...Debt Policy at UST The primary business risk facing UST in 1998 was that the U.S. tobacco industry itself was facing an uncertain future characterized by legal challenges, declining volumes, marketing restrictions, increased taxes, heavy discounting and consolidation. The U.S. smokeless tobacco industry also was transitioning away from the Premium Market and growing through the Price Value Market at a rate of 9%. Bondholders face very little investment risk given UST’s high interest coverage ratio and substantial cash flows, making UST less susceptible to the risk of bankruptcy. One would be concerned about the industry’s decline and the fact that growth is driven primarily by the Price Value Market. UST is positioned as the Premium Market leader, but owns just 6% of the Price Value Market. Of UST’s total portfolio of products, approximately 1% of the company’s 1998 tobacco sales revenue was derived from the Price Value Market. UST is facing aggressive pricing, heavy competition from new products and they are losing market share in their core operations. Their growth and pricing strategy was to introduce similar products rather than to cut prices. Further concerns are that UST has no plans to expand internationally, and both the CFO and President resigned in February 1997 due to “philosophical differences about the strategic direction of the company.” UST was facing growing threats of changes in legislation that could adversely affect the industry and faced several potential...
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...Debt Policy at UST Inc. Group #10 What are the attributes and primary business risks associated with UST, from viewpoint of a potential creditor (bondholder). Generally, UST is one of the most profitable companies in America. It is also the first and leading producer of smokeless tobacco. However, it still meet some risk. First of all, UST has seven current health related lawsuits. Secondly, UST didn’t has value opportunity to expand in international market. Finally, UST didn’t have an effective way to deal with the continued threat of price-value competitors. Rate the overall business risk In 1999, Debt Ratio = Total Liabilities/ Total asset=100/913.3= 10.95% D/E Ratio= Total liabilities/ Shareholders’ Equity= 100/ 468.3= 21.35% Why are they considering a leveraged recap after a long history of conservative debt policy UST wants to reduce the taxes paid and increase the firm value by leveraged recapitalization. Recapitalization can make capital structure of UST more stable, and sometimes to boost the company's stock price. Evaluate their past financial performance During 10 years, UST kept a good financial situation, which show a positive signal for shareholders an investors. This company was one of the most profitable companies because of good ROE, ROA and gross profit margin. Except decrease in earnings and cash flow in 1997, UST kept increasing in sales (10-year compound annual growth rate of 9%), Net income (11%) and Free operating cash flow (12%). UST also...
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...Case 1 – Debt Policy at UST Inc. 1) UST is the dominant producer of moist smokeless tobacco, or moist snuff, controlling approximately 77% of the market. UST has been one of the most profitable companies in corporate America with low debt compared to other companies in the tobacco industry and the company has been recognized by Forbes in terms of profitability by achieving return of capital of 92.1%. Price elasticity of its products is also important while evaluating. Smokeless tobacco industry has a relatively steep demand curve and should be considered as having an inelastic consumer demand. UST has products outside of its core operations in the wine and premium cigar market also. The company built itself strong brand name recognition over the years by providing premium products. Tobacco industry does not allow new competitors to enter the market due to strict legal regulations and advertisement bans. So, we can think that UST will hold its position in the market in the long run. Although for the past couple of years, UST faced market share erosion due to price-value brands which offer low priced products. UST have been criticized for lacking innovation and new product offering. The company also has lack of international (geographical) diversity. Also, there is a chance of a cultural shift against tobacco, and UST is unlikely to expand to international market We can say that; UST is in a good position in terms of brand name and market position, capability to generate...
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...Harvard Business School 9-200-069 Rev. May 3, 2001 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...
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...Decision. Positive points: UST was one of the most profitable companies in America. Average ROA is 54%, average ROE is 103% and GPM is 80%.EBITDA/Interest Coverage 105.6. UST is the first and leading producer of moist smokeless tobacco. UST has very conservative debt policy and stably growing free operational cash flows. Should UST undertake a billion $ recapitalization? Calculate the marginal (or incremental) effect on UST's value, assuming the entire recap is implemented immediately Yes, UST will be able to make interest payments and get a good (A) credit rating (EBITDA Interest coverage will be 829.37/70.5=11.7) and by issuing debt UST can increase the firm value through interest tax shield. Also issuing debt and recapitalization will increase the value of each share. The results of recapitalization are in the spreadsheet below. 1988 1999(no debt) 1999(after recapitalisation) Sales 1,423.20 1494.36 1494.36 Gross Profit 1,139.70 1191.00 1191.00 EBITDA 785 829.37 829.37 EBIT 753.3 796.49 796.49 Interest Expense 2.2 0 70.5 A Rating Pretax Earnings 755.5 796.49 725.99 Taxes 287.09 302.7 275.9 Net Income 468.4 493.8 450.1 Total Debt 100 0 1000 Shareholders’ Equity 468.3 468.3 Shares 185.5 185.5 158.2 Stock price 34.88 36.62 36.62 Market Value of UST 6470.24 6793.75 5793.75 Shares repurchased 27.304 P Value of the Tax Shield 380 Increase in firm value due to borrowing (P Value of the tax shield) = debt x tax rate=380...
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...Harvard Business School 9-200-069 Rev. May 3, 2001 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...
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...EXECUTIVE SUMMARY UST Inc. is a principal producer of moist smokeless tobacco products, controlling roughly 77% of the overall market, and widely known for its conservative debt policy and high dividend payout. UST also has an exceptional financial performance as net sales has been growing at 11% compounded annual growth rate, and cash flows have been growing at 12% compounded annual growth rate for the past 10 years. However, UST’s board of directors approved a plan to borrow up to $1 billion over five years to accelerate its stock buyback program in December 1998. Although this debt policy benefited UST in term of additional tax shield and rise in stock market price, however, the debt would directly increase financial distress and weaken UST’s cash flow. This report is prepared to consider debt policy for assessing a leverage recapitalization for UST and evaluate effect of dividend payment from buyback policy. After carefully evaluation of available information and using finance literature and relevant course lectures to conduct financial methodologies, including Unlevered beta, Value of levered firm with Financial Distress, Weighted Average Cost of Capital Analysis for Capital Structure Choice, and Proforma, I recommend UST to implement its one billion dollars buyback program in a period of five years. OVERVIEW OF UST Over the years, UST has been named the most profitable company in America in 1998 by Dreman Asset Management as measured by return on equity, return on...
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...UST Items for Discussion 1. What are the attributes and primary business risks associated with UST, from viewpoint of a potential creditor (bondholder). Attributes: UST has been a dominant producer in the tobacco industry. Also, UST is well known for its high gross profit margin, which means UST is capable of maintaining its stable financial situation. UST is a major moist smokeless tobacco producer, and the demand on moist smokeless tobacco is growing very fast due to increased government regulation on smoking. Potential business risks: UST has very little debt, which makes it more able to resist potential risk when the economy goes bad. In addition, the legislative environment is not good for UST because the government has the ongoing health concerns. Due to the high price of UST’s products, other companies selling low price tobacco threaten the market share of UST. 2. Rate the overall business risk The S&P rates UST’s long-term credit as A, and its short-term credit as A-1. However, the future of tobacco industry is unclear, and government may conduct some policy to control the tobacco industry’s growth due to health concerns. Therefore, the UST’s long-term credit should be BBB. Also, UST’s short-term credit should be lower than the S&P’s rating, which is A-2. 3. Why are they considering a leveraged recap after a long history of conservative debt policy UST’s growth rate is reducing since 1994. They are not able to make a high growth in the...
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...Situation/Conclusion UST is the dominant producer of moist smokeless tobacco or snuff, controlling 77% of the market. UST has been one of the most profitable companies in corporate America. UST's five-year return on capital of 9.21% was nearly 20% higher than the 2nd ranked firm. Annual return on equity averaged 89% and return on assets averaged 48%. Over the same period, UST also provided a generous return on capital to investors paying $2.2 billion in dividends and repurchasing $2.0 billion in stock. However, UST also faces challenges associated with the industry in which it operates. The tobacco industry faces significant legal; however, the smokeless tobacco industry is traditionally a less litigious environment than the cigarette industry. The industry as a whole also faces challenges from declining sales volumes, marketing restrictions, high taxes, and poor public perception. Additionally while smokeless tobacco is the fastest growing segment of the tobacco industry, the market has slowed in recent years with most of the future growth expected to be coming from the low-price segment. Despite these challenges the outlook for UST is still positive. UST benefits from incredibly high margins with a gross margin of 80% compared to the tobacco industry mean of 28%. Due to the high levels of cash generation and a historically conservative debt policy, UST has historically been able to maintain very high credit ratings. UST is currently planning to reinstate a previously approved...
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...Debt Policy at UST Case Questions Group members: Wei-Ting Liao; Cong Ren; Gerald Nyiti; Beidan Wang 1- ) Give a brief summary of the company background UST Inc. is a smokeless tobacco company which enjoyed a long tradition and a recognizable brand name. It is the leading producer of moist smokeless tobacco products and widely known for its conservative debt policy and uninterrupted cash dividend payout since 1912. The company is the major player in U.S. smokeless tobacco market. For example, it holds the maximum market share (77%) as a whole, and dominates especially in the growing segment of moist smokeless tobacco. Additionally, it has widely recognized brand and competitive positon in the market by constant innovation and new product innovation. Finally, UST has historically been one of the most profitable companies not only in the smokeless tobacco market but also in the corporate America. Although the above advantages, UST now faces with continuous threat from price-value competitors, a softening smokeless tobacco market, investors’ concern about over-investment on non-core operations and negative effect of public and political sentiment towards the tobacco industry. 2- ) Evaluate UST’s attributes/Risks from view point of bondholder The following factors weave into the risks and attributes of the company from the creditors’ point of view (“” and “” represents advantage and disadvantage, respectively): Widely recognizable brand Name UST has widely recognized...
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...Debt Policy at UST, Inc. Introduction In 1998 the U.S smokeless tobacco industry generated $2 billion of retail revenue with approximately 5 million consumers of moist tobacco and 7 million consumers of chewing tobacco including loose leaf, twist, plug and dry. Moist smokeless tobacco consumption approximated 50% of the total. The factors contributing to the continuous growth of the moist smokeless tobacco was the increased prevalence of smoking bans which had led customers to switch to smokeless tobacco and the fact that smokeless tobacco was 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, smokeless tobacco is no longer confined to the stereotypical blue collar or rural users as approximately 30% of users had attended college. The overall moist smokeless tobacco market was expected to continue to grow at an annual rate of 1-3% with a larger portion of the growth expected to be in the price value segment. UST is the dominant producer of moist smokeless tobacco, or moist snuff controlling approximately 77% of the market. UST also has other business interests such as wine, cigars and international marketing of moist smokeless tobacco. UST has been a driving force in the overall expansion of the moist smokeless tobacco market over the years, primarily through product innovations...
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...Debt Policy at UST Inc. Executive Summary In the 1990’s, UST was a dominant producer of moist smokeless tobacco, controlling 77% of the market. Smokeless tobacco products consist of snuff (dry and moist) and chewing tobacco (loose leaf, plug and twist/roll) categories. UST was a market leader of the snuff product category, innovating with new product forms and flavors over the years. UST has also been a profitable company, boosting its shareholders’ earnings by undertaking measures such as increasing the cost of its products steadily with time. UST also benefited from the steady increase in market demand for smokeless tobacco given the rising restrictions on cigarette second hand smoke. UST was still criticized at the time for its tardiness with new product introductions and losing its market share to new and smaller competitors. In 1997, instead of cutting product prices to compete, UST introduced new line of lower priced products such as Copenhagen Long Cut and Rooster. UST also renewed its focus on the marketing campaigns, launching promotions and increasing couponing. For years, tobacco industry had been embattled with health related lawsuits. Majority of these litigations were for cigarette companies in comparison to smokeless tobacco industry. Still, UST had seven pending health related lawsuits. UST has historically been one of the most profitable companies in corporate America. Even though S&P rated the debt of many tobacco companies as investment grade...
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...UST Inc. is considering a debt-for-equity recapitalization. In the deal, UST will issue $1 billion debt to buy back stocks. In class we argue that an important determinant of a firm’s debt policy is the tradeoff between the tax benefits of debt and the costs of financial distress and bankruptcy. Mature firms generating positive and stable operating income are more likely to take advantage of the debt tax shields and less likely to verge on bankruptcy, and thus may consider using more debt in their capital structure. Do you think UST Inc. would benefit from this transaction? Between 1988 to 1998, UST has enjoyed excellent financial performance. The firm has posted continuous increase in sales, earnings and cash over the entire period with a 10 year compound growth rates of 9%, 11% and 12% respectively. Most noticeably, the firm has also maintained margins with average gross profit, EBITDA, EBIT and nets margins of 77%, 53%, 50% and 31% respectively. Judging from the financial performance of UST (stable positive earnings), we can firmly conclude that the UST is an assets-in-place firm. The purpose of the debt-for-equity recapitalization is for UST to enhance their overall firm value. 1. First, UST will benefit from the interest tax shield. a. Tax Shield = Corporate Tax Rate * Debt = 0.38 * 1 billion = $0.38 billion In addition, the recapitalization will decrease the number of outstanding shares and as such generate higher returns for shareholders. Moreover, servicing...
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...17 years. Many factors contributed to the success of the smokeless tobacco industry. Increases in smoking bans caused many customers to switch to smokeless. Many consumers also perceived the smokeless tobacco as less of a health risk. The price of moist smokeless tobacco is comparably less than cigarettes. It is predicted that the market will continue to grow 1-3% over the next few years. UST is the largest smokeless tobacco producer controlling approximately 77% of the market. Historically, UST has been very aggressive with its price increases. This has resulted in a solid boost in the company’s earnings, and large payouts of dividends. UST is widely known for its conservative debt policy, and high dividend payout. This gives the company considerable attention on Wall Street. Despite a recent “neutral” outlook from Wall Street, UST has decided to borrow up to $1 billion to accelerate the company’s stock program. 1. What are the primary business risks associated with UST Inc.? Historically, UST has been one of the best investments in corporate America. In 1998, UST was deemed the most profitable company, in terms of ROE, ROA and gross profit margin, by John Dorfman. However, the tobacco industry as a whole faces a lightly less certain future due to many factors. I think the text touches on this in the statement, “Despite strong cash flows, the U.S. tobacco industry is characterized by legal challenges, declining volumes, marketing restrictions, taxes,...
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...Debt Policy at UST Inc. Executive Summary In the 1990’s, UST was a dominant producer of moist smokeless tobacco, controlling 77% of the market. Smokeless tobacco products consist of snuff (dry and moist) and chewing tobacco (loose leaf, plug and twist/roll) categories. UST was a market leader of the snuff product category, innovating with new product forms and flavors over the years. UST has also been a profitable company, boosting its shareholders’ earnings by undertaking measures such as increasing the cost of its products steadily with time. UST also benefited from the steady increase in market demand for smokeless tobacco given the rising restrictions on cigarette second hand smoke. UST was still criticized at the time for its tardiness with new product introductions and losing its market share to new and smaller competitors. In 1997, instead of cutting product prices to compete, UST introduced new line of lower priced products such as Copenhagen Long Cut and Rooster. UST also renewed its focus on the marketing campaigns, launching promotions and increasing couponing. For years, tobacco industry had been embattled with health related lawsuits. Majority of these litigations were for cigarette companies in comparison to smokeless tobacco industry. Still, UST had seven pending health related lawsuits. UST has historically been one of the most profitable companies in corporate America. Even though S&P rated the debt of many tobacco companies as investment grade...
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