1. 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 ...view middle of the document...
Thanks to their premium pricing, they are achieving more than average gross profit margin. So, over the years UST's revenues are stable and positive, and generally its statements are positive. The company does not have any problems with its cash flow.
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 company's capital structure more stable, and sometimes to boost the company's 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 UST's 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 company's high S&P credit rating (AAA investment grade).
EPS = earnings per share,
EBIT = earnings before interest and taxes,
I = interest expense,
T = tax rate
P = preferred stocks,
S = number of common shares outstanding
*a - $1bil was divided by price of shares in order to get how many shares would have to be sold to raise $1 bil
Breakeven point of EBIT is at $373.511997 mil. If EBIT is higher...