Case study: American home products
- The company's debt policy
- The company's reliance
- The takeovers
- Maintaining the debt ratio
- Avoiding higher debt ration
- Business and financial risk
- AHP's operating strategy
- Leverage: Good or bad ?
American Home Products manages diverse business ranging from packaged drugs, food products and household products. The company believes in aggressive marketing strategy which has helped company cloak phenomenal growth over the years. Being the consumer product company, it has cash rich balance sheet. The company has generated sales in excess of $4 billion with growth ranging between 10%-15% annually; and remarkable gains in market share while reducing or maintaining a low level of expenses. All this combined with dividend growth of 222% between 1972 – 1981, contributed to the firm’s AAA bond rating and to the popularity of AHP’s stock among retail and, primarily, institutional investors.
[...] Additionally, the company’s financing needs outside of cash to repurchase outstanding stock is not great considering that AHP does not launch new products until a product has been proven successful in the market. We also would avoid a higher debt ratio from a personal perspective. Due to Mr. Laporte’s conservative nature, we do not believe that he would welcome the recommendation of a drastic change to the company’s capital structure a move defined by an increase from 30% to 50 70% debt. [...]
[...] risk and tax issues when deciding on an optimal debt ratio. Recommendation After reviewing the disclosed information, we believe that AHP and its shareholders are best served by maintaining a debt ratio of 30% and using a portion of cash reserves to repurchase outstanding AHP stock. Given Mr. Laporte’s unique brand of management and company control, we believe that the primary argument for maintaining a 30% debt ratio is the threat of corporate takeover via a leveraged buyout. A method of corporate takeover or merger popularized in the 1980s, leveraged buyouts involved the purchase of controlling interest in a company’s corporate stock with a substantial fraction of borrowed funds financed with the takeover company’s assets. [...]