Massey Ferguson Case

Question 4. a) What are the main problems for MF in 1980? What alternatives were available to MF?

Market-wide problems:

* 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

...