Unformatted text preview: to total capital rises from 12% in 1976 to 58% in 1980 (ex. 6)
– By 1980, interest costs ($300 million) were responsible for Massey’s losses ($225 million)
31 Massey’s Response to the Crisis Why did Massey choose to finance with shortterm debt?? It had no choice!!
– The stock price fell dramatically (Exhibit 9)
– Lenders were unwilling to invest longterm funds in MF A large debt ratio Disorganized lenders Constraints given by covenants
– Lenders had no choice but to extend shortterm loans
– The alternative was to pull the plug, deny funding, and throw the firm into bankruptcy
Thus, Massey is in big trouble in 1980
32 Massey’s Response: Summary The firm had a promising though risky corporate strategy but financed with debt in good times When trouble hit, the firm had no financial flexibility, no time to respond
Loses had to be funded, and shortterm debt was the only available option
As debt spiraled upward, escalating interest costs compounded Massey’s difficulties
Its debt ratio went from 47% in 19976 to 82% in 1980. Covenant constraints became binding, paralyzing the firm
33 The Competitors’ Response
The The entire farm equipment industry was suffering: The two competitors also experience increases in leverage and reductions in profits (Exhibit 6) Harvester was in fine shape through 1979, but became financially distressed in 1980 with massive losses and a debt ratio of 54% (ends up like Massey). Why?
– North American farm equipment market collapsed in 1980 (somewhat later than many of the foreign markets served by Massey)
– Newly appointed CEO faces the firm’s union, trying to cut labor costs, which leads to a costly strike
34 The Competitors’ Response: Deere John Deere took advantage of the situation and locked up the North American market
During the worst downturn in the industry’s history,
Deere’s sales grew 75% from 1976 to 1980, increasing its market share from 38% to 49% (at the expense of the other two firms)
Capital expenditure share doubled to 68% as the firm built new automated plants to lower its costs
How was Deere able to do this while competitors were bleeding?
Its higher profitability was not enough to finance its aggressive expansion during 19761980. The expansion was financed with debt, mostly shortterm (exhibit 6)!!
35 The Competitors’ Response: Deere Deere used its financial slack as a competitive weapon and could prey on its competitors who could not respond.
Its low debt ratio in good times provided the flexibility to take advantage of an opportunity provided by adversity. By 1980 its debt ratio had risen to 40%. Deere could reduce leverage and risk by issuing equity, but its stock price was depressed by the poor industry conditions. While its...
View Full Document