Investment Banking - Financing and Acquisition - Assignment Example

Investment Banking Name: Tutor: Course: Date: Financing and Acquisition Q.1: Freeport-McMoRan Copper and Gold Inc. (FCX) in 2006 were able to report historic growth in terms of financial performance (FCX, 2006). To start with, the prices of its core commodities soared with gold going for $600 per ounce and copper trading at $3.00 per pound (ibid). The market fundamentals for both metals continue to improve. Secondly, the good performance in prices boosted the company’s financial results to record net income of $1.4 billion, revenues of $5.8 billion, operating income of $2.9 billion and operating cash flows of $1.9 billion. Thirdly, the company set a good number of records in its Grasberg operations which also reflected good performance (Bureau of Mines, 2009). Moreover, the company was able to pay its shareholders with dividends of more than $1billion in the year. In the nutshell, the company was liquid i.e. it had more cash ($907 million) compared to its debt of $680 million. The long-term growth opportunities and strong commodity prices as witnessed in 2006 gave the company a reasonable reason to pursue acquisition of Phelps Dodge. FCX acquired Phelps Dodge for $26billion in cash and stock. This share purchase saw FCX take on all the assets and liabilities of the later. To understand the attractiveness of Phelps Dodge to FCX, it will be crucial to look at liquidity, leverage and profitability ratios of the company. Under liquidity ratio is the acid test ratio which when computed= current assets/current liabilities. In 2005, the acid test ratio was 4070.7/1609.3=2.53; and in 2006, the acid test ratio was 7600.9/3262.9=2.33. These ratios were relatively higher as preferable ratios are those slightly higher than 1.0. Since the ratios were above 2.0, it implies that the company was underutilizing its capital and required long-term investment in innovation, international marketing and product development (Value Line, 2007). In terms of profitability ratios, Return on Equity (ROE) is used to determine the performance of shareholder investment. ROE=Shareholder Equity/Net profits before tax. In 2005, the ROE = 5601.6/1786.1=4.668, while in 2006, the ROE 7690.4/1915.7=4.01. The ratios are high but decreasing meaning that shareholders are beginning to sense a reduction in their earnings. Lastly on leverage ratios, the rationale is to understand long-term solvency of the company and how the long-term debt is being used to support the business. Debt-to-Equity will be used for the year 2006. In 2006, Debt-to-Equity=Total Liabilities/Stockholders Equity, the ratio was 5692.3/7690.4=0.74. In 2005, the Debt-to-Equity was 3840.5/5601.6=0.68. The ratio increased in the year 2006 as compared to the year 2006. It implies that the company was at a higher risk given that debt holders have more claims on the assets of the company. However, the value was less than 1.0 which means that debt holders have less claims on assets that the equity holders themselves. From the ratios above, Phelps Dodge was performing well in terms of liquidity, profitability and leverage. The company was already present in many countries overseas with leases exceeding 25 years (PDC, 2006). The company also owns most of the land and plants in which the operations are based. The company was also employing more than 13,000 people globally generating employment and tax/levies to host countries. Since the company was subject to potential liabilities for environmental damage, it had established environmental remediation liabilities and was a responsible party. The company had built on research and development into metal deposits, and extraction technologies. Lastly, the company is engaged in heavy production in countries have also represent a huge market for the metals. For example, in the US, it produced five segments of copper while in South America; it produced three production segments of copper. Q2. JP Morgan and Merill Lynch are financial advisors and financiers of the cash portion of the transaction (Stowell, 2010). They were actively doing coordination work in the entire process right from acquisition to capital raising. They are also financing the cash portion of the $26billion buy-out of Phelps Dodges by acting as common stock underwriters. Their role in the transaction was to help boost the total debt to over $17.5 billion before the transaction was sealed. The two companies had combined tasks of equity offering. These included timing of financing or origination function, pricing, size, and advise to the company on the optimal structure (Miller, 2011). They also worked alongside colleagues in the equity sales area of the firm to determine the ‘placement’ function or potential investor interest. The two companies agreed to fund the cash portion of the transaction deal by contributing $18 billion (Stowell, 2012). Since they were joint book-running managers, each created a mining and metals industry coverage team to determine the priorities and needs of FCX (ibid). The Mergers and Acquisition team had the responsibility of advising the company on likely shareholding reaction, timing, mix of cash and stock and merger valuation. JP Morgan and Merill Lynch faced capital and reputation risks when executing transactions and advising clients respectively (Stowell, 2010). Under capital risks, financial risks emanate that affect the financing commitment of the bank with regard to acquisition. Any commitment by the bank to provide a loan is a considerable risk. This kind of risk is syndicated up to about 90 percent to money managers and wider group of banks by large banks (Stowell, 2012). Any debt that they are unable to be syndicated to others means that the bank will keep. Reputation risk on the other hand is no less risky even though they are intangible. This risk comes by association of the investment banking firm with the company that raised the capital. Residual effects on reputation can be felt by the investment bank if there happens to be serious problems experienced by the company (Wicks Business Information, 2008). Q.3: Companies consider investment banks for financial assistance or advisory (Stowell, 2012). They request them to present the view of investor demand, preliminary valuation and their credentials. There are several other reasons that companies look at when choosing investment banks and one of them is existing relationships in addition to other factors such as league table rankings, independent research function and execution capability (Bruner, 2004). In the case of FCX, the ties with both Merill Lynch and JP Morgan were well established. The company had great trust for both underwriting responsibilities and mergers and acquisition advisory. The choice of the investment banks is held on the belief by companies that investment banks talk on two sides of ‘Chinese wall’ of financial information (Stowell, 2012). The banks also have capital market teams, mergers and acquisition and coverage team that conduct both valuation work and all of the due diligence. Merill Lynch and JP Morgan are considered as insiders in of sensitive information they regularly receive. The sales and trading group are on one side of the wall, the public side of which they work with investors and are limited to information that is already available to the public. Even a company issuing a press release on proposed M&A or financing it is not unusual for the sales and trading individual to hear it for the first time. At each bank, the leveraged finance group was responsible for analysis in which bridge financing commitments will be based. In this case the financing commitment was not drawn down since the banks made a successful attempt to place with institutional investors, high-yield notes. In order for FCX to show commitment in financing Phelps Dodge, a bridge loan of $18 billion was particularly important (Stowell, 2012). A firm needs to set aside some of its capital to complete the transaction by syndicating out the bridge loan (ibid). This process also includes securing highest possible ratings, negotiating with credit rating agencies on bond offerings that are up-coming. Q.4: Ratings advisory professionals advised the company on the credit rating process as they were part of JP Morgan’s debt capital market group (Stowell, 2010). Based on the selected capital structure, the expected ratings outcomes were also conducted by the professionals. The ratings information was essential to FCX in providing the terms and conditions of the financing, and pricing. This information was also fed to the M&A team in each bank to assess likely investor reaction, expected valuation and impacts on earnings per share (EPS). Equity Capital Market Syndicates Group had a role of tracking concerns and worries of the investors as well as feedback about the transactions. This group also assists the firm in proper pricing of stocks and convertibles so that investors can be kept happy. Equity research has been providing ideas on investment especially to institutional salespeople since they take the ideas to portfolio managers (Stowell, 2012). They provide an overview of convertible offerings and equity. To explain acquisition of Phelps Dodge, the presentation was done by the sales team of FCX, providing information that convinced employees regarding the acquisition. Since 2003, the role of equity research has changed since analysts can from now give investment opinions. A ‘limit order’ is the highest price in the primary stock market in which a company is willing to pay for stock. The impact of the order on the sales function is that firms will have to set good limit orders for their prices of newly issued stocks not to go too high or too low. Q.5. To start with, share trading of FCX rose by 39 cents from the previous year 2006 to close at $62.30 which was a gain of about 2% from the transaction price. Before FCX acquired Phelps Dodge , financial ratios and performance indicators were as shown below; The acid test ratio computed= current assets/current liabilities. In 2006 prior to the merger, the acid test ratio was 907/520=1.74; after the merger, the acid test ratio was 1626/2345=0.69 The ratio in 2006 was relatively higher as preferable ratios are those slightly higher than 1.0. Since the ratio was 0.69 which was less than 1.0 it implies that the company was utilizing its short-term assets to meet its short term financial obligations. It also shows that the company was utilizing its capital well as well as investment in innovation, international marketing and product development. Some of the noticeable changes in the assets were acquisition of new plants, property and equipment. There were also other long-term assets and intangible assets such as goodwill. However, the company had to meet new liabilities on environmental and reclamation obligations as well as protecting the prices of copper. In terms of profitability ratios, Return on Equity (ROE) is used to determine the performance of shareholder investment. ROE=Shareholder Equity/Net profits before tax. In 2006 prior to the merger, the ROE = 2445/1499=1.63, while in after the merger in 2007, the ROE 18234/9355=1.94. The ratios are low compared to the performance of Phelps Dodge in both 2005 and 2006 but decreasing meaning that shareholders are beginning to sense a reduction in their earnings. However, the values are more than 1.0 meaning that the company is able to generate good returns for the shareholders. On leverage ratios, understanding the long-term solvency of the company and how the long-term debt is being used to support the business was important. Debt-to-Equity will be used prior to the merger in the year 2006. In 2006, FCX Debt-to-Equity is given by = Total Liabilities/Stockholders Equity. , the ratio was 2445/2732=0.89. In 2007 after the merger, the Debt-to-Equity was 18234/21188=0.86. The ratio decreased in the year 2006 as compared to the year 2007. It implies that the company was at a higher risk given that debt holders have more claims on the assets of the company. However, the value was less than 1.0 which means that debt holders have less claims on assets that the equity holders themselves. In the nutshell, the company gained a lot in terms of financial ratios and performance indicators in which the values of shares gained by 2%. The acquisition of Phelps Dodges by FCX was a success. This is because the company was listed on a positive watch in late 2006. It was also upgraded from B1 to Baa3 in March the following year (Stowell, 2010). These credit upgrades was because the company had risen over $5 billion in equity capital from convertible offering and common stock. There was also synergy as well as significant increase in cash flow after the merger (Buono & Bowditch, 2003). On the other hand, FCX debt rating was upgraded from B+ to BBB by S&P. The company believed in making concessions on price for its long-term holders in the allocation of newly issued shares. The management also gained confidence in continued work in mining and long-term career in management (Stowell, 2010). They now believe in the security of their jobs, incomes and satisfaction of employees. Reference list Bruner, RF 2004, Applied Mergers and Acquisitions, John Wiley & Sons. Buono, AF & Bowditch, JL 2003, The Human Side of Mergers and Acquisitions: Managing Collisions Between People, Cultures, and Organizations, Beard Books. Bureau of Mines, 2009, Minerals Yearbook, The Bureau. Freeport-McMoRan Copper and Gold Inc. (FCX) 2006, 2006 Annual Report. Miller, EL 2011, Mergers and Acquisitions: A Step-by-Step Legal and Practical Guide, John Wiley & Sons. Phelps Dodge Corporation (PDC) 2006, Annual Report on Form 10-K. Stowell, D 2010, An Introduction to Investment Banks, Hedge Funds, and Private Equity, Academic Press. Stowell, D 2012, Investment Banks, Hedge Funds, and Private Equity, Academic Press. Value Line, 2007, The Value Line Investment Survey, Indiana University. Wicks Business Information, 2008, Treasury and Risk, Pennsylvania State University. Read More