Mar 28, 2016 1905 Words  Pages


Massey-Ferguson, 1980
Case Study Solution
Q1) Assess the product-market strategy and financial strategy Massey pursued through 1976. Where possible, compare Massey’s strategy with those of its leading competitors.
Market strategy
Massey is a multinational company and has a series of products. It produces farm and industrial machinery and diesel engines, which contributes to 80% and 20% of sales respectively. The farm and industrial machinery has two product lines: the farm machinery line and industrial machinery line. The former produces tractors, combine harvesters, balers, forage harvesters, cane harvesters, agricultural implements, farmstead equipment and other equipment for agricultural purpose, while the latter produces different types of loaders.
Massey had been a large provider of the agricultural equipment because it was holding 17% market shares for tractors, 14% market shares for combines and 13% market for machinery worldwide in the year 1980. Although accounting for 20% of sales, the diesel engines are products promising for future growth. However, the engines were produced by Perkins Engine Group in England, where the currency was strong and margins became low.
In terms of market distribution, the company’s main focus moved to less-developed places such as Peru, Pakistan and Egypt. The shift to overseas market in less-developed countries made the company lag behind in research and development to make high-tech products to attract customers in the North American market.
Financial strategy
Since the 1960s, Massey had been engaged in aggressive operation expansion and asset acquisition. The leverage was increasing since the new investment was mainly financed with short term debt. From Exhibit 4, we learn that Net Property, plant and equipment rose from $168 million in 1971 to $519 million in 1976, more than tripled. During the same years, the LTD due in one year rose from 1 million dollars to 66 million. The company relied more on debt financing since we can see the percentage of equity reduced from 40% in 1971 to 23% in 1976.
Competitors
Massey’s competitors were International Harvester and Deere&Company. In 1976, Massey’s market share was 34%, while the other two were 27.7% and 38% respectively. International Harvester had the highest sales and it was also the most efficient in making use of its assets, with a sales/asset ratio of 1.54. Massey was in the middle, doing better than Deere&Company. With regard to financing, in 1976, Massey and International Harvester both had a less than 50% debt/total capital. While till 1980, International Harvester managed to keep the ratio around 50%, Massey had the total debt/capital ratio out of control, with more than 80% debt financing. Neither of the two competitors relied on short term debt such as STD, while Massey relied heavily on STD.
Q2) Assess the various alternatives at the current stage of Massey’s difficulties. What options are available for alleviating Massey’s financial problems?
Given its current financial situation, the following alternatives are available to Massey-Ferguson.
a) Merger/Acquisition
A merger offer would raise the stock prices of Massey-Ferguson, if the deal is perceived as synergic for the company in the long run, and would infuse financial resources and flexibility into the company in the short term. In the light of Massey-Ferguson’s negative performance, however, a merger offer from any company seems highly unlikely due to its massive debt load of $2.5 billion. Furthermore, most of this debt is short term and hence close to maturity, which would impose an immediate burden on the acquiring company. In addition, Massey-Ferguson requires an additional investment of $500 million to $700 million over the next five years to consolidate its operations in Canada and attain profitability. Considering the depression-level demand and the prevalence of International Harvester and Deere in the North American market, however, recouping such an investment in the near future seems unlikely. Moreover, Massey-Ferguson has $968 million receivables in its balance sheet, a sum unlikely to be recovered in the depressed market, and another $989 million worth of inventories that will probably remain unsold, given the low demand circumstances. Given these reasons, therefore, it is highly unlikely that a merger offer would be available to Massey-Ferguson.
b) Liquidation
While a potential alternative, liquidation is unattractive for a number of reasons. It would cause the shareholders to lose all their investment, since Massey-Ferguson’s share price has already depreciated by 69%, and an announcement of liquidation would make the price plummet further. Furthermore, Massey-Ferguson’s receivables are owed by customers ravaged by the recession-hit markets, who would have an incentive to renege on a contract with a firm that will not exist in the near future. In addition, with its assets spread over 31 countries with 150 lenders, Massey-Ferguson would face substantial liquidation costs, in addition to the losses incurred due to the fire-sales of assets. For the countries in which Massey-Ferguson has its operations, it would mean the disappearance of an important investor, and job cuts in the thousands (6,700 in Ontario, and 17,000 in the UK). For the above reasons, therefore, liquidation is not a viable alternative.
c) Pay the debtholders
This alternative is as unattractive as liquidation, for both Massey-Ferguson and the debtholders themselves. Since the company is subject to cross-default provisions, default on a single loan would make all loans callable, effectively cutting off credit, halting company operations, and necessitating substantial sale of assets and worker layoffs. Admittedly, this would minimize the risks of the debtholders, guarantee a partial return on their loans, and allow them to wash their hands off an unprofitable enterprise and invest the money recovered elsewhere. However, it is interesting to note that Massey-Ferguson would suffer a discount on receivables before maturity ($968 million), on the sale of its non-current assets ($721 million) and on its inventory dismissal ($989 million). The sum of these discounted values, and the cash-in-hand ($56 million), would be insufficient to cover the $2.5 billion debt outstanding. Hence, the best alternative for Massey-Ferguson’s lenders would be to wager on the company’s financial recovery, with an increased probability to recover the total amount due.
d) Equity issue
While a lower debt-to-equity ratio would improve Massey-Ferguson’s credit flexibility, the increased equity would pay off part of the short-term debt, and offer greater protection to the incumbent debtholders. However, such an alternative is unfeasible, since a dilution of their voting power would be unacceptable to current shareholders, and the market would be unwilling to finance such a debt-ridden company.
e) Refinancing: Debt-equity Swap
This is the most attractive option for Massey-Ferguson’s future survival, although it will be detrimental to the debtholders’ short-term interests, and expose them to higher risk as equity-holders. Nevertheless, if credible and interested parties such as the Canadian government intervene as guarantor, the debtholders may agree to the swap, provided they receive, at the very least, preferred equity. If a debt-to-equity swap is not acceptable to the lenders, however, they might have to relinquish nearly $301 million ($71 million plus $230 million) in interest payments. Furthermore, in order to survive for the short term, Massey-Ferguson must ensure that interest payments are at least suspended, and debt maturities extended.
f) Government Intervention
Despite the conversion of debt to equity, Massey-Ferguson would nevertheless require a considerable financing of $500 million for their future operations. To alleviate this problem, the company must approach the Canadian government, which is interested in rescuing Massey-Ferguson due to the 6,700 jobs at stake in Ontario. The involvement of the government would also allow the company better leverage in their negotiations with debtholders, and allow them to arrive at more agreeable terms.
Q3) As a financial advisor to Massey’s management, what refinancing plan would you propose? Give particular attention to the various interested parties: shareholders, lenders, employees, governments and management.
Given its financial situation, the best-case outcome for Massey-Ferguson would consist of a three-pronged approach that would allow it to tide over the current depression-level market.
a) Convert debt to equity
b) Financing from the Canadian government
c) Suspend all dividend, interest and principal payments until the company becomes profitable, and extend debt maturities by 5 years
Since it is in the Canadian government’s interest to ensure that Massey-Ferguson is an ongoing enterprise due to the 6,700 jobs involved and the upcoming elections, the company may secure an equity/preferred equity infusion from the Canadian government (since its debt is already substantial) and finance its future expansion worth $500 million to $700 million. This may profit the government in the long run: assuming unemployment benefits of $10,000 per year, and 5 years to get the laid-off workers of Massey-Ferguson back into employment, 6,700 lost jobs would cost the Ontario exchequer nearly $335 million. By adding the increase in Canadian GDP, political capital, welfare benefits and capital gains on the equity if Massey-Ferguson flourished later, it is clear that the $500 million investment would repay the government considerably. This capital may also be provided by the government in the form of long-term debt.
The news of the government bailout will boost investor confidence, and provide insurance to the debtholders. Nevertheless, it is in Massey-Ferguson’s best interest to implement a debt-equity swap, which would decrease its debt-to-equity ratio and improve its credit ratings. However, the debtholders might not agree to lose their priority position in the pay-off hierarchy, even with preferred equity. However, especially with the entry of the Canadian government, they may want a provision that allows a swap to equity in the future if the company does well, which may be leveraged by Massey-Ferguson to achieve more favorable clauses, such as deferred repayments. In addition, the debt may be guaranteed by the Canadian government, eliminating the debtholders’ risk completely. Furthermore, the short-term and medium-term debt may be swapped for long-term debt (preserving their pay-off priority) or preferred equity (which provides them a share of future gains), or both. However, if the Canadian government provides long-term debt financing instead of equity, the incumbent debtholders may have to be assured of their seniority in the pay-off process.
Nevertheless, a combination of debt-to-equity swap, suspended interest and principal payments and government intervention would be agreeable, if not favorable, to the lenders, since they would lose their money if Massey-Ferguson defaults, and by acquiring equity, they stand to be part of the company’s board of directors. The shareholders stand to gain too, since they have a chance of getting their investment back in the future with capital gains, instead of losing it entirely if Massey-Ferguson defaults. At the same time, the current losses may be carried forward and provide significant tax benefits. Despite these financial alternatives, however, it is essential that Massey-Ferguson reevaluate its set of core businesses, develop a strong market presence and focus on its higher-margin products in lucrative markets. With regard to Perkins, Massey-Ferguson must retain its R&D facilities in the UK, sell its production facilities there, and shift manufacturing entirely to Canada, thus insulating it from currency fluctuations. More importantly, the nature of Massey-Ferguson’s industry necessitates a conservative strategy with preference for long-term capital, and the company must reduce its dependence on (particularly short term) debt.