by Erlandson, CFO of United Health Group (Ballow, 2006). Erlandson believes that in order to achieve and sustain high performance a company needs to generate returns above the risk-adjusted cost of capital. In fact, research has shown a strong correlation between a high-performance business and mastery of a suite of five finance capabilities that includes a sophisticated capital stewardship. (United Health Group, 2008)
In order to create a value-centered culture capable of maximizing capital, a firm would look at some basic competencies that include “Capital Investments” to effectively manage new financial investments with the goal of maximizing total returns to shareholders; “Capital Structure Oversight” which is maintaining the right balance between debt equity of efficiently finance investments and growth strategies; “Existing Capital Management” which is managing working capital and other capital within the enterprise to an optimal level to free up capital for new investments; “Tax Management” to proactively manage tax liability for a timely financial reporting of all financial statements to avoid risk and finally “Intangible Management” which is recognizing, managing and levering the value of intangible capital and off-blance-sheet transactions that include brands, customer pools, operating leases and take or pay contracts. (United Health Group, 2008)
Lester will have the opportunity with its strong management team behind them to put in place checks and balances to insure all capital structure is optimized when it comes to recommending financing mixes.
Wells Fargo by Cara Brown
Wells Fargo is a financial holding company providing banking services for retail, commercial and corporate accounts through banks located in 39 states of the US. The company’s headquarters is currently in San Francisco and the company employs about 276,600 people. During the end of fiscal year 2007 the company recorded revenues of $39,390 million which was a 10.43% increase over 2006. On the other hand, Wells Fargo noticed a net profit lose of 4.3% from 2006 to 2007 (Marketline,2008).
One significant change that Wells Fargo is currently going through is a merger with Wachovia. With this merger Wells Fargo has increased the number of states the company provides service to. The company has became the number one competitor in community banking, small business lending, middle market commercial banking, agriculture lending, commercial real estate lending, commercial real estate brokerage, and bank-owned insurance brokerage. Wells Fargo and Company is a diversified financial services company with $1.4 trillion in assets, providing banking, insurance, investments, mortgage and consumer finance through almost 11,000 stores and the internet across North America and internationally. While acquiring Wachovia they have acquired all of Wachovia and its business as well. When the two companies merged, Wells Fargo obtained all of Wachovia’s common stock in a stock for stock transaction. Meaning Wachovia shareholders received 0.19 shares of Wells Fargo common stock in exchange for each share of Wachovia’s common stocked they owned. In order to satisfy all of the shareholders each share of the outstanding series of Wachovia preferred stock were converted into shares or fractional shares of a corresponding series of Wells Fargo preferred stock which allowed the same rights and preferences (Marketline, 2008).
Lester could take the example from Wells Fargo and to a stock for stock transaction when it comes to Shang-Wa. This process does not just help eliminate some of the debt but also keeps some of the shareholders happy while analyzing the risk associated with this investment decision. According to John Stumpf, President and CEO of Wells Fargo, “This merger creates what we believe will be a very compelling value proposition for our team members, customer, and communities and shareholders with significant potential for even more market share growth, ” (Marketline, 2008). If Lester follows this leader they too can be a global leader in the electronics field.
InBev by Cara Brown
InBev, a Belgium based brewery, has more than 200 brands to offer such as Becks and Stella Artois. While the company’s headquarters is based in Leuven, Belgium the company has operations in Europe, America, and Asia-Pacific. For the fiscal year 2007 InBev saw a significant financial increase from 2006 in the areas of recorded revenue, operating profit, and net profit (Marketline, 2008).
Another leading company in the beer industry is Anheuser-Busch. While the company is also engaged in the packing and entertainment business most of the company’s profit comes from the sell of its beer products. Anheuser-Busch operates primarily in the US with its headquarters in St. Louis, Missouri. This company also made a significant finical increase from 2006 to 2007. The company saw an increase in the areas of recorded revenue, the operating profit, and net profit (Marketline, 2008).
InBev and Anheuser-Busch both hold a top position when it comes to the beer industry. In order for the companies to become a global leader a merger has taken place. In order for this to be successful Anheuser-Busch InBev decided to issue five billion dollars in bonds to help refinance the merger. The company had determined it had priced 1.25 billion in five years noting a 7.2 percent increase. AB InBev also noted an increase within the next 10 and 30 years. According to Felipe Dutra, “We are pleased with the successful completion of this capital markets transaction. This operation would provide the company with more flexibility,” (Coppola, 2009). With the proceeds of the bonds shorter-term bride loans that were used to finance the merge with Anheuser-Busch in 2007. With this merger AB InBev is to have about 36 billion dollars a year of net sales, offering consumers about 300 different brands of beer (Coppola, 2009). Lester taking its quos form AB InBev with merging with Shang-Wa will allow them to grow financially. It will allow them to eliminate some of the debt that is inherited and also become a leader in the electronics field.
Kmart by Christopher Gilmore
First opened in 1962, Kmart quickly became a major competitor in the retail business. This trend continued throughout the 1970’s and 1980’s, with sales slowing in the 1990’s and 2000’s due to increased competition from Wal-mart. During the early 2000’s Kmart experienced low sales and a decreased market share due to competition from retail giant, Wal-Mart and the rising popularity of other retail stores, such as Target. After exhaustive efforts to keep the company profitable during the times of increased competition, Kmart filed for chapter 11 bankruptcy on January 22, 2002. During this difficult time for the company, a new CEO was brought in to assist in the rebuilding of the Kmart concept.
During this rebuilding phase, the leadership team of Kmart, led by the new CEO, Bruce Johnson, began to focus on establishing a financing mix that would allow the company to maximize its current assets in hopes of revamping the consumer’s image of the Kmart stores. In efforts to allocate all resources possible, Kmart closed more than 300 stores and lay off 34,000 employees. While a difficult decision, no doubt, this step was necessary for Kmart to fully immerse itself in the restructuring effort. In addition to the store closings and the lay offs, the company embarked on a marketing campaign aimed at presenting a new kind of Kmart to the consumers, something more likely to compete with Wal-Mart and other retail competitors. This process included updating current stores, introducing a new logo, and giving the Kmart experience a more straight lined approach for the consumer.
Still struggling after the store closing, the lay off’s, and the new marketing campaign, Kmart needed to find something to give the company an additional financial advantage. In November of 2004, Kmart announced its intention to purchase Sears Roebuck and Company, a well-known American appliance and retail company. This merger created the third largest retailer in the country, Sears Holding Company (Bhatnager, 2004). This investment brought new opportunities for both companies, including more convenient locations for Sears and a greater market share for Kmart. The risks associated with this type of reorganizing paid off.
Kmart serves as an example for Lester because of the unique financial position the company was in. Kmart recognized the need to make major changes in the way their business is conducted and acted on this knowledge. Much like Lester’s impending merger, taking the step to merge with Sears was a large-scale financial investment. However, despite the upfront expenses, this investment made it more likely that Kmart would be able to emerge from these troubled years and become a strong retail competitor once again.
Verizon Wireless by Christopher Gilmore
With a total of 83.7 million users, Verizon Wireless is the largest telecommunications company in the United States. Understanding the success story of Verizon wireless requires an understanding of the successful mergers and acquisitions that have assisted in molding and shaping the company into the multi-billion dollar company that it is today. One course concept discussed this week is analyzing risk associated with investment decisions. Verizon Wireless is an example of a company that has had significant experience analyzing this kind of risk and has done so in a way that continually increases the value of the company.
The most recent example of a successful investment decision can be found just this month, as Verizon Wireless invested in and acquired Alltel, another wireless company. This investment increased Verizon’s customer base and eliminated a significant competitor in the market, opening the door for future would be Alltel customers to now make the move to the nation’s largest wireless provider, Verizon. One of the issues involved in this situation was that of Alltel’s debt. If Verizon acquired Alltel, they would also acquire any debt associated with the company. Verizon Wireless partnered with Morgan Stanley, a well-known financial advising company, to research the best financing options to bring this vision to a reality. Bridge financing, which is defined as financing extended to a person, company, or other entity, using existing assets as collateral in order to acquire new assets, was used to provide Verizon with the capitol needed to make the investment possible (Investorwords, 2008).
Lester should take the example of Verizon Wireless in carefully analyzing financial investment options. As Lester is in the position of needing to make a significant change to avoid the severe loss of revenue in the upcoming years, taking the approach Verizon took would provide Lester with a more detailed analysis of the options for the company. Once this analysis has been completed, Lester will be in a better position to make a decision about any possible merger, acquisition, or other financial investment decisions.
Conclusion
As presented in the previous paragraphs, Lester will be well advised to examine the strategies of other companies that have successfully gone through similar circumstances. The most crucial point for Lester to focus on is developing a thorough understanding of financial concepts, such as weighted average cost of capitol and developing a financing mix that optimizes capitol structure. Understanding and developing the finance mix within the company will allow Lester to explore all available options for investing in the future of the company, including the merger with Shang-Wa. Developing a working knowledge of these concepts and how they relate to the scenario Lester is in will greatly assist the company in acquiring the knowledge that is necessary to make an informed decision that will secure the future for Lester.
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