Massey Ferguson Case

High interest rates ? After the 1973 oil crisis and the 1979 energy crisis, the US economy was affected by stagflation. In an effort to fight excessive inflation, the Fed adopted a tight monetary policy, raising interest rates (as an illustration, the federal funds rate increased from 11% in 1979 to 20% by June 1981). This affected all players as it led to a plunge of stock market prices, on the one hand, and an economic recession, on the other.Furthermore, Massey was particularly hit hard: since it mainly financed its operations with short-term debt, its financing cost went up dramatically. ?Low demand ? The above-mentioned contractionary monetary policy pushed the American economy into recession. Massey’s renewed drive into North America (by 1978, it had introduced a new range of large, high-horsepower tractors and an improved baler line) unfortunately coincided with the slow down in US demand. The company’s efforts to penetrate the North American market thus remained unsuccessful. Specific problems:Debt level and structure ? Massey’s financing choices over the years brought with them many problems, which aggravated the already grim situation in the product markets. First, during its expansion in the 1970’s, Massey levered itself immensely. Compared to its two main competitors, it systematically had the highest Total Debt/Capital ratio (in 1980: 80. 85% compared to 53. 56% for International Harvester and 40. 28% for Deere & Company). While this might have been justified by the growth strategy, it turned out to be very damaging for the company in view of the current situation.What was more unusual was the fact that it used short-term debt to finance its business operations, fixed asset capital maintenance , and long-term principal and interest repayments. As a result, Massey was much more affected by the increase in interest rates than its two main competitors. Another problem associated with Massey’s debt was its structure: borrowings were dispersed among more than 100 lenders in various countries, most of which operated independently from one another. This made it very difficult to negotiate the restructuring of claims the company needed to survive.Finally, cross-default provisions substantially increased Massey’s default risk. If any single default ocurred, all short- and long-term debt would become callable, leaving the company with no choice but to stop operations and use its assets to pay off lenders. ?Inability to further finance its operations ? While Massey needed new funds even to be able to honour its commitments, its extremely high leverage and the numerous covenants on its existing loans impeded it from raising new debt, or equity for that matter.Its 1980 initiative to issue preferred shares was indefinitely postponed when its largest shareholder refused to take a block of the preferreds as a vote of confidence. ?Currency risk ? In 1980, 76. 7% of Massey’s engine production was concentrated in the UK. However, its UK Perkins subsidiary exported more than 86% of its products. As a consequence, when the pound rose in 1980, it increased Massey’s cost of goods sold disproportionate to its revenue, reducing margins. ?Operating costs of financial distress ? Doubts about the future of the company weakened Massey’s distribution network.Furthermore, the bargaining power of its customers and suppliers increased, so that while barely supporting its daily operations, Massey granted more payment deferrals to its customers (receivables turnover days increased from 74 in 1978 to 77 in 1979 and 99 in 1980). Receivables Turnover Days 197819791980 747799 b) What alternatives were available to MF in 1980? Liquidation ? This seemed a highly probable resolution, as the company’s position became daily more precarious and a default on its existing debt was practically inevitable. However, this was an undesirable outcome for all stakeholders.Shareholders’s would lose the full amount of their investment, employees would find themselves on the job market again, equipped with firm-specific skills that would shrink their job prospects, the goverments would lose through both the job cuts, and the disappearance of an important investor in their countries while lenders would probably not be able to recover the full amount of their funds from the liquidation proceeds. Restructuring ? In this case, the first step would be to come up with a refinancing plan acceptable to all creditors, to avoid the situation in which all debts would be called and the operations stopped.At the same time, a revaluation of Massey’s operations had to be carried out, in order to determine a set of core businesses in which it should further invest and which would ensure its growth. Major alternatives for the company were related to the markets in which it would compete and the future of its Perkins Engine subsidiary ? which could be kept to ensure Massey’s presence in the promising market for small diesel engines, be relocated to Canada (to mitigate the currency risk and in the same time please the governments of Canada and Ontario) or finally, altogether sold to support other business lines.