What Stone did

• • • On April 8th, Stone announced that the equity offering was being canceled Stock price recovered 1 1/2 points (16.7%) on the announcement, but continued to trade in the $8-$9 range for the rest of April. The junk bonds lost about 6% of their value.

Subsequent financial moves: – Renegotiated bank loans – Sold $150 million of 12 5/8% Senior Notes due 1998 – Sold $250 million of 8 7/8% Convertible Senior Subordinated Notes due 2000; convertible at $11.55

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• • • • •

More …

Other actions – Sold Mexican subsidiary – Sold minority interests in Canadian and British newsprint subsidiaries – Shut down 220,000 tons of U.S. capacity Linerboard prices began to rise in last half of 1993, eventually rising $180 per ton above 1993 lows by 1995 Stone lost $205 million in 1994, but reports 1995 PAT of $255 million Stone’s stock hit $18 1/2 in 1994 Stone issued 16.5 million new shares at 15 1/4 ($250 million), but leverage was still high at (72%) 2.11.09

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Human and market imperfections

• “I’ve told the junk bond people they won’t be seeing me anymore.” Roger Stone • “Given his past, why should we believe him?” - Sharyl Van Winkle Merrill Lynch analyst 2.11.09

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Two-day wrapup

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Optimal/Target capital structure—Checklist

• • • • • • • • Can company pay interest —coverage ratios?

– – EBIT/Int, EBITDA/Int In good times and bad Industry volatility or cyclicality?

– Operating leverage makes cash flow more volatile/cyclical Industry standards —what are competitors doing?

Is company able to make use of its ITS?

Costs of financial distress?

– What will customers and suppliers do in shadow of bankruptcy?

Agency costs?

– High leverage=>Mgrs take negative NPV projects with high risk – Low leverage=>Mgrs have few incentives to be efficient, may consume excess perks (private jets, plush offices…) Leverage needed to control renk-seeking?

– Unions and/or regulators Does company need strategic flexibility?

– Will covenants interfere with strategy?

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Getting to your optimal capital structure

Stone’s V = D+E = 4323 +1189 = 5512 • • • • • • • • From low leverage, it’s easy: do a leveraged recap From high leverage,

it’s hard

Assume D+E is approx constant (Ignore value of ITS) Each 1% decline in D/V => $55MM in new equity To go from 78% to 50% requires ~ $1.5 Bn in new equity!

At least 100 MM new shares (1.5 B/$15) Dilution = 100/(100+71) = 58% Family share = 42% of what previous holdings 2.11.09

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And that’s before announcement effects!

• • • • • Two explanations for the drop in Pstk on announcement of equity issue Debt overhang – – Transfer of value from new equity to impaired debt Arises under

symmetric

information when

D/V is high

Signaling – Action (debt or equity) communicates true state of company to – market Arises under

asymmetric

information when

D/V is anything

Net result => Companies are reluctant to issue equity – … even when company is over-levered and experiencing costs of – financial distress (out of bankruptcy) … when a company bucks the trend, it is punished Converts can be “backdoor equity” 2.11.09

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Epilogue

• Merged with Jefferson Smurfit Corp. on May 8, 1998 in an exchange of shares implying a value of $20.30 per share ($2.12 billion market cap).

•

Jan. 27, 2009:

Smurfit-Stone Container filed for Chapter 11 bankruptcy protection with debt of $5.6 billion.

Today, they are learning firsthand about the bankruptcy process

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“Indeed, indeed, repentance oft before I swore – but was I sober when I swore?” -Rubaiyat of Omar Khayyam 2.11.09

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