1. Summary of Massey-Ferguson’s 1971-176 Goals, Strategy and Risk/Return profile Goals/Strategy: •Focus on small tractors, combine harvesters and industrial machinery •Exploit markets outside North America and Western Europe •Dealing directly with governments and public institutions •Central production of diesel engines in UK Risk/Return profile: •Empire Building; engaging in potential negative NPV investments •Expanding potentially unprofitable divisions (ambitious program of expanding operations) •Potentially pay too much for acquisitions (ambitious program of acquiring assets; e. . purchasing Hanomag) •Make unnecessary capital expenditures (high debt-to-equity ratio) •Possible hire of unnecessary employees •Overconfidence; New opportunities are better off than they actually are •Free cash flow hypothesis •Continue to invest in projects that should be cancelled •Limited Diversification •Due to strength in negotiating deals with governments versus vulnerability to political distress in 70’s in Iran, Pakistan, Libya and Poland. 2. On which assumptions were goals, strategy and related risk/return policy based? Exchange Rate stability (higher UK pound) •Stable cost of goods sold (Diesel Engines in UK) •Political stability in relation to countries in developing countries •Continued economic growth •Limited volatility in cash flows •Customer’s ability to make the principal payments •Stable or declining interest rates 3. How were the goals, strategies compared to those of the competition? Massey-FergusonDeere & CoInt. Harvester RegionsStrong outside North America and Europe Focus on North AmericaFocus on North America ProductionLack of alignment, e. . diesel engine production only in UKConcentrated to North American marketConcentrated to North American market Farm and industrial machineryStrong in small tractors and combine harvesters on NA marketStrong in larger tractorsStrong in larger tractors 4. Would you agree that MF was trying to reduce risk by diversifying markets? Depends; a. Yes, in a way that MF invested in developing countries with growing sales versus local US and Western European markets b. No, in a way that it had limited product differentiation and was not supplying e. . at the home (US) market the products that customers (high horse power) wanted. Later corrected though. 5. Summary of what happened after 1976 Economics: •Increasing Interest rates •Declining demand Strategy: •Returning attention to the North American Market •Introduction of new competitive (more horsepower) products in the North America and Western Europe. Finance: •Losses on continued operations •High debt-to-equity ratio as a consequence of ambitious program of acquiring assets and expanding operations HR: Cost cutting and labour lay offs Operations: •Elimination of unprofitable operations 6. Describe (using details from financial statements) MF’s financial strategy and changing financial position during 1977-1980. •High interest rates having a double negative effect •High costs due to high Debt level •Lower revenue due to higher cost of acquisition for customers •Indirect Costs of Financial Distress •Doubts about the future of the company eroded sales and weakened distribution network •Cost-cutting efforts made MF viable 7.
Comparison of MF to its competitors regarding financial strategy and changing financial position (including graphs and comments) Massey-Ferguson LtdIntern. HarvesterDeere & Company Sales (see Figure 1) IncreasingIncreasing until 1979Increasing steadily Operating Profit, see Figure 2 Declining and losses in ‘78, ‘79, ‘80Increasing until 1980 when it falls sharplyIncreasing until 1980 when it falls slightly Debt to equity ratio, see Figure 3 High and increasing to very high levelsStable with small increase in 1980Stable with small increase in 1980
Generally, one can notice that Deere has a more steady growth with smaller fluctuations across all parameters. Massey Ferguson has during 1976-1980 had higher debt levels than its competitors and it has probably been too aggressive in its acquisitions. Deere shows a stable growth also in difficult market conditions, which indicates that it is a well managed and well positioned company. Figure 1. Sales during 1976-1980 Figure 2. Operating profit during 1976-1980 Figure 3. D/E ration during 1976-1980. 8.
What are the main problems for MF in 1980? •Worldwide demand for farm equipment at depression level •1. 5 bln dollar Debt outstanding with 150 banks around the world causing default in beginning in 1981 (and potential bankruptcy) •International Financial Press reporting possible assistance of Canadian Government 9. What alternatives were available to MF (in 1980)? •Bankruptcy •Restructuring with a plan of debt decrease •Selling assets eg Perkins 10. As a financial advisor what would you recommend (numbers based argumentation)?
Due to steady revenue growth (22% growth 1975-1980) even in difficult financial markets we believe that the business is viable and can be recovered with a strict restructuring program. Since Massey’s stock price has dropped rapidly over the years, issuing new equity is not an attractive option with the low stock prices. Obviously increasing debt is not an option either so the only alternatives for Massey to finance it’s business going forward is to either find savings from it’s Balance sheet and income statement or to sell it’s assets.
In below we discuss some opportunities we’ve identified in Massey’s financials. •Working capital management, benefit 325m: Massey’s receivables balances have grown 100% between 1975 and 1980 from 485m to 968m with a DSO increase from 70 days to 113 days. This is extremely high against the revenue growth of 22% in the same period and can be an indication of poor credit management. We estimate that the average of prior 5 years (1975-1979) DSO at 75 days would be a reasonable DSO level. With more focus on collection the target DSO of 75 days would be easy to reach with a minimum financial input from the company.
With a DSO of 75 days Massey’s AR would total to (revenue/365xDSO= 3132/365×75) 643m which means that Massey would receive 325m in cash to invest. •Reduce the level of cash, benefit 40m: from 1975 to 1980 Massey’s cash balance has also increased from 20 to 56m. Since companies typically don’t get a high interest for their cash balances we recommend Massey to reduce it’s cash balance significantly and to invest any excess cash. We estimate that the average cash level of prior 5 years at 16m would be reasonable amount of short term ready cash.
This means that Massey could invest 40m of it’s excess cash. •Reduction of inventory, benefit 255m: looking at their financials from 1980-1971 it appears that Massey has typically kept very high inventory; in 1980 their inventory turns were only 2. 6 meaning that Massey only sells it inventory 2. 6 times a year. This in turn gives us DII (days in inventory) of 141 days (365/2. 6). Even though the companies selling machinery typically have lower inventory turns, we feel that 2. 6 for Massey is too slow and by optimizing it’s inventory management Massey could increase it’s inventory turns.
We estimate that inventory turn of 3. 5 and DII of 104 days would be reasonable levels for Massey. With this reduction Massey will decrease it’s inventory from 989m to 733m and will gain a benefit of 255m. •Capacity optimization: Comparison between Massey’s capacity and sales in different regions indicates that the capacity hasn’t been allocated effectively. Massey has allocated 10. 5% of it’s capacity in Australia that has generated a revenue of only 131m. Also serving other markets from Australia would be extremely expensive due to high transportation costs.
By freeing up some of the capacity from Australia Massey could better serve better the markets in North America and Africa where they feel the growth will come from. Maybe even selling it’s Australian operations would be an attractive option for Massey. •Cuts in SG&A costs, benefit 50m: despite of financial problems Massey increased it’s SG&A costs by 52. 8 m between years 1979 and 1980, which seems inappropriate. With all the planned cuts in spending we estimate that they can save 50m in SG&A. •Gross margin improvement: The gross margin in 1980 at 17. 99% seems very low and it has decreased by 2 % points from 1979.
We believe there are some improvement opportunities in the COGS for instance by better hedging to avoid the FX impact strong pound is having into the COGS. Taken into account that with the negative FX impact the COGS has been around 80% of the revenue. With efficient hedging we believe that gross margin of 22% should be reachable, appendix 1 shows our forecast assuming 1% revenue growth and 22% gross margin as well as efficiencies identified in earlier bullet points. •Debt reduction: looking at Massey’s profit and loss statement it becomes clear that their current debt level has become unbearable.
The interest costs alone in year 1980 at 300. 9m represent 53% of their gross profit. Our recommendation is to urgently cut the level of the debt and repay the short term loans with highest interest rates. Massey’s debt/capital ration at 80. 85% is unreasonably high compared to International Harvester’s 53. 56% and Deere and company’s 40. 28%. With the actions mentioned in earlier bullet points Massey would have gained 670m. We recommend they’d use 500m out of this to repay their short term loans. This would bring their short term loan to 575m and total debt to 990m.
This represents 46. 5% decrease in short term loan balances so we’d estimate the interest costs to be reduced by 46. 5% from 229. 9m to 123m. It was estimated that Massey would need 500-700m in coming 5 years, with above described actions we believe the company can be turned around and can be profitable generating needed cash in 5 years. Attached is our forecast for coming years. Appendix 1983198219811980 Sales3,227. 013,195. 063163. 4213,132. 10 cogs2,517. 062,492. 142467. 46842,568. 500. 78 Gross profit709. 94702. 91695. 95563. 60 FX impact7. 70
SGA350. 00350. 00350404. 70 R&D100. 00100. 006059. 70 EBIT259. 94252. 91285. 9599. 20 Interest LT debt70. 0070. 007171. 00 Interest ST debt100. 00120. 00123229. 90 Interest income-40. 00-40. 00-42-42. 00 FX adjustment49. 90 minority interest0. 200. 200. 200. 20 Misc. income-13. 50-13. 50-13. 50-13. 50 Operating profit (loss)143. 24116. 21147. 25-196. 30 Assumptions: Revenue growth 1% annually Cross margin 22% SGA reduction in 1981 Interest reduction due to loan repayments Remove negative FX impact with effective hedging R&D cost increase after 1981