Case 35 deluxe corporation solution

Theme: Capital Structure and leverage

Assignment Case 3

Deluxe Corporation

Case 35 page 479

GUIDANCE SHEET

Synopsis

In July 2002, an investment banker advising Deluxe Corporation must prepare recommendations for the company’s board of directors regarding the firm’s financial policy. Some special considerations are the mix of debt and equity, maintenance of financial flexibility, and the preservation of an investment-grade bond rating. Complicating the assessment are low growth and technological obsolescence in the firm’s core business.

The objective is to recommend an appropriate financial policy for Deluxe Corporation and, in support of that recommendation, it is recommended to show the impact on the cost of capital, financial flexibility (i.e., unused debt capacity), bond rating, and other considerations.

Objectives

The following are the analytical objectives of this case study:

· Survey the determinants of corporate bond ratings. The case highlights the important influence of the rating agencies on the costs of debt and the access to capital markets. The case data afford students the opportunity to explore profitability, coverage ratios, and capitalization ratios as measures of credit quality.

· Explore the practical challenges involved in determining the optimal mix of debt and equity, in particular assessing the tradeoff between the benefits of debt tax shields and the costs of financial distress. The case affords the opportunity to highlight methodological problems in estimating the optimal mix.

· Consider the concepts of debt capacity and financial flexibility. The notion advanced in this case is that flexibility is the ability to access capital without falling short of the firm’s minimum target credit rating.

Introduction

In the check printing industry Deluxe has been one of the most dominant companies. The company occupies 49% of the market share and its compound annual was growing at the rate of 12%. The new forms of payments have really encroached on the demand of check printing industry. The demand greatly went down annually. There is a big challenge that is faced by the core business of Deluxe. The company opted to retain Singh was retained by the board of directors and asked him to come up with a plan for the new round of debt issuing. A clear indication is that at some point in the future the company will really struggle. In order to deal with the bad situation in the future, Deluxe must maintain the flexibility of its finances and ensure that it sets its cost of capital as low as possible through adopting the appropriate capital structure. This paper will be trying to find out the recommendations that can help Dluxe company to get back on truck with running its business.

Questions

1. What are the risks associated with Deluxe’s business and strategy? What financing requirements do you foresee for the firm in the coming years? ( HERE YOU ARE SUPPOSE TO ADD NUMBERS CHECK THE SAMPLE AGAIN PLEASE)

The nature of the Deluxe Corporation’s business is paper check printing.

In the late 1990’s, the firm’s strategy was to reduce expenses. They did this by divesting 20 non-core businesses, closing 49 plants, reducing its labor force by 8,000 employees, outsource IT and focus on improving manufacturing efficiencies.

Currently (2000’s), the Deluxe Corporation (DC) strategy has been to spin-off technology related subsidiaries. They spun-off eFunds and iDLX Technology Partners thru an initial public offering (IPO). Management believe there was more value in these companies are separate entities, and that these companies did not have valuable synergies.

The current strategy is very risky. iDLX Technology Partners offered technology related consulting services to financial service companies while eFunds offered electronic payment products and services. The CEO admits that the paper check business is dying, but spun-off a company that seems to be replacing it in eFunds. People were shifting from writing checks to using credit cards, debit cards and using electronic payment services over the internet, so a major risk that just occurred is DC just lost a huge growth company, and that company they just spun-off can come back and take market share from the paper check industry in the form of electronic payments. If the CEO is correct in predicting the demise of the paper check business, then it is likely that electronic payments would be the business the kill the paper check industry. Another risk is they lost diversification by spinning-off these two companies, especially losing the consulting service company; iDLX. The consulting service company could have provided a very different business than the payment business they were in.

Short term financing needs

Working capital, capital asset purchases, possible acquisitions, repayment of outstanding debts, dividend payments and repurchasing the firm’s securities.

In February 2001, Deluxe paid off $100 million of its 8.55% long-term unsecured and unsubordinated notes, which is had issued in 1991.

Repurchase program:

As shown as below, in the end of 2001, the company repurchase 11.3 million shares. Singhalso believe that the board would continue to pursue an aggressive program of share repurchase.

Other demands on the firms resources:

Cash dividends would be held constant for the foreseeable future. Capital expenditures would be about equal to depreciation for the next few years.

Considerations in assessing financial policy

In addition to assessing Deluxe’s internal financing requirements, singh recognized that his policy recommendations would play an important role in shaping the perceptions of the firm by bond-rating agencies and investors.

2. What are the main objectives of the financial policy that Rajat Singh must recommend to Deluxe Corporation’s board of directors?

Sihgh believed that it was essential that the company’s financial policies afford it the necessary funding and flexibility to steer a path to survivability. So, Rajat Singh recommended new debt program and stock-repurchase to the board of director. The main objective is to fend off the eventual disintegration of its core business.

Management’s key objective is to focus on its core business. By spinning-off eFunds and iDLX, DC can concentrate on its core business - which the CEO strongly feels still has growth opportunities. The core business is very profitable, and he states that can generate good revenue and profits from it over the next five years, and does not want to abandon a good business too early. After the spin-off, the company is repositioned as a pure-play check printing company. Since this is what their investors wanted, after the news of the spin-off, the stock rose. DC then used cash for company share buybacks. The share repurchase plan authorizes the purchase of up to 19% of total shares outstanding, this will increase the value of the stock to its shareholders. However, the dividends will remain constant.