Rethinking Capital

To weather the credit crisis and a recession, CFOs will have to unlearn much of what they thought they knew about capital structures.

Consistency in McCormick’s capital structure lets the company keep the doors open to the commercial-paper market. The key is to maintain an investment-grade rating (A2 by Moody’s) by adhering to targeted ratios: debt to total capital of 45 to 50 percent and debt to total EBITDA of about 1.7. “That has allowed us to access commercial paper as we need it,” says Stetz.

Occasionally, McCormick increases leverage, as it did last August when it acquired spicemaker Lawry’s from Unilever for $605 million. Financing the deal first with commercial paper and then with long-term debt raised the company’s debt to total EBITDA and debt to total capital to 2.5 and 53 percent, respectively, Stetz says. (McCormick did the same thing in 2006 when it acquired Thai-food company Epicurean International.) Fitch Ratings and Standard & Poor’s downgraded the company’s debt a notch this time, but it remained investment grade.

Tempting as it is to squirrel away cash, McCormick is deleveraging again. It suspended its stock-buyback program in the fourth quarter of 2007 (when the Lawry’s deal was announced) and is paying down debt. Meanwhile, the Lawry’s acquisition helped boost McCormick’s sales 9 percent in the third quarter. “What we’ve done has served us well historically,” Stetz says.

Others agree that paying down liabilities has a place in financing strategies today. “Why would you sock away cash unless you were worried about your bank failing?” asks First Capital’s Sunshine. “It’s always good to reduce your liabilities.”

Sweet Equity

Building up the asset side doesn’t have to hurt either. The rising cost of issuing corporate debt could make equity the answer to some situational financing problems, says Sunshine. “For businesses that have legs, that have sound products people are willing to pay for, there’s always equity,” he says.

One such company, Waste Connections Inc., wanted to prepare itself recently for a potential pipeline of acquisitions, as market-share leaders in the waste-collection and -disposal industry were merging and government-mandated divestitures (resulting in assets coming onto the market) were on the horizon. The company raised $394 million through a common-stock offering amid the September swoon in equities.

The cash gives the company flexibility and repositions Waste Connections’s balance sheet for growth, says CFO Worthing Jackman. Meanwhile, the company stays one times leveraged. “There was a certainty of acquisitions and uncertainty in the capital markets,” comments Jackman. “We took the uncertainty off the table.”

William Welnhofer, a managing director at investment bank Robert W. Baird & Co., says equity financing is best used to complete an acquisition for which sufficient debt cannot be raised; to refinance debt that can be replaced only under onerous terms; or to finance capital expenditures if present leverage is high and covenants restrict incurrence of additional debt. Preferred stock or convertible subordinated debt have been popular alternatives to common stock, he adds.

Terms are not light these days for convertibles, however. Convertible subordinated debt for performing, non-investment-grade companies is being priced at a 10 percent coupon and a 15 percent conversion premium from a weighted average share price. Terms also include “make-whole” provisions, which require the issuer to pay the present value of the interest payments that the investor would have received until the bond’s maturity. (That eliminates the incentive to hold on to the bond, says Welnhofer.)


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