Corrected, 4/11/2000
University of Southern California
Marshall School of Business
FBE 532
Corporate Financial Strategy
Spring, 2000
Prof. M. Weinstein
Tu 6:30-9:15
x06499, HOH 702G
TTh 2:00–3:15
email: mweinstein@marshall.usc.edu
REQUIRED TEXTS
Case and Readings Packet (and supplemental): at the Bookstore
Ross, Westerfield and Jaffe, Corporate Finance (5th ed.), Irwin, 1998 (RWJ)
I assume you have all been through this, or a similar textbook before. Readings in this text are for background and to refresh your memory.
COURSE OBJECTIVES
This course will use a mix of cases and discussions to study the practical aspects of some of the major topics of modern corporate finance. We will apply the concepts and methods that you learned in FBE521 (or 548) to “real world” situations. The second major objective of the course is to examine the linkages between the financing issues and the main strategic objectives of the firm. It will be important to see what these linkages are and how the financial decisions reached must be consistent with the firm’s objectives. By the end of the course, you should have become somewhat comfortable with taking raw financial data from the firm and applying different valuation approaches as a guide in decision-making. You should also have a deeper appreciation for the role of financial decisions in furthering corporate objectives and for the relations between the finance side of the firm and the operating side of the firm.
COURSE PROCEDURES:
For the evening class, I will treat each meeting as consisting of two 80-minute classes with a 5 minute break in between. Thus, my plan is for the class to run from 6:30 – 7:50, then there will be a 5 minute break, and class will then resume at 7:55 and run to 9:15.
This applies to both sections. I will require case writeups. Note well: During weeks when more than one case is assigned, those whose family names begin with the letters A-M will do a writeup of the first case, those whose family names begin with the letters N-Z will do the second case. Thus, you will do one, and only one, writeup each week. Case writeups will be no more than two pages in length. They are simply designed to show me that you have read the case and thought about the issues. Each memorandum must be typed and double spaced. Write the memorandum as if you were addressing the CEO in the case.
For each case I present a number of “study questions.” These questions are designed to get you going in addressing the case. Note that a case write-up does not consist of answering the study questions. The study questions should be the start of your thinking about the case, not the end.
Another aspect of the course is that we will try to integrate material from a number of different areas. Although this course is primarily concerned with financial decisions, these decisions cannot be made without an understanding to the competitive environment in which the firm finds itself, and without an understanding of the accounting principles that lead to the financial statements that are used in decision making. Thus, in order to do well in this course, it is important that you recall what you have learned in all your coursework, not just your finance courses.
Because of the nature of this course (and the grading criteria), it is extremely important that you attend every class, arrive on time and be prepared to participate. To help me out, you should bring a name card and place it on the desk in front of you. I may not remember who said what without those cards. I will pass out a seating chart at the first class. I ask that you remain in your seat for the entire term. This will help ensure that class participation is accurately recorded and rewarded.
EXAMS
There will be a final exam. It will be given during the examination period stated in the Official Class Schedule for this class. There will be few, if any, excuses for missing the exam, which I will NOT reschedule.
GRADING
Grading will be based on the case-writeups (20%), final exam (40%), and class participation (40%). In evaluating class participation I will be considering the contributions that you have made to furthering the discussion of the topic at hand. Mere opening your mouth is not good class participation. I am looking for comments that are thoughtful and lead the discussion forward, not astray.
Class participation will be graded in the following way. At the start of the semester each student will have 70 points. If you don’t open your mouth voluntarily the entire semester, you will end the semester with 70 points. If you do open your mouth voluntarily, your class participation point score will vary between 60 and 100. Around the mid-point of the semester, I will send you an e-mail with your current participation score so that you have time to adjust. Note that good class participation does not mean simply speaking, it means participating and moving the discussion along in a productive manner.
I will cold-call. Thus, I expect everyone in the class to be able to discuss each case. However, I recognize that there are times when you will be unable to be prepared for a class. In that case, you must contact me BEFORE class and you may ask for a “cold-call” pass. Of course, I do not expect you to abuse this privlege.
ELECTRONIC RESOURCES
I will maintain web pages for this course at my website, http://marshallinside.usc.edu/mweinstein. The website will contain an electronic version of this course syllabus, with hypertext links to 1) Excel spreadsheets for each case, 2) every handout as a PDF file, 3) any lecture notes this I write up as Powerpoint presentations, 4) all supplemental readings other than HBS teaching notes and HBR reprints. Each spreadsheet contains most of the exhibits in the case. This will make it easier for you to spend time on the analysis rather than punching in numbers. I will also monitor a conference for the course on First Class. I would like you to post any questions that you have to the conference. I will leave them open for a bit so that other students may respond, then I will reply. This way all questions are available to all students. Of course, if you have a private question please contact me directly by e-mail, or at my office.
ACADEMIC DISHONESTY
The use of unauthorized materials, communications with fellow students during an examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of an examination, or other class work is unacceptable to the University. It is often difficult to distinguish between a culpable act and inadvertent behavior resulting form the nervous tensions accompanying examinations. Where a clear violation has occurred, however, the instructor may disqualify the students work as unacceptable and assign a failing mark on the paper.
Please note that I take this very seriously. We are a professional school and, while it is tempting to suggest that the prevailing ethic of business is “Just Win, Baby,” this is not, in fact, the case.
OFFICE HOURS
Thursday 4:00 - 5:00 and by appointment, in my Hoffman Hall office.
COURSE SCHEDULE
Day Class #1, January
11, 2000
Evening Class #1A, January 11, 2000
Introduction to course
Day Class #2,
January 13, 2000
Evening Class #1B, January 11, 2000
Readings:
Introduction to
Cash Flow Valuation Methods (RP)
Note on Valuation in Entrepreneurial Ventures (RP)
Note that in the above reading, Gompers uses the phrase "Capital Cash
Flow" in a manner different from the way that Ruback uses it in the first reading. We
will use the phrase the way Ruback does. What Gompers is talking about is what is usually
referred to as the Adjusted Present Value approach.
Note on Adjusted Present Value (RP)
Note on Capital Cash Flow Valuation (RP)
RWJ Ch. 17
Two DCF Approaches for Valuing Companies...(RP)
Note on Leverage, Betas, and Taxes
Day Class #3, January 18, 2000
Evening Class #2A, January 18, 2000
DCF Valuation Approaches (Continuation)
Day Class #4, January 20, 2000
Evening Class #2B, January 18,2000
Study Questions
1. What is your estimate of the value of Eskimo Pie Corporation as a stand alone company?
2. Why would Nestlé want to acquire Eskimo Pie? Are there potential synergies? Is Eskimo Pie worth more to Nestlé than it is worth as a stand alone company?
3. As an advisor to Reynolds, would you recommend the sale to Nestlé or the proposed IPO?
Day Class #5, January 25, 2000
Evening Class #3A, January 25, 2000
Study Questions
1. Assess Interco's financial performance. Why is the company the target of a hostile takeover attempt?
2. As a member of Interco’s board, are you persuaded by the premiums paid analysis (Exhibit 10) and the comparable transactions analysis (Exhibit 11)? Why?
3. Wasserstein, Perella & Co. established a valuation range of $68 - $80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis section of Exhibit 12. As a member to Interco's board, which assumptions would you have questioned? Why?
4. How would you advise the Interco board on the $70 per share offer?
5. How would you assess the actions of Interco's board up to August 8, 1988? Wasserstein, Perella & Co.'s? The Rales brothers'? Drexel Burnham's?
Day Class #6, January 27, 2000
Evening Class #3B, January 25, 2000
Corporate Restructuring
Day Class #7, February 1, 2000
Evening Class #4A, February 1, 2000
Study Questions
1. In 1986, then-chairman and CEO David Roderick described USX as possibly one of “the most restructured corporations in America.” Even so, Carl Icahn believed that further restructuring of the company was still necessary. In late 1990, what operating and/or strategic problems, if any, do USX’s two main businesses still face that would warrant some form of additional restructuring?
2. Do you think there is any merit in Carl Icahn’s claim that problems in USX’ steel business are depressing the value of its energy business? As a USX stockholder, how credible a spokesperson do you consider Icahn to be on this issue?
3. Which restructuring option—Icahn’s spin-off proposal or the company’s targeted stock proposal—will create the most value for shareholders? For creditors? For the firm’s other stakeholders?
4. For what kinds of companies is targeted stock most appropriate? Least appropriate?
5. Should the company seriously consider any other options besides doing a spin-off or issuing targeted stock?
6. If the company decides to go ahead with the targeted stock issue, what specific provisions or features should the stock include in order to ensure maximum value creation?
Day Class #8, February 3, 2000
Evening Class #4B, February 1, 2000
Reading:
Form Follows Function: The Transformation of Banking (RP)
Case 4: Chase Manhattan Corporation: The Making
of America’s Largest Bank
Study Questions
1. Recently a growing number of U.S. companies have tried to cut their operating costs through various kinds of restructuring. Chemical and Chase are attempting to reduce their costs by merging. This approach (“bigger is better”) represents a sharp contrast to the refocusing and downsizing which has characterized most U.S. manufacturing in recent years. Do you think the interests of the bank’s shareholders and other constituencies would be better served by some alternative form of restructuring that emphasizes increased corporate focus?
2. What are the strategic benefits, in any, of combining Chase and Chemical? What is the most significant benefit that the banks will realize from this merger?
3. Should Chemical reconsider any of its other prospective merger partners?
4. Assuming that all the anticipated benefits from the merger are realized, what is the likely dollar impact of the merger on the combined wealth of Chase and Chemical common stockholders? How will the merger affect the banks’ financial performance (e.g., as measured by return on equity)? As a banking industry financial analyst, how would you measure the success of this transaction? (The equity beta for each bank’s common stock at the time of the case was about 1.25)
5. To what extent, if any, do the prospective financial gains of the banks’ shareholders represent transfers of value from other claimholders, such as bank customers, employees, and communities in which the banks do business.
6. If you were the Chemical CEO, what exchange ratio would you seek for the merger? What if you were the Chase CEO?
7. Critically evaluate the analysis that Chase and Chemical performed for determining the level of employee layoffs and branch closings. How should a company determine what level of downsizing is appropriate for its circumstances? Over what time-period should the layoffs and branch closings be scheduled?
8.
As a general matter, when a company undertakes a complex or controversial
restructuring program, what issues should management be concerned about in designing the
company’s disclosure strategy? In the context of the Chemical-Chase merger, how much
and what kind of information about this deal should management disclose to Wall Street and
the media?
Day Class #9, February 8, 2000
Evening Class #5A, February 8, 2000
Case 5: Signet Banking Corporation
This doesn't have anything to do with the case, but Paul Gompers, a Prof. at HBS whom I know, sent me this presentation on internet stuff that you may find interesting/
Study Questions
In its present state, how well is Signet Bank positioned in the industry?
What are the objective of management at this time?
What evidence is there to support the "value gap" and the concerns of management that the bank is undervalued
How do you assess the various restructuring alternatives develpoed by the firm's investment bankers?
Which alternative should Mr. Millner recommend to the board?
Day Class #10, February 10, 2000
Evening Class #5B, February 8, 2000
Case 5: Signet Banking Corporation (continued)
Day Class #11, February 15, 2000
Evening Class #6A, February 15, 2000
Real Options
Reading:
RWJ Ch. 21, 22
Valuing Offshore Oil Properties with Option Pricing Models (RP)
Valuing Managerial Flexibility (RP)
Scientific Management at Merck (RP)
Day Class #12, February 17, 2000
Evening Class #6B, February 15, 2000
Project Finance
Reading Assignment:
Project Financing: an Economic Overview (RP)
Using Project Finance to Fund Infrastructure Investments (RP)
Day Class #13, February 22, 2000
Evening Class #7A, February 22, 2000
Study Questions
1. Evaluate Amoco’s and Apache’s corporate objectives and strategies. Is it reasonable to expect that the MW properties are more valuable to Apache than to Amoco? What sources of value most plausibly account for the difference between buyer and seller?
2. Structure and execute a discounted cash flow valuation of all the MW reserves using the capital cash flow approach. How much are the reserves worth? Is your estimate more likely to be biased high for low? What are the sources of this bias?
3. How would you structure an analysis of MW as a portfolio of assets-in-place and options? Specifically, what parts of the business should be regarded as assets-in-place and which as options? What kinds of options are present? Should this approach yield a higher or lower value than the capital cash flow approach you employed above?
4. Execute the analysis you structured in question 3, beginning with the assets-in-place. How risky are the assets that underlie the options: i.e., how would you estimate s2 for each? How much is the portfolio worth?
5. Assuming a sale goes through, how does Apache exercise each of the various options? When should it do so?
Day Class #14, February 24, 2000
Evening Class #8A, February 29, 2000
Case 6: MW Petroleum (A) Continued
Day Class #15, February 29, 2000
Evening Class #7B, February 22, 2000
Study Questions
1. How should PDVSA finance the development of the Orinoco Basin? What ar ethe costs and benefits of using project finance instead of traditional internal debt finance?
2. What are Petrozuata’s three or four most important operating risks? How does the deal structure address these risks? Who would bear these risks if the project were financed internally by PDVSA instead?
3. As currently envisioned, debt will comprise 60% of the funds needed for the project. Would you recommend a higher or lower leverage ratio” What happens to the minimum debt service coverage ratio and internal rate of return on equity (IRR) as project leverage increases to 70% of project funds? Decreases to 50%?
4. What kind of debt (agency debt, bank debt, or Rule 144A bonds) should the sponsors use to fund the deal? What are the advantages and disadvantages of each kind of debt?
Note: You may find the following information useful as you prepare this case for either or both class sessions.
1. Rated Project Bonds ($ millions)
Year |
Total Project Bond Issuance |
Emerging Market Bond Issuance |
Total Project Bonds Outstanding |
1992 |
$1.2 |
$0.2 |
N/A |
1993 |
1.6 |
0.7 |
$5.8 |
1994 |
4.3 |
0.8 |
10.2 |
1995 |
4.3 |
2.2 |
14.2 |
1996 |
7.8 |
1.2 |
19.6 |
1997 est. |
9.0 |
4.8 |
22.2 |
2. Brady bonds were created in 1990 as a means for developing nations to convert long-term bank loans into marketable securities. Under the Brady plan, long-term bank debt was restructured as dollar-denominated bonds. AS of December 1996, the spread between 10-year US Treasury yields and Venezuelan Brady Bond yields was 4.98%. Between 1990 and 1996, the average spread was 9.74%, the maximum spread was 19.97% (March, 1995), and the minimum spread was 3.51% (September, 1991)
Y You may find this reading useful. Ben Esty, Improved Techniques for Valuing Large Scale Projects.
Day Class #16, March 2, 2000
Evening Class #8B, February 29, 2000
Case 7: Petrolera Zuata, C.A.(continued)
Study Questions
1. Will project bonds receive and investment grade rating? What is the “weakest link” in the project?
2. As one of the sponsors, what are your expected returns? Please assume the asset beta for an integrated drilling, pipeline and refining firm is .60.
3. What kind of sensitivity analysis would you do to verify the project’s economics?
4. Would you invest in project bonds? Would you invest in equity capital as Conoco?
5. How should PDVSA finance its other oil field projects?
Day Class #17, March 7, 2000
Evening Class #9A, March 7, 2000
Case
8: ALZA and Bio-Electro Systems (A):
Technological and Financial Innovation
Study Questions
We will spend two class sessions studying a popular new product that is used to finance biotech firms. Today we focus on the financing, design, and pricing issues facing Martin Gerstel, ALZA’s CEO and the inventor of the product now know as SWORDs (Stock Warrants for Off-balance-sheet Research and Development). Next class, we will study the execution of the offering and the subsequent pricing of the instruments in the market.
1. How does the competitive environment and ALZA’s strategy affect its need and ability to finance the new drug delivery technologies? How could Gerstel fund the research on new drug delivery technologies? On what grounds should he compare various funding alternatives? How do they compare to one another?
2. Carefully read the proposal to create BES and finance it by issuance of the callable common plus warrant package. Try to beak apart the units into simpler pieces that we can understand. How does the unit work? Does it solve Gerstel’s problems? Will it appeal to investors? Why or why not?
3. How much is a unit worth? Is $11 a fair price?
Day Class #18, March 9, 2000
Evening Class #10A, March 21, 2000
Case 8: ALZA and Bio-Electro Systems (B1): Rights
Offering Strategy
ALZA and Bio-Electro Systems (C)
Study Questions:
1. Why is Gerstel offering the units at $11?
2. As an ALZA shareholder, what can you do with your rights to subscribe to the BES (Bio-Electro Systems) units? AS an ALZA shareholder, how can you obtain additional units beyond those to which your common shares entitle you to purchase for $11? Assuming that you want to own the units, does your guess about the likely success or failure of the offering affect how you will attempt to obtain additional units?
3. Critique strategy to offer the security described in the (B-1) case. Does his offering strategy make sense? What are its pros and cons? What would you have done differently? Why?
4. In the (C) case, we see the subsequent performance of the AZLA, the BES units, and the pieces of the units that traded after the instrument separated into callable common and warrants. How should the callable common shares have been valued by the market in early 1991? On August 14, 1991? On November 12, 1991? On January 10, 1992? How were they valued by the market?
Day Class #19, March 21, 2000
Evening Class #9B, March 7, 2000
Mergers
Reading Assignment:
RWJ Ch. 30
Stock or
Cash? The Trade-Offs for Buyers and Sellers...(SRP)
Day Class #20, March 23, 2000
Evening Class #11A, March 28, 2000
Merger Defense
Reading
Assignment:
Richard Ruback,
"An Overview of Merger Defense"
Day Class #21, March 28, 2000
Evening Class #10B, March 21, 2000
Case 9: Atlantic Energy/Delmarva Power & Light (A)
Study Questions
1. Does this merger make sense strategically?
2. Why are they having trouble making the deal?
3. How can the deal be structured to preserve the benefits of the combination?
Day Class 22: March 30, 2000
Evening Class 11B: March 28, 2000
Bankruptcy and Reorganization
Reading:
Bankruptcy: A Debtors Perspective (RP)
Note on International Comparisons Involving Troubled Companies
Day Class #23, April 4, 2000
Evening Class #12A, April 4, 2000
Case 10: Time Inc.’s Entry Into the Entertainment Industry (A)
Study Questions
1.
How attractive is the merger of Time and
Warner?
(a) What
are the value enhancement opportunities?
(b) Is
the proposed exchange ratio of .465 per Warner share attractive?
2. What prompted Paramount’s interest in Time?
3. What legal, financial, and restructuring options does Time have to combat the Paramount bid? To ensure that it is not a target in the future?
4. What would you do as Mr. Munro? How would you explain a decision to reject the Paramount offer at the annual shareholder’s meeting?
5. Why would Martin Davis be really upset in 1993?
Day Class #24, April 6, 2000
Evening Class #12B, April 4, 2000
Venture Capital
Reading: Note on the Venture Capital Industry
You
may also be interested in this paper:
The
Legal Infrastucture of the German Venture Capital Market: Barriers to Replicating the U.S.
Template by Baums and Gilson.
The first part of the paper shows how the structure of Venture Capital in the U.S.
provides solutions to a number of organizational problems likely to arise in a VC setting.
Day Class #25, April 11, 2000
Evening Class #14B, April 18, 2000
Case 11: Bankruptcy and Restructuring at Marvel Entertainment Group
Study Questions
1. Why did Marvel file for Chapter 11? Were the problems caused by bad luck, bad strategy, or bad execution?
2. Evaluate the proposed restructuring plan. Will it solve the problems that caused Marvel to file Chapter 11? AS Carl Icahn, the largest unsecured debtholder, would you vote for the proposed restructuring plan? Why or why not?
3. How much is Marvel’s equity worth per share under the proposed restructuring plan assuming it acquires Toy Biz as planned? What is your assessment of the pro forma financial projections and liquidation assumptions?
4. Will it be difficult for Marvel or other companies in the MacAndrews and Forbes holding company to issue debt in the future?
5. Why did the price of Marvel’s zero-coupon bonds drop on Tuesday, November 12, 1996? Why did portfolio managers at Fidelity and Putnam sell their bonds on Friday, November 8, 1996?
Day Class #26, April 13, 2000
Evening Class #13B, April 11, 2000
Case 12: EDocs
Study Questions
1. Why is Charles River interested in eDoc?
2. Why is eDocs interested in CRV?
3. How much is eDocs worth?
4. Who has bargaining power in this negotiation? Why?
5. Evaluate the importance of the various terms in the Exhibit 7. Why are they there?
Day Class #27, April 18, 2000
Evening Class #14A, April 18, 2000
Study Questions
1. What are the barriers to starting a biotechnology company in France
2. What does Brandys bring to the Genset startup? Vasseur?
3. From whom should Brandys and Vasseur raise money? What should the terms be?
4. What is the value of Genset? How important is option value? Can we get rough values for their investment value?
Day Class #28, April 20, 2000
Evening Class #13B, April 11, 2000
Case 14: Immulogic
Pharmaceutical Corporation (A - B4)
You should read the (A) case and all 4 (B) cases. However, you should focus your preparation on the (A) case and one of the 4 (B) Cases. Students with family names beginning with A – F should prepare (B1). Students with family names beginning with G – L should prepare (B2). Students with family names beginning with L – R should prepare (B3). Students with family names beginning with S – Z should prepare (B4).
Study Questions
1. Why is Malcom Gefter working at ImmuLogic, rather than at Merck or at M.I.T.?
2. Is ImmuLogic Pharmaceutical Corporation ready to go public? Should it go public?
3. What is the value of Immulogic? What is a fair price for the initial public offering?
Day Class #29, April 25, 2000
Evening Class #15A, April 25, 2000
Case 15: Genset IPO
Study Questions
1. Why are there so few IPOs outside the United States?
2. What are the costs and benefits of an IPO?
3. What is the business environment of the genomics industry? What are the key success factors?
4. Is the genomics field competitive?
5. What are the economics of running a genomics company? How does that affect funding needs?
6. What is the current state of the financial markets? Are they conducive for an IPO by Genset?
7. Should Brandys take such extreme measures to issue both in France and the United States? Why is the doing it?
8. Why is Brandys going public now? Does it make sense?
Day Class #30, April 27, 2000
Evening Class #15B, April 25, 2000
Review of Course