Williams Case
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1) Evaluate the terms of the proposed $900 million financing from the perspective of both parties. How would you calculate the return to investors in the transaction?
Steven Malcolm was appointed the CEO of Williams Companies in January 2002 to take charge of the problem at hand at Williams. The company was facing liquidity crisis and amidst the anxiety in the energy markets and the losses of its subsidiary Williams Communication group, its credit ratings had tanked and was unable to find a ready lender.
Berkshire Hathaway and Lehman brothers had proposed a short term financing option of $900 million for one year with strings attached as laid in the terms and covenants. The two parties that are concerned here are Williams Companies as debtors and Berkshire, Lehman et al as lenders or creditors.
From the perspective of lenders, it was an intelligent strategy to provide short term financing to Williams when none was available with perks and rewards if Williams defaulted or breached any of its covenants. The potential reward of the RMT assets of $2.8 billion dollars was definitely much more coveted than the potential interest payments from Williams. Warren Buffet who was shopping in the crisis struck energy markets for troubled assets had found one in Williams if things went sour for this troubled company. So making available $900 million dollars as short term liquidity for Williams for sweet returns of almost $315 million in interest payments or the big jackpot of the RMT assets of $2.8 billion was no brainer, in fact it was meticulously carved out to take advantage of the situation.
From the perspective of the borrower that is Williams Companies, Malcolm was in a very tight spot to make the decision regarding this proposed offer of $ 900 million loan. The payments required from Williams are shown below:
Principal 900
Lender – Berkshire, Lehman et al
million
Required Payments
Cash interest @ 5.8 %
million
Additional interest 14% per annum
million
Deferred set up fee of 15 % assuming no sale of RMT assets
million
Total payment obligations to lenders after one year (34.8 % returns to lender)
313.2
million
Also, interestingly if Williams was still struggling and it had to sell some of its assets to make liquidity available, the terms of the above financing would slap even more payments to Williams under its deferred set
up fee clause. Lets assume hypothetically that Williams had to sell $2.0 billion of RMT assets and that the rate applicable is 17% of the purchase price, then the company would be liable for an additional $187 million (17% of $2 billion minus 900 million debt) which would bring the total payments to $365 million. So the return to lenders is at minimum of $313 million in interest payments for $900 million debt which come to 34.8% returns. If Williams has to sell any of its assets for $2 billion then the returns are approximately whopping 41% to the lenders. The tax advantage from paying 313.2 million dollars in interests is $109.6 million, not enough justification for committing to a loan with very restrictive covenants and especially if its a one year loan. Williams might find itself struggling with a similar situation six months from now.
The question on return to the investors or stock holders is really interesting. The cash flows to the investors has taken a hit very recently when dividends were slashed 95% to 1 cent per share and the share prices have tanked to $2.95 per share as of July 2002. So most of the investments have evaporated the in the last year as stock price started plummeting because of Williams credit crisis. Now whether this proposed $900 million short term loan to help Williams be profitable again has to be seen in the following light.
At the end of 2001, the stock price of Williams was trading at $25.5 per share with 515,362 thousand shares outstanding, equity made up 53% of the firm value.
In 2002, the stock price tanked to $ 2.95 per share bringing the stock holders equity down from $ 13 billion to $1.5 billion, thereby the structure of the firm and its market value was completely changed too as shown below with equity having 10% of the total firm value pie:
This changed situation alone made up for the distressing situation for the investors as the debt to equity ratio was almost 9, meaning debt was 9 times the equity as compared to less than 1 before (0.88). When a firms debt equity ratio is normal around or less than one, getting more debt is a signal to investors that the firms value is in good shape. But in this situation, more debt is not exactly good news to the investors. So the question of return to the investors here is definitely not a cash flow return in the short term(as dividends and stock prices both have tanked), but rather a subjective question of whether this proposed finance of $ 900 million is going to help Williams survive and be profitable in the long run. If this proposed financing helps Williams survive the credit crisis and gives it enough time to restructure itself for better poise, profit and growth, then the investors would say yes, but if this additional debt creates more problems and compounds Williams already bad situation then investors