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.

“The real question is whether a public company would be willing to suffer the dilution associated with selling equity — possibly at a discount,” Welnhofer warns. “Few companies outside of regulated financial institutions in need of additional capital are likely to be interested in issuing new equity at these prices unless they have to.”

But while equity offerings may be dilutive in the near term, deploying the assets quickly can mitigate the dilutive effect, counters Jackman.

Slicing and Dicing

Thinking anew about freeing up capital also means exploring the sale of marginal assets, painful as it may sound.

When Tyco Electronics was spun off in 2007 and became a stand-alone public company, it performed an extensive review of its portfolio of businesses, using growth potential, market position, profitability, leverage with items in its portfolio, and return on invested capital as the measures, says Sheri Woodruff, a Tyco spokesperson. Based on the reviews, the Bermuda-based company decided to divest a radio-frequency components and subsystems business and an automotive radar sensors unit.

The sales netted $470 million in cash in September — almost a quarter’s worth of the company’s total operating income. The cash helped finance a $750 million increase in the company’s share repurchase program as well as a dividend boost. Of course, not every company generates the free cash flow that Tyco Electronics does, which gives it the luxury to cut income-producing businesses.

If companies are considering asset sales, they should avoid the trap of basing portfolio decisions on performance instead of value, says Justin Pettit, a partner at Booz Allen Hamilton. “Value is the present value of all future performance,” Pettit says. “Sell assets that are worth more to someone else than they are to you.”

Indeed, jettisoning assets in a depressed market where demand is sketchy is not the shortest or most certain path to liquidity. Strategic M&A for 2008 increased to $939 billion as of last September, up 16 percent from the same period a year earlier, according to Dealogic. But the sclerotic capital markets have corporate buyers nixing announced deals, either because they can’t raise the debt or the financial upside has evaporated.”M&A advisers are not even willing to take assignments,” says Mackinac’s Gordon. “There simply are no buyers — a lot of them aren’t sure the bottom has hit yet.”

Since CFOs can’t know where the bottom is, the safest play is to build a capital structure that can withstand the bitter-cold shock to the credit markets. For purposes of longer-term planning, decisions about optimum capital structures (Leverage up? Leverage down?) will diverge as CFOs confront a highly uncertain environment in which the standard playbook no longer applies. Says Gordon: “I don’t know if there is a good model right now for capital raising — everyone is in such a state of flux.”

Vincent Ryan is a senior editor of CFO.

Virgin Territory

An M&A deal that also made the balance sheet healthier

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