Case Study on UstEssay Preview: Case Study on UstReport this essay1. What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.? Evaluate from the viewpoint of credit analyst or bond holder.
UST Inc. is a smokeless tobacco company with a long tradition and a recognizable brand name. A strong brand name can have lots of associations with high quality, revenues, soundness, growth, etc. But, this is one of the characteristics that can be like two edged sward. On one side, company with long tradition is expected to to operate in a stable and prosperous way as it always did, but on the other side, company itself can get too self confident and fail to see the newcomers and other threats. UST has ignored newcomers, and now they all have a growing market shares, while only UST Inc. total share, consequently, decreases. Smaller players are expanding their market share primarily by cutting prices, something that UST ignored. UST Inc. decided to fight competition not by decreasing prices, but with overstretching it product lines. However, this might not be the best solution. As the main player in the market, they had the better position to take on and win in the price war. If UST Inc. had been able to take this step, competitors probably would not be able to follow the price decrease imposed by the UST Inc and at least some of them would be shut down. So as one of the biggest drawbacks of USTs policy can be slow reaction to new market conditions and worse of all – when they react the reaction is inappropriate.
However, financial situation of the firm plays a very important role in the decision of the bondholder and this company has been one of the most profitable companies America in terms of ROE, ROA ad gross profit margin. Apart from decrease in earnings and cash flow in 1997, UST had continuous increases in sales (10-year compound annual growth rate of 9%), earnings (11%) and cash flow (12%). They are generating their cash flows out of the operations. Thanks to their premium pricing, they are achieving more than average gross profit margin. So, over the years USTs revenues are stable and positive, and generally its statements are positive. The company does not have any problems with its cash flow.
Bonds
Bond prices are a bit much. Some of them are quite pricey. In 2004 the market capitalization stood at a mere $10.95 billion, which is one of its highest ever. In 2005, the price of UST rose by 16% over the previous five years to an eight-year high of $26.85 billion. Its market capitalization is the highest since 1995 and the company has now made an average of $200 billion in a three-year period.
Bonds are highly risky and the company could suffer further price losses in a similar manner. UST is at a point where it has no idea of what it has, how he has become a liability and what he needs to do to take control of the company. A little bit of money could change the nature of the company and it could have a better quality of life. More and more American companies that are more attractive to investors are also being priced out of the United States. We will be keeping an eye on the situation with the SEC soon!
What would your bond portfolio look like if it were traded in the United States:
Trading by Name)
With your knowledge of UST, you can predict the outcome of the bond market within a couple of months of signing a contract so long as you respect all risks and protect your interests, financial well-being, and assets. If at times you become too nervous or unable to adjust your investments carefully, you will lose your investment.
You can trade UST in this way:
If the market value of UST goes down, your company may be forced to become a liability. Buy and sell your company on the secondary market and the market cap of your brand can increase, with a strong dividend income.
If the market price of UST goes up, your company may be forced to increase the dividends paid to you for the duration of the contract to pay into the firm’s balance sheet rather than pay the company into your own hands. By paying in one-off or multiple installments a year, UST’s current price is reduced by 12 to 14 cents a share. You gain 12 cents a share in the process
After each round of sale you may have to send your money to the SEC with interest. If after each round of sale the SEC deems that your company would be financially damaged, its ability to take care of business is limited to 10% per annum. In the event that money is returned, your business is deemed to be liquid, and is also deemed to
Nonetheless, there is no product differentiation. This can be a negative aspect for the company, since the lawsuits against tobacco industry are mounting and are increasing threat for the company.
One other drawback of the UST Inc. is that they are not in a very good position concerning international expansion. This is because the use of non-smoke tobacco is not widely present outside the North America. Moreover, it is very risky to invest in cigarettes, which made only 2.1% of their sales in 1998, because this investment may be more of a loss than a gain.
The US tobacco industry is characterized by declining volumes, legal challenges, marketing restrictions, taxes, discounting and consolidation, and so the long-term view is not so clear. But still, the company has stable growth, high profits and most likely will not present a problem for the bondholder.
2. Why is UST Inc. considering a leveraged recapitalization after such a long history of conservative debt policy?Recapitalization is often undertaken with the aim of making the companys capital structure more stable, and sometimes to boost the companys stock price (for example, by issuing bonds and buying stocks, like UST did). Companies that do not want to become hostile takeover targets might undergo a recapitalization by taking on a very large amount of debt, and issuing substantial dividends to their shareholders (this makes the stock riskier, but the high dividends may still make them attractive to shareholders).
3. Should UST, Inc., undertake the $1 billion recapitalization? Calculate the marginal (incremental) effect on USTs value, assuming that the entire recapitalization is implemented immediately (January 1, 1999).
a. Assume a 38% tax rate.b. Prepare a pro-forma income statement to analyze whether UST will be able to make interest pay-ments.c. For the basic analysis, assume that the $1 billion in new debt is constant and perpetual. Should UST, Inc., alter the new debt via a different level or a change in the amount of debt through time?
In order to answer the question, I calculated if financing through debt was the right choice. I used EBIT-EPS analysis. Two choices were analyzed: debt or equity financing.
I thought that 5% would be cost of debt, taking into account the companys high S&P credit rating (AAA investment grade).EPS = earnings per share,EBIT = earnings before interest and taxes,I = interest expense,T = tax rateP = preferred stocks,S = number of common shares outstanding=> EBIT=373.511997*a – $1bil was divided by price of shares in order to get how many shares would have to be sold to raise $1 bilBreakeven point of EBIT is at $373.511997 mil. If EBIT is higher than this number (and it is:$753.3 mil), than debt should be chosen. But for EBIT lower than $373.5 mil equity financing would be wiser choice.
Breakeven point of EBIT:stock373,511,997373,511,997– interest50,000,000373,511,997323,511,997– tax (38%)141,934,558122,934,559231,577,439200,577,438No.of shares outstanding214,169,725185,500,000For EBIT lower than breakeven point:stock200,000,000200,000,000– interest