London Stock Exchange: BAE Systems - Case Study Example

London Stock Exchange: BAE Systems Looking at the accounts of the company (BAE SYSTEMS) and supported by any analysis you may have undertaken, describe the progress of the company over the two years to the balance sheet date of the accounts you have. “BAE Systems, with 106,400 employees worldwide, delivers a full range of systems and services for air, land and naval forces, as well as advanced electronics, information technology solutions and customer support services”. (BAE systems at a glance, 2009). They are the pioneers in the armament and defence industry and has made remarkable progress in business during the fiscal period 2009 as compared to fiscals 2008. The Turnover of the company has increased from £18,543m during 2008 to £22,415m during 2009, an increase of 21% over the earlier period. Correspondingly, the underlying Earnings before Interest, Taxes and Amortization (EBITA) have also increased from £1897m in 2008 to £2220m in 2009, showing increases of 17% growth rate in these two years. Again, the progress of the company could be judged by the fact that there has been a 10% hike in dividends to shareholders from 14.5 p during 2008 to 16p during 2009. During this period the Basic Earnings per Share (EPS) has increased from 37.1p in 2008 to 40.7p in 2009, an increase of around 10%. Cash inflows have also registered good increases from £2009m during 2008 to £2232m in 2009, an increase of around11%. However, a disconcerting occurrence in this company has been that the US Department of Justice and UK Serious Fraud Office has filed cases of conspiracy by making false statements to the US Government in matter of regulatory filings and documents. Again, regarding the case the Company will plead guilty to one charge for breach of duty to keep accounting records in relation to payments made to a former marketing adviser in Tanzania. The Company has agreed to pay penalties and fines in both these cases. “The Board uses a range of financial and non-financial performance indicators, reported on a periodic basis, to monitor the Group’s performance over time”. (Our strategy: Our key performance indicators, 2010). What have been the major influences on the share price of the company? The ongoing legal proceedings by US Department of Justice (DoJ) and the UK Serious Fraud Office have had an adverse impact upon the share prices of BAE systems. The last quotation of share price has been 360.60 GBp with a reduced rate of -16.80 GBp. (Share monitor, 2010). Revenue movements of BAE Systems since 2004: Other considerations that impact upon the share price of the company would be the economic scenario in which this major company operates with its competitors and rival businesses, the number of defence contracts it is able to gain during the year and its major inroads into global markets like Indian and Kingdom of Saudi Arabia. Being essentially a global company which operates even in the United States, it is subject to many concerns that could affect its trading in the London bourse. The main impacts, besides its top management being awarded the execution of major defence contractors in many countries, including KSA, India, etc, is that the present scandal has undone the lot of good will gained by the past business. “The arms giant BAE yesterday agreed to pay out almost £300m in penalties, as it finally admitted guilt over its worldwide conduct, in the face of long-running corruption investigations”. “BAE Systems, the biggest manufacturing company in Britain, was dealt with a major blow today when the government awarded the first phase of a £4bn contract to build new armoured cars for the British army to Americas General Dynamics. “The move jeopardizes the future of the firms armaments factory in Newcastle and 600 jobs”. (Wachman 2010). What are the main risks to which the company is subject to and how has the management of the company sought to manage those risks? The main risks that the company could be subject to could be seek in terms of the following: Political risks BAE Systems undertakes armaments contracts and transacts supplies of military supplies to many destinations across the world. These negotiation entails technical and commercial discussions with Government representatives for discussions of governmental interests and for getting necessary permits and licenses for commencing operations. Political conditions may stall such negotiations and may become barriers for gaining of such contracts. Exchange Rate fluctuations: Global commerce is fraught with issues connected with exchange rate fluctuations, especially with the impact of recession and lowered demand for goods, services and utilities. It is necessary that the Company takes up schemes like Derivatives. In order to lessen the impact of wide currency fluctuations contractors may see to it that such measures are identified and eliminated as far as possible. Money supply: Economic conditions dictated by local governments may detrimentally affect the demand and supply chains. Since these are no local Governments, their impacts may be severe on corporates like BAE. On the one hand, there is the situation for getting contracts and executing them on time and within predetermined budgets in accordance with the norms and policies of internal audit, while on the other, local conditions and demands may become an overriding factor. Legal issues: There have been instances in the past when BAE stood guilty of bribing officials or agencies and was forced to pay penalties and fines to extricate themselves from such situations. Besides, there is the need for this company to respect local laws and norms while executing projects in various countries across the world. If the event’s characteristic local surroundings are not honoured, there are ample risks of getting into legal imbroglios. Proposed remedies: BAE needs to make thorough investigations and assessments before taking up global projects, especially in lesser developed countries. The political, economic and social milieu needs to be well known and strategies need to be drawn up to protect BAE’s interests also. This Company also needs to professionally recruit, train and deploy key technical and non-technical personnel who have high loyalty in order to reduce the negative impacts of business and to promote the economic or non-economic interests of the company. Only when there is a strong and committed professional team is it possible to achieve objectives, and further, business development activities of the unit. Find out the Beta of the company? Calculate the WACC. This measures how much a companys share price moves against the market as a whole. “A beta of one, for instance, indicates that the company moves in line with the market. If the beta is in excess of one, the share is exaggerating the markets movements; less than one means the share is more stable. Occasionally, a company may have a negative beta (e.g. a gold mining company), which means the share price moves in the opposite direction to the broader market” (McClure 2010). The value of Beta of this company is 0.7415” (BAE systems PLC, 2010). (BAE systems PLC, 2010). Calculation of Weighted Average Cost of Capital of BAE: “Weighted average cost of capital is the weighted average of the cost of equity and the cost of debt based on the proportion of debt and equity in the company’s capital structure.” (McClure 2010). The WACC is the weighted average of the cost of equity and the cost of debt based on the proportion of debt and equity in the companys capital structure. The proportion of debt is represented by D/V, a ratio comparing the companys debt to the companys total value (equity + debt). The proportion of equity is represented by E/V, a ratio comparing the companys equity to the companys total value (equity + debt). The WACC is represented by the following formula: WACC = Re x E/V + Rd x (1 - corporate tax rate) x D/V. What are the arguments for and against the use of a single WACC for assessing the viability of all projects considered by any one company? The arguments for the use of a single WACC for assessing the viability of all projects could be seen in terms of the fact that this could be the most appropriate and plausible figure for knowing the cost of capital or the amount that has to be paid by the company for acquiring funds, whether debt or equity. The WACC takes into account the weighted averages of debt, equity and other kinds of capital structure and thus would be a good indicator of capital. Besides, for the purpose of comparison with similar industry or industries undertaking the same kind of business, it is important that rational comparisons could be made, so that to reach competitive decisions. Thus, by use of the single WACC, it is not only possible to arrive at correct estimates, but also to make constructive comparisons between firms. “IRG acknowledges that the WACC is a widely accepted methodology to calculate the cost of capital, understood by both the finance community and the industry, and already used by many regulators.” (Principles of implementation and best practice for WACC calculation: Executive summary, 2007, p.3). However, there are also major concerns with WACC arising due to the following aspects: 1. The firm may not be a listed one and therefore the figures of market capitalization may not be available. Under such circumstances, without the figures for market cap, it becomes difficult or nearly impossible to calculate WACC. Under such circumstances the best option would be to seek out comparative kinds of business within the same industry, for a company like BSA, it would be necessary to make comparisons with other rivals or competing firms in the defence electronics and armament field. 2. The firm in question may be dealing with just one kind of equity - maybe just equity shares and therefore, the question of any debt or other kinds of internal or external debts do not arise. The determination of WACC under such circumstances is also a matter of conjecture and assumptions, which may compromise on correct estimation of the figure for WACC. Again, it is seen that this would need to consider just the return on equity part and the weighted average of equity capital. There are also aspects of how WACC could be correctly estimated under such circumstances. 3. The next aspect is that if there are no available figures for the necessary inputs to calculate WACC, it would surely have a negative impact and the figures of WACC so created may not be plausible or correct. Thus, the use of a single WACC may not really suit the purpose when the figures provided are dubious. 4. The next aspect is that WACC figures are very sensitive to impacts, either direct or indirect, and thus may be dynamic and very moving. Thus, it would not be correct to have a standard WACC estimate, especially when other parameters are moving rapidly from time to time. There may be factors that would impact WACC and this would need to be identified and fresh figures calculated over time. Thus, it would be wrong to base WACC on a single or set of figures alone since other determinants and weightages also need to be assessed. For instance the position of rival firms and competitors and their WACC determinants are also needed for business. Market capitalization, interest rates, taxation, and other economic factors also play a part in determining the correct status of WACC. Therefore, these also need to be understood in its proper perspective. 5. Another important factor regarding WACC is that market volatility and share movements need to be assessed for the correct estimation of WACC. All impinging factors need to be considered for determination of WACC. “In particular, the calculation of the WACC is affected by the value of imputation credits and tax concessions. Thus in working out the WACC, adjustments for taxation and imputation credits needs to be accounted for.” (Weighted average cost of paper, 2002, p.7). During 2009, “The middle market price of the Company’s ordinary shares on 31 December 2009 was 359.5p and the range during the year was 306p to 408.25p.” (Cautionary statement, 2009). Conclusion: It is thus seen that BAE despite having been involved in some controversies has been a global market leader in its business and has provided a chain of services not only to companies but also to governments in their defence segments. It is believed that in future the company would soar greater heights in their efforts for providing state-of the- art defence technology to their clients and customers and would also take excellent care of their employees, shareholders and business partners. Reference List BAE systems at a glance, 2009. [Online] BAE systems. Available at: http://www.annualreport08.baesystems.com/overview/at-a-glance.aspx [Accessed 22 April 2010]. BAE systems PLC, 2010. [Online] Financial Times: ft.com/Marketsdata. Available at: http://markets.ft.com/tearsheets/businessProfile.asp?s=BA.:LSE [Accessed 22 April 2010]. BAE systems PLC, 2010. [Online] Financial Times: ft.com/Marketsdata. Available at: http://markets.ft.com/tearsheets/performance.asp?s=BA.%3ALSE [Accessed 22 April 2010]. Cautionary statement, 2009. [Online] BAE Systems. Available at: http://bae-systems-annual-report-2009.production.investis.com/shareholder-information.aspx [Accessed 22 April 2010]. McClure, B., 2010. DCF Analysis: calculating the discount rate. [Online] Investopedia. Available at: http://www.investopedia.com/university/dcf/dcf3.asp [Accessed 22 April 2010]. Our strategy: Our key performance indicators, 2010. [Online] BAE systems. Available at: http://bae-systems-investor-relations-2009.production.investis.com/en/strategy-and-performance/our-strategy.aspx [Accessed 22 April 2010]. Principles of implementation and best practice for WACC calculation: Executive summary, 2007. [Online] IRG Regulatory Accounting, p.3. Available at: http://www.erg.eu.int/doc/publications/erg_07_05_pib_s_on_wacc.pdf [Accessed 22 April 2010]. Share monitor, 2010. [Online] BAE Systems. Available at: http://bae-systems-investor-relations-2009.production.investis.com/en/share-price-information/share-monitor.aspx [Accessed 22 April 2010]. Wachman, R., 2010. BAE systems hit by defence cuts. [Online] Guardian.co.uk. Available at: http://www.guardian.co.uk/business/2010/mar/22/bae-systems-defence-spending-cuts [Accessed 22 April 2010]. Weighted average cost of paper, 2002. [Online] Independent Pricing and Regulatory Tribunal, p.7. Available at: http://www.ipart.nsw.gov.au/files/Discussion%20Paper%20-%20Weighted%20Average%20Cost%20of%20Capital%20WACC%20-%2019%20August%202002%20-%20website%20document%20ISBN%201877049956.pdf [Accessed 22 April 2010]. Read More