Group 4 Massey Ferguson Case Study -...
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INCEIF: The Global University of Islamic Finance MASSEY FERGUSON Ltd. (1980) January ‘11 by: Wan Fadzil Azamat Nazarbaev Fikri Ali Mohammed Adam Ruslan Nagayev Case Study Professor Obiyathulla Ismath Bacha Corporate Finance, FN5033
Transcript of Group 4 Massey Ferguson Case Study -...
I N C E I F : T h e G l o b a l U n i v e r s i t y o f I s l a m i c F i n a n c e
MASSEY FERGUSON Ltd. (1980)
January ‘11
08 Fall
by:
Wan Fadzil
Azamat Nazarbaev
Fikri Ali Mohammed
Adam Ruslan Nagayev
Case Study
Professor Obiyathulla Ismath Bacha
Corporate Finance, FN5033
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Massey Ferguson ltd (1980)
TABLE OF CONTENTS
1. INTRODUCTION .............................................................................................................................. 3
2. PROBLEMS ...................................................................................................................................... 3
3. FACTORS AFFECTED ................................................................................................................... 3 3.1. INTERNAL FACTORS .................................................................................................................... 3
3.1.1. Too fast expansion and growth (M&A) .......................................................................... 3 3.1.2. Inefficient working capital ................................................................................................ 3 3.1.3. Capital structure ................................................................................................................ 3 3.1.4. Product market alignment ............................................................................................... 4
3.2. EXTERNAL FACTORS .................................................................................................................. 4 3.2.1. Interest rate ........................................................................................................................ 4 3.2.2. Demand .............................................................................................................................. 4 3.2.3. Currency exchange .......................................................................................................... 4 3.2.4. Political risk ........................................................................................................................ 4 3.2.5. Extreme climate ................................................................................................................ 4
4. POSSIBLE SOLUTIONS ................................................................................................................ 5
5. CONCLUSION .................................................................................................................................. 5
APPENDIX ............................................................................................................................................ 6
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1. INTRODUCTION Founded in 1847, Massey Ferguson (MF), a division of Argus Corporation, is one of the leaders in farm equipment production in the world. In 1953, MF merged with the Ferguson Company, the former UK farm equipment producer, to become Massey-Harris-Ferguson, before finally taking on its current name in 1958. By 1980 it had manufacturing and assembling facilities in 31 countries and its products were sold in 140 countries. Main products are tractors, diesel engines and industrial machinery.
2. PROBLEMS In late 1970s Massey Ferguson experienced severe financial losses and in fact reported an unprecedented year-end loss of 262 million USD in 1978. We have attempted to identify the problems the company was faced with and divided them into two groups: internal factors or firm specific and external factors, or market-wide.
3. FACTORS AFFECTED
3.1. Internal Factors
3.1.1. Too fast expansion and growth (M&A) The company has made many acquisitions in different countries without taking time to stand firmly in terms of marketing decisions, procedures, etc. It seems that the priority was given to expansion – strategic decisions without implementation of a proper operational framework. (see Table 3 in the Appendix)
3.1.2. Inefficient working capital MF adopted an aggressive financing strategy. The expensive short term financing was utilized to finance non-earning assets: inventories and accounts receivables. Later, in 1980, the company started to offer a hire-purchase contract to its customers, rather than facilitating bank loans for them. (see Figure 5, and 6).
3.1.3. Capital structure The company was highly leveraged compared to its peers. (see Chart 1). MFʼs high dependence on short-term debt played its significant role in the companyʼs severe financial distress leading it to default in early 1981 as the company was unable to meet its short run obligations. The company attemted to issue preferred stocks in April 1980; however its major stakeholder AGCO blocked the decision. On the whole, MF could not issue equity and, thus, obtain long term capital. Therefore, it had to depend on short-term debt.
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3.1.4. Product market alignment Not only MF suffered from imbalanced capital structure but also from misaligned product market. It produced machines in highly developed countries and sold them in less developed states. (See Figure 8, 9, and 10).
3.2. External Factors
3.2.1. Interest rate The US economy and other major economies were hit by high inflation in 1974/75 and 1979/80 (see Figure 10). The majority of economists state that the 1973/74 and 1979/80 oil crises were the main cause of the economic downturn. However, others view the roots of that economic hardship in excessive global liquidity. In particular, after the demise of the Bretton Woods System in 1971 the Japanese and European central banks intervened heavily to prop up the dollar and greatly boosted money supply. Nevertheless, OPEC oil price hike was indeed evident. To contain the high inflation Paul Volcker, the chairman of the Fed, tightened the Fed funds rate by increasing it from 11% in 1979 to 20.5% by January 1981. Massey Ferguson was hit hard since its operations were mainly financed by short-term debt, thus its financing costs went up dramatically.
3.2.2. Demand MF's renewed drive into the North American market in the late 1970s regrettably happened in line with the aggregate demand fall in the U.S. economy as the country was entering deep recession. The U.S. GDP in 1980 and 1982 stood at just below zero growth and far below at -4% respectively. Private consumption also fell considerably.
3.2.3. Currency exchange With the enlarged production of the North Sea oil in the late 1970s the UK pound sterling appreciated significantly against the other major currencies including the currencies in which Massey Ferguson traded its products (see Table 4).
3.2.4. Political risk Despite MF was successful in negotiating with less developed countries and the Eastern European governments, the company was still susceptible to unstable political conditions in those countries. For example, the 1979 Iranian revolution, or Pakistanʼs regional problems in 1970s.
3.2.5. Extreme climate In June-September 1980 anomalous heat and drought covered vast territories of the USA. Total deaths amounted 10,000 people. Agriculture and related industries were estimated to have lost $20.00 billion.
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4. POSSIBLE SOLUTIONS • Restructuring/refinancing: to avoid disruption of operations. This involves
paring down debt towards optimum capital structure by rescheduling and having debt-equity swap. The nature of MFʼs industry would necessitate a more conservative strategy with preference for long term funding.
• Re-evaluation: to determine a set of core businesses in which it should further invest to ensure its growth, possibly with governmental policy assistance.
• Merger & acquisition: but in the light of negative performance of MF, it is highly unlikely.
• Liquidation: it would cause shareholders to lose full amount of their investment, job cuts, disappearance of an important investor in their respective countries, and deprive lenders of full recovery.
• Government bailout: “too big to fail” – the most feasible option.
5. CONCLUSION The above facts about MFʼs financial status in the late ʻ70s revealed their problems, which was clear for sound decision makers either investors or creditors. Investors, on the one hand, aim to benefit from capital gain which is the growth of company value and hence the stock prices. On the other had, some investors are interested in dividends for coming periods by buying shares of a company. In the case of MF, neither capital gain nor dividends were expected. On contrary, the company was demonstrating all the signs of a near bankruptcy and in fact it began fiscal year 1981 in default on its total debt of $2.5 billion. Finance leverage was too high comparing to its competitors. MF stopped paying dividends to its shareholders in 1978 while its capital loss per share reached $12.79 in 1980. The company also lost 69% of its market value from 1976 to 1980. In general, Massey Ferguson had poor performance, particularly due to bad financial management and planning. The company also had cross-default provisions on its debt obligations, meaning that a single default on one loan contract would have led to an automatic default on all its debt obligations. Taking into account all these reasons, we believe it would have been not right decision for both existing and prospective shareholders to invest into MF in the late ʻ70s.
To sum up, neither long term debt nor equity was available for MF due to its high financial leverage, poor financial management and position in the late 1970s; thus, it was forced to raise short-term funds. In other words, MF was far beyond its optimal capital structure. This fact played one the of the main roles in the companyʼs financial distress.
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APPENDIX Figure 1: Stock performance
-7.5%
-3.8%
0%
3.8%
7.5%
11.3%
15.0%
1976 1977 1978 1979 1980
OPER. PROFIT / SALES
-9.0%
-6.8%
-4.5%
-2.3%
0%
2.3%
4.5%
6.8%
9.0%
1976 1977 1978 1979 1980
NET INCOME / SALES
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Table 1: Balance Sheet (in millions of USD)
DESCRIPTION 1978 1979 1980 ASSETS USD Δ% USD Δ% USD Δ% Cash 23.4 0.92% 17.2 0.63% 56.2 1.99% Receivables 531.3 20.86% 731.1 26.63% 968.2 34.24% Inventories 1,083.80 42.55% 1,097.60 39.98% 988.9 34.97% Prepaid expenses, other 63.8 2.50% 89.8 3.27% 93 3.29% Current assets 1,702.30 66.83% 1,935.70 70.50% 2,106.30 74.49% Investments 213.3 8.37% 217.1 7.91% 205.8 7.28% Fixed assets, net 602.2 23.64% 568.7 20.71% 488.2 17.27% Other assets and deferred charges 29.3 1.15% 24 0.87% 27.3 0.97% Total Assets 2,547.10 100% 2,745.50 100% 2,827.60 100% LIABILITIES USD Δ% USD Δ% USD Δ% Bank borrowings 362.3 14.22% 511.7 18.64% 1,015.10 35.90% Long-‐‑term debt, current portion 115 4.51% 59.3 2.16% 60.2 2.13% Accounts payable and accrued charges 778.7 30.57% 907.4 33.05% 793.8 28.07% Other 16.1 0.63% 31.1 1.13% 24.5 0.87% Current Liabilities 1272.1 49.94% 1509.5 54.98% 1893.6 66.97% Deferred income tax 64.3 2.52% 13.8 0.50% 14.3 0.51% Long-‐‑term debt (less current portion) 651.8 25.59% 624.8 22.76% 562.1 19.88% Minority interest in subsidiaries 18.4 0.72% 19.1 0.70% 4.5 0.16% Total liabilities 2006.6 78.78% 2167.2 78.94% 2474.5 87.51% Redeemable preferred shares 95.8 3.76% 95.8 3.49% 95.8 3.39% Common (18,250,350 shares) 176.9 6.95% 176.9 6.44% 176.9 6.26% Retained earnings 267.8 10.51% 305.6 11.13% 80.4 2.84% Shareholders'ʹ equity 540.5 21.22% 578.3 21.06% 353.1 12.49% Total liabilities and shareholders'ʹ
equity
2,547.10 100% 2,745.50 100% 2,827.60 100%
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Table 2: Income Statement (in millions USD)
DESCRIPTION 1978 1979 1980 ITEMS USD Δ% USD Δ% USD Δ% Net sales 2926 100.00% 2973 100.00% 3132 100.00% Cost of goods sold, at average
exchange rates for year
2371 81.03% 2382 80.12% 2569 82.02%
Effect of foreign currency exchange
rate changes*
0.00 0.00% 19.00 0.64% 8 0.26%
2371 81.03% 2400 80.73% 2576 82.25%
Marketing, general, and
administrative
372.00 12.71% 352.00 11.84% 405.00 12.93%
Engineering and product
development
66 2.26% 58 1.95% 60 1.92% Interest on long-‐‑term debt 79 2.70% 76 2.56% 71 2.27% Other interest expenses** 108 3.69% 129 4.34% 230 7.34% Interest income 0 0.00% -‐‑40 -‐‑1.35% -‐‑42 -‐‑1.34% Exchange adjustments 91 3.11% -‐‑25 -‐‑0.84% 50 1.60% Minority interest -‐‑1 -‐‑0.03% 1 0.03% 0 0.00% Miscellaneous income -‐‑11 -‐‑0.38% -‐‑10 -‐‑0.34% -‐‑14 -‐‑0.45% Total costs and expenses 3,075 105.09% 2,941 98.92% 3,336 106.51%
Profit (loss) before items shown
below
-‐‑150 -‐‑5.13% 32 1.08% -‐‑204 -‐‑6.51%
Provision for reorganization expense -‐‑116 -‐‑3.96% -‐‑95 -‐‑3.20% -‐‑29 -‐‑0.93% Income tax recovery -‐‑12 -‐‑0.41% 6 0.20% 10 0.32% Equity in net income of finance
subsidiaries
16 0.55% 17 0.57% 23 0.73%
Equity in net income of associate
companies
5 0.17% 5 0.17% 0 0.00%
Income (loss) from continuing
operations
-‐‑257 -‐‑8.78% -‐‑35 -‐‑1.18% -‐‑200 -‐‑6.39%
Loss from discontinued operations 0 0.00% -‐‑23 -‐‑0.77% -‐‑26 -‐‑0.83% Extraordinary item 0 0.00% 95 3.20% 0 0.00% Net income (loss) -‐‑257 -‐‑8.78% 37 1.24% -‐‑225 -‐‑7.18% Unfavorable (favorable) impact on
continuing operations of exchange
adjustments and foreign currency
exchange rate changes in cost of
goods sold
0 0.00% -‐‑6 -‐‑0.20% 58 1.85%
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Table 3: Acquisitions
Year Company Country
1955 HV Mc Kay Australia
1959 Landini Italy
1959 Perkins Engines UK
1966 Ebro Spain
1973 Eicher Germany
1974 Hanomag West Germany
1974 Contract
($360mln)
Poland
Figure 6: Main components of Current Assets Figure 5: Net working capital
Chart 1: Financial leverage
0%
23%
45%
68%
90%
1976 19771978
19791980
DEBT TO ASSETS
0%
22.5%
45.0%
67.5%
90.0%
1976 1977 1978 1979 1980
TOTAL DEBT TO CAPITAL
0
100
200
300
400
500
600
700
800
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
336 372
439
502
625
732 697
430 427
212
Mill
ions
of U
SD
Net Working Capital
0
100
200
300
400
500
600
700
800
900
1000
1100
1200
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
Current Assets
Cash Receivables Inventory Other
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Figure 7: Sales in 1980
Canada, 219
United States, 819
Mexico, 75
United Kingdom, 297
France, 227
Italy, 211
West Germany, 157
Spain, 8
Benelux, 28
Brazil, 306
Argentina, 44
Australia, 131
Scandinavia, 114
South Africa, 66 Iran, 31
Pakistan, 29
Japan, 25 Turkey, 14 Sales: 1980
0%
15.0%
30.0%
45.0%
60.0%
1976 1977 1978 1979 1980
SHORT-TERM DEBT TO EQUITY
0
2.00
4.00
6.00
8.00
1976 1977 1978 1979 1980
TOTAL DEBT TO EQUITY
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Figure 8: Diesel Engines Production Capacity in 1980
Figure 9: Farm Equipment Production Capacity in 1980
Figure 10: US inflation in 1970-‐‑1985
Diesel Engines: 1980
United Kingdom
United Kingdom
France
Brazil
Australia
Farm Equipment: 1980
Canada
United Kingdom
United Kingdom
France
Italy
West Germany
Brazil
Argentina
Australia
0
5
10
15
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
US Inflation: 1970-‐‑1985
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Table 4: Currency exchange rates to 1 pound UK
Year 1978 1979 1980 1981 US Dollars 1.92 2.12 2.33 2.03 German Marks 3.85 3.89 4.22 4.57 French Francs 8.65 9.02 9.82 10.96 Canadian Dollars 2.19 2.48 2.72 2.43 Australian Dollars 1.68 1.90 2.04 1.76 Swish Krona 8.67 9.09 9.83 10.21 Norwegian
Kroner
10.05 10.74 11.48 11.61 Italian Lira 1,628.30 1,762.20 1,988.60 2,289.90
