I want a Finance Case study report. Which has to be very accurate. Please accept the work if you believe that you can do it accurately and if yo

case sheet

ust

Case: UST

Capital Structure Policy

Debt Policy at UST, Inc.

Case Report: General instructions

 Please answer the exact questions asked in this case assignment.

 The numbers and details provided in this case assignment override any conflicting numbers and details from the case text.

 All other numbers and details should be from the text of the case. No other information/data can be used, including external data from the Internet.

 Your report should consist of a single file based on the template excel file provided.

 Please do not add spreadsheets. Please do not change the format of the template spreadsheets. Any changes to the format of the spreadsheets will result in score deductions.

 Please make sure to name your case report file “case# firstname lastname” before submission. For example: “case1 Armen Hovakimian”. For group cases, the case report file name should follow this template: “case 1 group 6”.

 Please note that the template spreadsheet is only a tool to help students complete and report the results of the case assignment described in this handout. This handout is the primary document describing the assignment.

Debt Policy at UST, Inc.

Case Report: General instructions

 All the spreadsheet cells that are marked with “x” need to be filled.

 The unshaded cells with “x” should be filled with numbers (if given) or references to other cells.

 All the shaded cells should contain formulas.

 The shaded cells with “x” should be filled with formulas that calculate numbers.

 In the shaded cells that came with numbers prefilled in the template file, the numbers should be replaced with formulas. Such prefilled numbers are given to help students check their formulas.

 A formula like this “=2000+I9/J9” is unacceptable. Instead of “2000”, there should be a reference to the cell where “2000” is located.

 All numbers in the “Case sheet” should refer to cells in other spreadsheets where the calculations are done, e.g., “=returns!B2”. There should be no calculations or plain numbers in the “Case sheet” itself, unless specifically indicated.

Debt Policy at UST, Inc.

Case report: Assignment

Please answer the following questions assuming that UST is

planning to issue $1.2B of 11-year bonds on December 31,

1998 and use the proceeds to buy back shares on the same

day.

Please use UST’s financial data for 1998 and assume the

following pre-recapitalization (as of 12/30/1998) parameters:

stock beta of 1.3

credit rating of AAA

please use the market value of equity and the share price

given in the case to calculate the number of shares

outstanding.

Debt Policy at UST, Inc.

Case report: Assignment

Please use the following market-wide parameters in your

calculations:

benchmark financial ratios for different ratings from Exhibit 8

market risk premium of 6%

tax rate of 20%

Interest rates as given in the table below

Yields to

Maturity

U.S.

Treasury AAA AA A BBB BB B

10-Year (%) 4.00 5.00 5.50 6.20 7.00 8.00 12.00

Debt Policy at UST, Inc.

Case report: Assignment – questions

1. What is the market capitalization (market value) of equity of UST before the

change?

2. What is the firm value of UST before the change?

3. Based on UST’s EBITDA coverage ratio, what is the interest expense of UST

before the change?

4. What would be the credit rating for UST bonds, based on EBITDA coverage, if

UST borrowed $1.2B? Explain.

5. What would be the firm value if UST borrowed $1.2B?

6. What would be the market capitalization of equity if UST borrowed $1.2B?

7. What would be the share price if UST borrowed $1.2B?

8. What would be the cost of equity if UST borrowed $1.2B?

9. What would be the WACC if UST borrowed $1.2B?

10. If the choice is between recapitalizing as described earlier vs. doing nothing,

would you recommend UST to recapitalize with $1.2B in debt? Explain.

Debt Policy at UST, Inc.

Case report: Assignment – questions

11. Let us now ignore the plan to borrow $1.2B. Suppose UST wants to decide what

would be the best amount of debt to have. Assume that:

• In the case of bankruptcy, UST will lose 10% of its firm value.

• The probabilities of bankruptcy are as follows:

a. For each rating, based on EBITDA coverage, calculate the amount of debt

UST will likely be able to have.

b. For each rating, calculate the firm value

c. For each rating, calculate the share price

d. Based on your calculations in (11.a, b, c), what rating would you recommend

for UST to target? Explain.

e. Based on 11.d, what would be the target debt ratio?

AAA AA A BBB BB B

Prob. of

bankruptcy 0.5% 1.2% 2.0% 8.0% 20.0% 45.0%

UST – hints

UST

rating

UST

value

Cost of capital

 Exhibit 8 shows the average characteristics, including EBITDA coverage, of industrial firms with various ratings.

 For each rating, we can use the corresponding interest rate to calculate what the EBITDA coverage ratio would be if UST borrowed $1.2B and received that rating.

 Comparing the coverage ratios for hypothetical UST ratings to industry benchmarks for each rating would show which rating would be feasible for UST.

 The valuation method here should be like APV

 Except, there is no need to calculate the unlevered value. The value of UST, as it is, is given.

 The new value = old value + tax savings from new debt

Old RE = RF + b(RM – RF)

RE = R0 + (D/E)(R0-RD)(1-T)

𝑅0 = 𝐸

𝐸+𝐷(1−𝑇) 𝑅𝐸 +

𝐷(1−𝑇)

𝐸+𝐷(1−𝑇) 𝑅𝐷

UST – hints

Q11: Target rating

Amount of

Debt for

Each rating

Value for

Each rating

 For each rating, we know average EBITDA/Interest

 Given UST’s EBITDA, we can calculate the expected interest expense for each rating for UST

 Given the interest rate for each rating, we can calculate how much debt UST can have for each rating

 Value = old value + PV(tax savings) – E(Bankruptcy costs)

 PV(tax savings) will be different for each rating because interest expense will be different

 E(Bankruptcy costs) = (bankruptcy cost)×(probability of bankruptcy)

 Q10 provides info on both terms needed to calculate E(BC)

Harvard Business School 9-200-069 Rev. May 3, 2001

Professor Mark Mitchell prepared this case from published sources with the assistance of Janet T. Mitchell as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 2000 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

1

Debt Policy at UST Inc.

In December 1998, UST Inc.’s board of directors approved a plan to borrow up to $1 billion over five years to accelerate its stock buyback program.1 For UST Inc., the leading producer of moist smokeless tobacco products and a company widely known for its conservative debt policy and high dividend payout (uninterrupted cash dividends since 1912), this announcement generated considerable attention on Wall Street. Investors eagerly awaited the subsequent actions of Vincent Gierer, Jr., UST’s Chairman and CEO.

In 1997, UST had suspended its stock repurchase program, approved in 1996, because of legislative and legal issues confronting the tobacco industry.2 In November 1998, the company signed the Smokeless Tobacco Master Settlement Agreement resolving its potential state Medicaid liability and reinstated its repurchase program.3 Management believed that this agreement represented significant progress with respect to the legal and legislative matters confronting the company, permitting UST to proceed with its business strategy and potential recapitalization.

The Smokeless Tobacco Market

The U.S. smokeless tobacco industry generated $2 billion of retail revenue in 1998 with approximately 5 million consumers of moist smokeless tobacco and 7 million consumers of chewing tobacco including loose leaf, twist, plug and dry. Moist smokeless tobacco consumption approximated 50% of the total. See Table A on page 2 for a description of smokeless tobacco products. While decelerating recently, the USDA reported moist smokeless tobacco has been the fastest growing segment of the tobacco industry with volume increasing at a 3.7% annual growth rate over the past 17 years compared with a 2% annual decline in cigarette volume over the same period. A.C. Nielson reported that moist snuff volume grew 2.9% in 1997 and 1.2% in 1998.4

A number of factors contributed to the continued growth of the moist smokeless tobacco segment. The increased prevalence of smoking bans has led consumers to switch to smokeless

1 UST Inc. Press Release, “UST Increases First Quarter 1999 Dividend; Accelerates Stock Repurchase with $1 Billion to Be Borrowed Over 5 Years,” December 10, 1998. 2 “UST Stock Buybacks: Initiatives Planned for 1999,” Dow Jones News Service, December 10, 1998. 3 Merrill Lynch & Co., “UST Inc.,” December 4, 1998. 4 Data in this paragraph from Credit Suisse First Boston, “UST, Inc.: Still Chewing on the Story – Stay Tuned,” August 27, 1999.

This document is authorized for use only by Robin Boby ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected]rdbusiness.org or 800-988-0886 for additional copies.

200-069 Debt Policy at UST Inc.

2

tobacco to circumvent smoking restrictions. Consumers perceive that moist smokeless tobacco is less of a health risk than cigarettes. Smokeless tobacco is less expensive to use than cigarettes based upon an average per-week usage measurement. Additionally, consumers have been shifting over time to moist smokeless tobacco from loose leaf chewing tobacco. While the consumer base remains primarily male (approximately 98%), smokeless tobacco use is no longer confined to the stereotypical blue collar or rural users as approximately 30% of users have attended some college. The overall moist smokeless tobacco market is expected to continue to grow at an annual rate of 1-3%, with a large portion of the growth expected in the price-value segment.5

Table A Smokeless Tobacco Products

Category Definition Use Brand/(Manufacturer)

Snuff

Dry Powdered dry tobacco Snorted through nose (Conwood), (Swisher), (UST) & (B&W)

Moist Fine, long or powdered cut moist tobacco

Placed between lower lip and gum

Copenhagen (UST), Skoal (UST), Kodiak (Conwood), Silver Creek (Swisher) & Timber Wolf (Pinkerton)

Chewing Tobacco

Loose Leaf Moist tobacco which is cut into small strips

Placed between cheek and gum

Red Man (Pinkerton), Levi Garrett (Conwood) & Beech Nut (National)

Plug Moist or dry tobacco compressed into a chunk

Placed between cheek and gum

Day’s Work (Pinkerton), Red Man (Pinkerton), & Levi Garrett (Conwood)

Twist/Roll Tobacco fashioned into a roll Placed between cheek and gum

(Conwood)

Source: Credit Suisse First Boston, “UST, Inc.: Still Chewing on the Story – Stay Tuned,” August 27, 1999

Competitive Position

UST is the dominant producer of moist smokeless tobacco, or moist snuff, controlling approximately 77% of the market.6 Exhibit 1 provides a description of UST’s products and Exhibit 2 displays market share in the moist smokeless tobacco market from 1991 to 1998. Table B on page 3 displays the 1998 market share of the top moist smokeless tobacco brands. UST was a driving force in the overall expansion of the moist smokeless tobacco market over the years, primarily through product innovations such as new forms and flavors. Historically, UST has been aggressive with its price increases, instituting almost annual, often twice annual, price increases over the past twenty- five years. Steadily increasing prices provided a solid boost to earnings and the company’s stock price. Meanwhile, as UST expanded the category and continued to raise prices, smaller players eroded UST’s market share primarily by cutting price.

Given UST’s relatively significant share erosion in recent years, the investment community called upon management to take actions to compete more effectively against the value brands and stem the erosion of market share. Despite its history of expanding the overall smokeless tobacco industry through new product introductions and innovations, UST had been criticized recently for a reduction in innovation and tardiness of new product introductions and product line extensions.

5 Ibid. 6 Ibid.

This document is authorized for use only by Robin Boby ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies.

Debt Policy at UST Inc. 200-069

3

Inroads by smaller competitors, primarily in the value segment, led to missed earnings and lowered Wall Street expectations. A Wall Street Journal article in 1997 noted “The company’s management, pleased with their dominant market share and keenly aware of the company’s strong heritage, turned their noses at the smaller upstarts.”7 In fact, an alleged dispute over the company’s course of action reportedly led to the resignation of two key executives. In February 1997, John J. Bucchignano, CFO, and Robert D. Rothenburg, President of the tobacco unit, resigned due to “philosophical differences about the strategic direction of the company.”8

Table B Smokeless Tobacco Brands (1998 Dollar Share)

Copenhagen Fine Cut (UST) 29.9% Skoal Fine Cut Wintergreen (UST) 11.8% Kodiak Wintergreen (Conwood) 9.5% Skoal Long Cut Wintergreen (UST) 9.4% Copenhagen Long Cut (UST) 7.2% Skoal Long Cut Straight (UST) 5.9% Skoal Long Cut Mint (UST) 4.4% Skoal Long Cut Cherry (UST) 2.9% Skoal Bandits Wintergreen (UST) 2.2% Skoal Long Cut Classic (UST) 2.0% Skoal Long Cut Spearmint (UST) 1.8% Skoal Fine Cut Straight (UST) 1.3%

Source: 1998 A.C. Nielson data

In 1997, rather than cut prices to counter the growth of value players, UST introduced its Red Seal brand tobacco to compete with the price-value brands and preserve pricing power and profitability of its premium brands.9 Despite this new product, analysts felt that UST was too slow in responding to the threat of value competitors. At the time of its introduction, the value segment had already gained 9% market share, requiring Red Seal to compete against already successful value brands. Another 1997 product introduction, Copenhagen Long Cut was introduced to combat Conwood’s full-priced Kodiak brand. Conwood, through its promotion of “long-cut” brands, which are easier to use than fine cut products, had made strong inroads with young and new consumers. UST originally stood by its traditional Copenhagen Fine Cut, only succumbing to the pressure to introduce a competitive product after continuing market share losses. Rooster, introduced in 1998, was a new premium product packaged in a larger can, 1.5 ounce compared to the traditional 1.2 ounce, to provide more tobacco for the consumers’ money.10

In addition to product introductions, UST renewed its focus on marketing and promotion. Due to restrictions on public advertising, UST focused its marketing expenditures on free samples, mail-in rebates, and promotional sales. In 1997 and 1998, the company implemented a number of marketing initiatives and promotions. For example, UST offered 4-for-3 pricing on selected products, increased couponing, expanded its sales force, provided retailer and wholesaler incentive programs,

7 See Suein L. Hwang, “UST Stock Falls 12% as Firm Says Profit Won’t Meet Expectations,” Wall Street Journal, March 3, 1997. 8 See Cathleen Egan, “UST Resignations Likely Turned on Battle vs. Private Labels,” Dow Jones News Service, February 24, 1997. 9 David Adelman, “UST(UST): No Surprises in 1Q Results; Retaining Underperform Rating,” Morgan Stanley Dean Witter U.S. Investment Research, April 30, 1998. 10 Credit Suisse First Boston, “UST, Inc.: Still Chewing on the Story – Stay Tuned,” August 27, 1999.

This document is authorized for use only by Robin Boby ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies.

200-069 Debt Policy at UST Inc.

4

expanded outlets and/or markets for new products, executed selected per can discounts, used special commemorative lids and repositioned certain Skoal products.11

Litigation and Legislative Environment

Litigation and legislation are everyday occurrences in the tobacco industry. Smokeless tobacco manufacturers have historically faced less exposure to health related lawsuits than cigarette manufacturers. For example, UST had seven pending health related lawsuits (excluding the state Medicaid cases) at the end of 1998, compared to cases numbering in the hundreds filed against cigarette companies.12 The lower exposure to health-related lawsuits is largely due to the fact that scientific evidence linking smokeless tobacco to cancer is less conclusive than studies researching cigarettes tie to cancer, and snuff producers face no potential “second hand” smoke litigation.

In 1998, the tobacco industry experienced a number of developments in the legal and political arena, most of which were viewed positively by the industry. In June, Congressional efforts to pass broad-based tobacco legislation unfavorable to the industry collapsed. In July, a U.S. District court judge issued a ruling to “vacate” major portions of a 1993 EPA report classifying environmental tobacco smoke as a known human carcinogen.13 In August, a federal appeals court ruled that “the FDA lacks jurisdiction to regulate tobacco products, and all of the FDA’s regulations of tobacco products are invalid”. Additionally, cigarette manufacturers won dismissal of several class-action lawsuits filed on behalf of smokers and labor union health care funds. 14

Furthermore, in a landmark event for the tobacco industry, the industry agreed in November to settle state Medicaid lawsuits with a $206 billion settlement and a ban on advertising and promotions that appeal to youths. The settlement was negotiated among the four major cigarette manufacturers and eight states, but received unanimous approval of a

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