MOGEN, INC. Teaching Note
Synopsis and Objectives
In 2006, Merrill Lynch became the lead book runner for a $5 billion convertible bond issue for MoGen, Inc. This was the single, largest convertible bond issuance in history and required a considerable amount of effort on the part of Merrill Lynch’s Equity Derivatives Group to convince MoGen’s management to choose Merrill Lynch over its competitors. The case is focused on Merrill Lynch’s choice of the conversion premium and coupon rate to propose to MoGen management. This pricing decision requires students understand the concept of valuing a convertible as the sum of a straight bond plus the conversion option. Valuing the conversion option as a call option requires the
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2. How would you describe MoGen’s financing strategy? (10 minutes)
Students should see that the risks of the biotech business are driving all of MoGen’s financial decisions: debt policy, dividend policy, and share repurchase program. Debt is relatively low because higher debt levels would result in debt rating decreases and therefore higher interest rates. Similarly, the company chooses to pay no dividends because of the risk of being forced to cut the dividend during the difficult times that invariably arise in a biotech business. Students should realize that a share repurchase program is a very good match for a biotech company like MoGen. The company can distribute cash to its shareholders when profits allow, but without making an explicit (debt) or implicit (dividends) promise to the market. 3. What are MoGen’s uses of funds for 2006? How important is the share repurchase program to MoGen’s choice to issue a convertible bond? (10 minutes)
This question is designed to focus the class on the share repurchase program as a critical use of funds for 2006. The primary advantage of share repurchases using dividends is that management can turn share repurchases off and on as allowed by cash flow. The other projected uses of funds, however, are largely driven by business issues that are not as flexible for management. Students should notice that
In the open market share repurchase, the firm may or may not declare the repurchase. Depending on the market condition and the firm’s position in the industry, the firm can decide when and how many
1.The differences in accounting for proceeds from the issuance of convertible bonds and of debt instruments with separate warrants to purchase common stock.
The repurchase program increases the shareholder’s value. This is because of a rise in the price of the shares of the original shareholders.
2. Companies buy back shares on the open market over an extended period of time.
There is a consistent trend of Applebee's in repurchasing it's common stock as shown by the increased of Treasury Stock Account. A big jumped in repurchasing was noted in 2004. A year to year comparison has shown Applebee's increased is repurchasing activities by 30% from 2003 to 2004. This is evident from the management intention to distribute it's earnings to the shareholders in order to maximize shareholders' wealth and also to prevent dilution of shares when distributed options and compensations are exercised. However, considering the financial situation of Applebee's is running low in cash reserve, a red flag is raised because it will be in the best interest for the company to scale back it's repurchasing program to conserve cash to pay for it's obligations such as deferred taxes.
The idea of repurchasing shares was no stranger to Bill Marriott by January 1980. Almost five million shares of common stock had been repurchased on the open market by Marriott Corporation during 1979 at a total cost of $74 million and an average price of $15.16 in the belief that they were undervalued—a belief that still was not fully reflected in the market price. At $19 5/8, the stock was selling at only six times cash flow per share; and its price/earnings ratio of nine was a far cry from historical multiples as high as fifty times as recently as 1973. Its low price seemed to offer once again an obvious opportunity to benefit shareholders. However,
Firstly, the goal of the share repurchase is maximum the shareholder’s value rather than paying dividend.
Recently, however, competition has become stiffer and such large biotechnology firms as Genentech, Amgen, and even Bristol-Myers Squibb have begun to recognize the opportunities in SIVMED’s research lines. Because of this increasing competition, SIVMED’s founders and board of directors have concluded that the firm must apply state-of-the-art techniques in its managerial processes as well as in its technological processes. As a first step, the board directed the financial vice president, Gary Hayes, to develop an estimate for firm’s cost of capital and to use this number in capital budgeting decisions. Haves, in turn, directed SIVMED’s treasurer, Julie Owens, to have cost of capital estimate on his desk in one week. Owens has an accounting background, and her primary task since taking over as treasurer has been to deal with the banks. Thus, she is somewhat apprehensive about this new assignment, especially since one of the board members is a well-known Northwestern University finance professor.
We note that the company’s previous stock repurchases and its plans to continue with the said program effectively signals to the market that the management feels that its stock is underpriced and that it has a positive outlook on the stock’s future performance. Adding to this the company’s relatively low leverage position and a strong A+ rating, which is the highest in the
Since 1952, Bio-Rad Laboratories (BIO) has been a cutting edge leader in life science research and clinical diagnostics. In 2015, this NYSE listed company had seven thousand employees, customers in more than 30 countries, and revenues exceeding two billion dollars. Beyond the laboratory, Bio-Rad runs numerous outreach programs in hopes of inspiring the next generation of scientists. We chose to invest in this company because the stock had been in a uptrend for six months. If we had had used technical analysis to research this stock, our purchase of this stock would have been delayed. Shares were bought on October 7, 2016, when the stock price was at the top of the bollinger bands, indicating high prices. Stocks should be bought on the bottom of the bollinger bands and sold at the top to reap the most profit.
Essentially, MCI relied heavily on convertible debt. As their stock price rose, the debt was converted to equity. Jeremy Stein (1992) states that a "good firm will use convertibles because the firm's true value will be made known before the debt is due". Following Stein's observations, Jen, Choi, and Lee (1997) conclude that "convertible bond financing is an attractive alternative for companies that have large growth potential but find both conventional debt and equity financing very costly". MCI clearly had a vision for substantial growth. The MCI management saw an opportunity for financing that would result in issuing equity and leave the possibility open to acquiring more debt in the future, if needed.
First, a large share repurchase will significantly increase shareholders’ percentage ownership of BKI. BKI has been under levered for decades. The company acquisitions of several small manufacturers made shareholders’ equity be diluted even more. In other words, shareholders, especially the main shareholders in Blaine’s board, are paying for BKI’s over-liquidity. This share repurchase will not only give the board more flexibility to allot dividends, but will lead to a stable development of BKI’s business in the long run.
The second method to distribute extra cash is through a share repurchase. Share repurchase means a company buys its shares back from the market or from those shareholders who are willing to tender such shares. The buyback methodology is used primarily when companies such as Ford believe that their share price is undervalued. Buying back its stock will help Ford to increase its share price by promoting greater interest in its stock. However, we cannot effectively increase company’s liquidity through a conventional share repurchase. And also for traditional stock buyback, it usually will take years of time to executive. In Ford case, stock buyback option will put Ford’s family’s voting power in the company at risk.
From 1993 until the start of 1995, MCI’s stock had outperformed the S&P. However, in 1995, the stock’s performance was poorer than the S&P. With shareholder’s getting restless, the idea of a stock repurchase was being considered. Depending on which option MCI chooses—stock repurchase with debt issuance or open market repurchase program—the message being sent could be different. Let’s consider option one—MCI issues debt and uses the proceeds to repurchase stock. According to the article “Raising Capital: Theory and Evidence” by Clifford Smith, the market would likely react very positively to this leverage-increasing event. Because of the information disparity between a
This section of the discussion turns to the creative structuring aspect of the problem. The returns to the equity investor seem skimpy. Students should be challenged to look for a way to improve the returns, rather than just reject the deal.