American Home Products
Pharmacy had not reached the heavy competition yet during early 1980s, AHP was still the early adopter in the industry, however, the nature of the market will change very quickly follow by the globalization and fast developing of medical technology, efficiency of information communication and financial industry. The competitor will able to launch variously strategies, with wild coverage of products via extended channels in more regions/counties. • Because of debt free strategy, the company had limited investment in R&D.
Even they can provide the “me to product” but the industry will change with more related regulation to be generated from government, that will require each pharmacy company spend longer time, more money to do the testing before launch to the market, “me to product” will slow down the process to catch the new market segmentation. • Brand risk, due to the company was only focus on the interest of shareholders; lack of CSR (corporate social responsibility) will be another risk. • Over centralized power in the leadership even $500 expense need approved by CEO.
Not easy money system and not enough flexibility. b) Financial risks Debt free strategy Case Study/American Home Products Corporation 1 • • Will cause the lack of confident from institutional investors and individual investors due to the low leverage. Inflation! According the public information, the inflation rates from 1979 to 1981 was 11. 22%, 13. 58% and 10. 35%, that means holding money equals losing money. 729m+593m+494 =1816 m which was the total cash AHP was holding, times the averagely discount rate of inflation 11. 72%, they company lost 212. 8 million in 3 years. http://inflationdata. om/inflation/inflation_rate/historicalinflati on. aspx • • • Mismatch between AHP’s performance and stock price, as there was not financial strategy. High tax High dividend payout ratio. 30%-70% debt of total capital • Could possibly downgrading the bond credit level from AAA to AA at beginning 2) Can AHP create value for its shareholders by changing the level of debt? What capital structure would you recommend as appropriate for AHP? What are the advantages and disadvantages of leveraging up this company? The simple answer is “Yes”. We propose the multiple steps to achieve better leverage.
Targeting 30% debt in the first year, because our competitor uses that ratio too, that can be use as benchmark to convince shareholders. Second year we can go for 50% and 70% in the third year. Advantage: Case Study/American Home Products Corporation 2 • Use the excess cash to repurchase common stock will reduce common shares from 155. 5(30% debt) m to 118. 9m (70% debt), as the result that will increase the earning per share as well as the stock price. • Will increase the tax efficiency, the income tax can be reduced to 383. 7m from 455. 2 m. Even the debt interest rate is at 14%, but comparing with 48% tax rate that is very low. •
Debt is a good tool to against inflation, as mentioned before, the average inflation rate from 1979-1981 was very high, borrowing money is good way to maintain the company’s assets to staying valuable. Disadvantage, • • • AHP might lose it AAA bond rate Shareholders and senior management team will disagree/agree, and that will split the team at the top of management Potentially risk to bankruptcy with less cash, and easy to be attacked by competitor or financial institutions. 3) What are the possible ways for leveraging AHP? Besides to repurchase the common stock, other ways are: • • • Buy government bond or financial institutions’ bond.