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To: Elaine Robinson, CEO
From: Benjamin Braddock, CFO
Re: Raising $1 billion for Big Time Plastics Co.
Don't believe what you read in the papers about Fed interest-rate cuts--they won't make it easier or cheaper for Big Time Plastics Co. to raise $1 billion. The days when bankers fell over themselves to press cash into our hands are long gone. Even after the economy recovers, we're going to have to work harder to raise money. Financial mergers and deregulation are changing the way Wall Street works.
Bad as the past several months have been, the financing environment is fast getting tougher. True, companies raised $73.8 billion in new equity through July 31. But that's less than two-thirds of the $112.5 billion they had gathered at the same stage last year through initial and secondary public offerings. Likewise, J.P. Morgan Chase believes debt issuance will slow as more companies try to get by on the record $1.6 trillion in debt, excluding syndicated loans, that they have issued so far this year.
As your chief financial officer, I need to tell you that we need a bank with the smarts to tap into a wide range of markets--from private equity to convertible bonds. Any dummy can line up cheap financing in a bull market. But now, even the best are having trouble. It's not just a question of how much we have to pay for finance, but whether we get it when we want it. As J.P. Morgan's co-head of investment banking, Mark Davis, tells me, "markets can snap open and closed."
If it's any comfort, tech and telecom companies are in a worse pickle than we are. Burned investors are wary of tech IPOs, and venture capitalists are struggling to raise funds. Researcher Venture Economics expects VCs to fund only half as many companies this year, as they're on track to raise only $50 billion, about half as much as in 2000. Longer term, says Mark G. Heesen, president of the National Venture Capital Assn., as many as 100 of the 700 U.S. venture firms will be out of business within five years.
At least we have some options. Here they are, from plain vanilla to the exotic:
1. Pay a Higher Price for Credit
The Fed may stay easy, but we're going to have to pay more for loans. Banks are gun-shy about lending, especially as credit ratings of even such icons as Motorola (MOT
) keep sliding. Although banks made $383 billion in syndicated loans--loans shared by several banks--in the second quarter, up from $350 billion a year ago, Thomas Okel, head of syndicated markets at Bank of America believes there will be a "heightened focus on credit quality" in the future. We have to make darn sure that we keep our balance sheet clean. If we lose our A credit rating and drop to BBB, for example, the banks could try to stick us with as much as an extra three percentage points of interest--a further $30 million a year on a $1 billion loan.
Even if we maintain our credit rating, we're going to have to disclose to our lenders more about the makeup of our earnings. Otherwise, we'll be able to get only a short-term loan, and one with very tough conditions such as a cap on any further borrowing.
2. Make a Trade: Cheap Credit for Investment Banking Business
I hear commercial banks such as Citigroup (C
) and Bank of America (BAC
) are giving cut-rate loans to companies that promise to give them all their future investment banking business. Some companies have gotten a 50% break on interest rates this way.
Trouble is, a trade-off like that could end up costing us and our shareholders plenty later. We need to consider carefully if it's worth giving up the option of choosing a more experienced banker for future mergers or acquisitions.
3. Consider a Spin-Off
Although investors have become pretty picky about buying equity issues, especially of tech and telecom outfits, it turns out they will still consider spin-offs by companies like ours that have been around the block. Indeed, my old friend David Mastrocola, co-head of the merger and strategic advisory group at Goldman Sachs, says that if you leave aside tech and telecom, the rest of Corporate America is raising more than 40% more common equity than in 2000.
Just look at Philip Morris (MO
), which collected $8.5 billion by spinning off a 16% stake in its food-and-beverage unit, Kraft Foods, on June 13. The beauty of such an operation is that companies get both cash and shares representing the stake in the spin-off they keep.
Such shares are a potentially valuable currency that we could use to pay for future acquisitions or to juice the compensation packages of key managers. Perhaps it's time to spin off our plastics research division and reveal our breakthrough discovery: a plastic as light as lint and as strong as steel? (Watch out world, here come plastic cars!)
4. Get More Bang for Our Bucks
If we go the spin-off route, we should look into ways of extracting more value, especially since dramatic jumps in stock prices following an IPO are history. "We're seeing a return to lower IPO premiums in the area of 10% to 15% above issue price," says global head of equity capital markets at Morgan Stanley Jon Anda.
We could try Wall Street's latest flavor of the month: a debt-for-equity swap linked to a spin-off. Lucent (LU
) just did that, as did AT&T (T
), and I hear Continental Airlines (CAL
) will soon follow. Basically, bankers buy huge gobs of our debt for a few weeks, then swap it for a predetermined allotment of shares in the spin-off when we do the IPO. It would clean a lot of debt off our books--and we would get a nice tax break.
5. Use Hybrid Financing
With stock markets in the tank, we have to think creatively. Walid Chammah, head of fixed-income capital markets at Morgan Stanley, told me recently that "the only way to motivate investors is to give them financial incentive and protection on the downside." One way to achieve that is by issuing convertible bonds--bonds that can be exchanged for company stock in the future at a preset rate--as a better alternative to straight bonds. In exchange for investors receiving lower interest rates, which helps us, they have a chance of making fat profits when our stock takes off. These "converts," as the bankers like to call them, are becoming very popular: Companies have issued a record $63 billion of convertibles through July 31, vs. $61 billion in all of 2000, according to Morgan Stanley's Converbond.com Div.
But let's face it, Elaine, our prospects for raising cash aren't as bright as the future for plastics. So, if I manage to raise $1 billion in this crummy environment, don't you think I deserve a raise?
Benjamin By Emily Thornton
With Heather Timmons in New York and Linda Himelstein in San Mateo, Calif.