Corporate finance

9 September 2016

Background of Company MCI communication corporation was a telecommunication company found in 1963. In the beginning the business plan of MCI was to build up a group of microwave relay stations that allow limited-range two-way radios signal to transfer. Which means providing long distance telecommunications. In 1971, the Federal Communications Commission (FCC) allowed those long distance companies compete and try to break out AT&T’s monopoly telephone service in the U. S. MCI wanted to grow further, however the AT&T did not want to provide interconnection services which MCI needed.

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As a result, MCI sued AT&T in 1974 and later won the law suit and FCC force AT&T to provide service to MCI , thus MCI continue its construction on its own network build. Before 1974, MCI was not profit too much but is all change based on their successful business strategy, knew as “Execunet” service they offer affordable service to those customers who could not afford AT&T’s service. MCI successfully attracted small business user and residential to use their services. Due to that success strategy MCI turning to very profitable.

Because of that, MCI saw a really high potential growth opportunity that could bring the company to a different level. However, they find out the need more funds and capital to support the growth. AT&T is MCI’s major competitor. And AT&T break up its business , AT&T now compete with MCI in the local telephone business, the means MCI must rise their rate in the local business, but at same time AT&T left a big cake on its market share that MCI could toke from them. SWOT analysis Before AT&T break up, MCI has strengths on its Execunet service, and fairly lower charge in their local network services.

Their weakness is short of capital and market shares which control by AT&T. Their opportunities was growth execunet services. They also face threats such as competition from AT&T. Before AT&T break out: Some of the SWOT analysis have changed after AT&T break up. Now their strengths beside execunet service is their high stock value and large amount of cash on hand. Their weaknesses are still lack of investment capital and market share. But they do have opportunities on take over AT&T’s market share, also their interest coverage ratio is high.

The threats they are facing is great competition from AT&T and other firms. After AT&T break out: Financial strategy and Analysis At beginning MCI was a very risk company, and like all other high risk company, MCI had high interest rate to cover its high risk. They offer a put warrants on their stock shares to get loans from investors. They also use a tax loss to deduct their tax amount when the success Execunt strategy to kick in. This strategy generated a great amount of revenue. Another way to rise fund for MCI is by selling its convertible preferred stock.

Preferred stock is a very safe investment tool, it offer investors dividend and at same time allow them to convert to common stock in a certain conversion rate. By issue these convertible preferred stock, MCI can not only rise capital, but also keep the high value on its common stock. The dividend paid to investor can also become a tax shield due to MCI still carry forward tax losses. Another great use of convertible prefer stock is that MCI can call a provision and investors need to convert their shares to common stock, this action can keep the cash flows tie.

MCI can issue preferred stock and convert to common stock later. MCI took lot of debt to get more capital they need, but the good thing is they are very profitable, and their stock is in very high value, and continued to grow. This would easily to cover their interest from the debt. This is a very risk move, by taking debt to leverage the company and then issue convertible prefer stock and convert it to common stock and take debt again. Because if the company is not growing, they will not be able to cover its interest payment.

The manager value more fund over the risk of high interest payment. It turns out they are correct in this action. However, in the future, they have to rethink of their position to continue be competitive and growing. The company have a current 55-60% debt in their capital structure, I think although this level can keep their growth, but for the long term they need to find a better way to rise fund and hopefully reduce their debt to 40% in the future. With lower debt ratio, company could be a better position when they are not growth as fast as they were before.

MCI were facing great competition from AT&T and other new entry companies. Four options for MCI in 1983 to rising capital According to Exhibit 6 on the case, in the 1983, the stock price is $43 on March. In the option A: $400 Million common stock. Although this option could raise $400 million cash to the company, but more shares issue may cause the current stock price fall, that would damage the current share holder, and the same time the market value of equity will rise lead to the cost of equity increase, thus this is not a very good option if there is another choose.

The next option B: $500 million of 12. 5% 20 year subordinated debentures, this option gives $100 million surplus over the option A, however, MCI ‘s debt ratio is already very high, and if the company stop growing very fast it could lead some serious cash flow issue to the company, as the result, this is not a good option too. The option C: $600 million convertible at 7. 625% over 20 years with conversion at 54 per share. This option give $600 million cash which is $100 million higher than option B, at same time the interest rate is much lower than 12.5% in option B, and this is an advantage.

Also, the company can convert is once the price reach $54 from the $43(April 1983). If is a very good option, MCI can take this deal and convert it from debt to equity once the price hit $54, by doing this, MCI can reduce their debt and satisfy their need of capital to growth. The final option D: $1 billion of a unit package consisting of a $1000 of 7. 5 %, 10 year subordinated debenture and 18. 18 warrants, each entitling the holder to purchase one share of MCI common stock for $55.

This option gives MCI the greatest amount of cash over all other option, and also with the lowest interest. Beside that, the warrant in this option gives company a way to covert early by the warrant( if stock price reach $55). That provides the company more liquidity. So all in all, the option D is the best option that manager should take for MCI. Recommend Finance step to MCI MCI has been very profitable, how every they are facing more competition and opportunities especially after the AT&T break out.

They need a lot of fund to continue growth and take more market shares, so they should do exactly they been doing in the past, which is taking debt and covert it to equity( common stock) and take new debt. However, because they are very profitable , they should decrease their debt level and maintain in a certain level if the stock price keep going in the right direction. By doing this, they can get enough capital and catch the potential growth opportunities.

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