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Loewen- Advanced Corporate Finanace

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Advanced Corporate Finance

Assignment 2nd October 2018

“The Loewen Group, Inc”

  1. How was the Loewen Group able to grow explosively for the first half of the 1990s? How much did it spend and where did the money come from? Quantify the advantages of debt financing (i.e., the interest tax shield) enjoyed by the firm in this phase?

The huge growth registered by Loewen Group in the first half of the 1990s was mainly due to its’ consolidation strategy, by acquiring small independent funeral homes and cemeteries in densely populated urban markets. This was a common strategy among the largest public death care companies because it allowed them to benefit from lower fixed and variable costs and increased buying power.

Loewen followed an acquisition strategy that was different from its competitors. It would take a majority ownership stake in each acquired business but retained the same managers if possible and allowed for relative autonomy. The seller often retained a small minority stake. After acquiring a business, Loewen would often invest capital to provide improvements and increased merchandising.

Implementing its consolidation strategy made Loewen Group spend $734.5 million in acquisitions, from 1990 to 1994 ($159.7m, $78.4m, $83.2m, $147.6m and $265.6m in 1990, 1991, 1992, 1993 and 1994, respectively).   This investment was mainly financed with debt, as we can see on Table 1.1., even though the debt-to-equity ratio minimum was registered in 1992, from 1990 to 1994 the ratio grows from 1.54x to 1.71x.

Despite the increase in debt, the market value of Loewen Group grow more than 260% from 1990 to 1994.

Table 1.1 - Loewen Group Capital Structure, Book Value, 1990-1994 (US$ Millions)

Debt

1990

1991

1992

1993

1994

CAGR

Total Liabilities

$207.1

$249.0

$301.4

$423.7

$704.6

35.81%

Total Equity

$134.2

$197.1

$245.6

$324.8

$411.1

32.30%

Total Assets

$341.3

$446.1

$547.0

$748.5

$1 115.7

34.46%

D/E Ratio

1.54x

1.26x

1.23x

1.30x

1.71x

 

The main advantage of debt financing enjoyed by the firm over this period is the interest tax shield.

The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage. Interest expense reduces the amount of corporate tax, which creates an incentive to use debt to finance its own consolidation processes. For the referred period, this financing strategy, allowed the group to reduce tax payments in $47,3m, as shown in Table 1.2.

Table 1.2 - Loewen Advantages of Debt Financing, 1990-1994 (US$ Millions)                                         Interest Tax Shield = Corporate Tax Rate × Interest Payments

 

1990

1991

1992

1993

1994

Total

Interest Payments

$12.4

$17.1

$19.8

$21.7

$34.2

 

ITS

$5.6

$7.7

$8.9

$9.8

$15.4

$47.3

   Corporate Tax Rate = 45%

Assumptions:

  1. Corporate Tax Rate = 45%
  2. First half of the 1990s as the period from 1990 to 1994
  1. By 1999, Loewen is in trouble. Why? What firm decisions/strategies led to the trouble? Please discuss briefly the “quality” of the acquisition’s strategy and the operations efficiency.

 Loewen’s main decisions/strategies that led to trouble:

  • Reneging on an agreement to purchase two funeral homes
  • Loewen response to SCI’s acquisition proposals
  • Consolidation strategy approach
  • Pre-need business marketing strategy

Following the mounting difficulties arising from those decisions, in October 1998, Loewen’s Board of Directors replaced Ray Loewen by John Lacey as CEO. However, John Lacey had relatively little time to develop a plan for dealing with the growing crisis, and in mid-February 1999 Standard &Poor’s downgraded Loewen’s public bond from B+ to B-, its fourth downgrade in less than a year. Over a period of twelve months prior to February 1999, Loewen’s stock price fell by about 92%, and its bond prices fell by 30%. Loewen’s would most likely default on its debt obligations due in 1999 (about $875m of the debt would mature in 1999).

Reneging on an agreement to purchase two funeral homes

In November 1995, Loewen saw its stock price fall and its bonds downgraded to speculative status, following an unfavorable jury verdict against the company in Mississippi. For the year, the company reported an expense of $165 million from the settlement of two lawsuits.

Loewen response to SCI’s acquisition proposals

Following several informal acquisition proposals. On September 1996, Service Corporation International (SCI), described in the news media as Loewen “arch rival”, made a formal offer to acquire Loewen. According to Exhibit 5, this offer payed a premium to Loewen Group stockholders of 27,4% above current stock price, and 48.9% above the price at which the stock was traded 30 days prior. Loewen’s board of directors rejected the offer.

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