Deluxe Corporation Is a Leader in the Essay
- Length: 7 pages
- Subject: Business
- Type: Essay
- Paper: #75923867
Excerpt from Essay :
Deluxe Corporation is a leader in the check printing industry. However, recent times have struck Deluxe with financial structure problems associated with obtaining the most optimal capital structure. Therefore, the objective of this summary is to assess the recommended capital structure alternative and its impact on the current capital structure.
The current problems with the capital structure are the equity-based financing to which the company will not have the free-cash flow necessary to repurchase the company stock at the accelerated rate projected by Singh. The cash on hand that Deluxe does generate will have to go to maintaining the operating capital to finance daily operations.
Secondly, the firm does not maintain or manage flexibility in financing well. The optimal choice is to issue debt as the company as the 37% tax shield that makes the cost of debt financing very attractive due to the 1/3 reduction in cost. However, this advantage was not managed properly as too much equity financing was used which increased the shares outstanding and (free float) and lowered the stock price. The stock repurchase program initiative proposed by Singh will cause the stock to appreciate do to the decrease in shares outstanding.
Additionally, the company failure to capitalize on the benefits of the use in debt financing created a higher cost of financing. Meanwhile, the emergence of new technology, e.g. electronic payments, has forced Deluxe to streamline its business and has constrained the firm to focus on only its core activities. This rather malevolent external environment the firm is immersed within has further identified the specific requirement of debt financing.
The decision to obtaining financing by issuing AAA rated bonds to finance future operations will yield a positive impact on the capital structure of the company as the tax benefits accrued by the tax shield and interest coverage ratio lower the cost of debt financing. By increasing the AAA debt financing and lowering the investment into equity financing, the wealth of Deluxe will increase as a function of retained earnings and shareholder value thus rendering a positive future impact. The financial return will be such that a higher EPS and market share for Deluxe will be the outcome.
The ability to use the WACC to finance the debt equity will enable Deluxe to keep the debt equity structure at a minimum. Financing the WACC is possible by investing into products with a greater IRR than the cost of borrowing at the WACC.
The end plan for Deluxe is to increase its market share by increasing its customer base and then to retire its outstanding equity shares whilst having the optimal amount of debt outstanding rendering a lower debt/equity ratio and increasing the target wealth of each investor.
Recommendations to board
In order to address the aforementioned problems effectively, we recommend Deluxe Corporation with the following remedial measures:
1. Acquire more debt to attain a lower cost of capital. At the same time diversify its current business to maintain its market share and secure future cash flow.
2. We recommend Deluxe to first reach the debt level of $810m, because this will reduce the current WACC immediately hence increasing the value of the firm.
3. We recommend that Deluxe prevent its debt from losing its current credit rating and therefore paying a higher rate of interest on its outstanding debt.
4. We recommend that Deluxe issue commercial paper to pay for its short-term obligations and invest its revenue stream at a rate higher than the cost to finance its short-term obligations using commercial paper.
To accomplish this task, Deluxe must optimize its equity trading price, preserve its debt capacity (ability to issue more debt and keep its AAA debt rating), and optimize the cost of capital while preserving a good debt rating by meeting debt payments via the cost of capital. Finally, Deluxe must strategize and make all operating decisions based on the financing strategy.
The recommendation to Deluxe and to Singh is to repurchase only a portion the outstanding stock that Singh recommended. Therefore, this is to be approximately $200 million, well within the financial capacity of Deluxe, over the next 3 months to increase the share price. After the three-month period, issue more debt and liquidate the shares within the rules and limitations of the SEC to cover the cost of servicing the debt by paying the cost of capital. This will maximize the debt/equity ratio and provide a segmented way to finance the debt while keeping the cost of capital low.
The operations of the business much reflect the financial strategy of Deluxe. Currently, Deluxe has the largest market share available and is set to benefit the most by transitioning to electronic checks. The debt taken by the firm should be used to purchase a small electronic checking firm that specializes in software development for integrating checking clients into stored databases for payroll and checking services. This will provide better and more integrated service to the current clientele and enable more sales by facilitating new clients whom wish to have such a level of service.
What specific risks are associated with Deluxe Corporation's business and strategy? Additionally, what financing requirements do you foresee for the firm in the coming years?
The nature of the Deluxe Corporation's business is paper check printing. It is a highly concentrated market with only three players controlling 90% of revenues
. With a relative market share of almost 2, Deluxe is dominating the scene!
However the check printing portion of the payments industry is mature. With the proliferation of alternative payments methods, such as debit / credit cards and other internet-based payment services, the check printing business has been in decline since the mid-1990's.
In order to face the annual decline in demand for paper checks, Deluxe undertook a major reorganization in the late 1990's. The firm's single-minded strategy was to reduce expenses. They did this by closing around 50 plants, reducing its labor force by half and divesting 20 non-core businesses.
In 2000 Deluxe announced a major strategic shift with the spin-off of its technology-related subsidiaries. They spun-off eFunds and iDLX Technology Partners via an initial public offering . On the on hand management believe there was more growth perspectives in these companies if treated as fully separated entities. On the other hand they were struggling to find any valuable synergy between these companies and Deluxe core business.
The chosen strategy to reposition "the company as a pure -play-check printing company" is debatable but risky.
One of the first and the foremost risk is the Business Risk. The company CAGR of - 4% over the last years is a proof Deluxe Corporation was struggling in a declining market. Deluxe' CEO himself admitted that the paper check business was slowly but surely dying. However he decided to spin-off eFunds, a company active in the fast developing electronic payment segment of the market. In other words he abandoned company plans to position itself in the promising adjacent electronic payment business. Another inherent risk of this single focused strategy is the loss of business diversification options. By selling iDLX, Deluxe lost a chance to enter a new business than the payment business they were in for years. More over the banking industry and the financial sector is very prone to cyclic and business changes and any negative impact like 9/11 or the great depression of 2008 might impact their businesses as well.
The other risk is the volatility of the capital market. If Mr. Singh do not decide on time about the capital structure, then it is going to be even more challenging as there is a chance the cost of capital will rise. Also the time line of the line of credit might also exhaust by August 2002.
This being said the recent drop in check demand as well as the current repositioning of the company on its core business have highlighted some possible issues in current financial structure:
a) Deluxe will need more cash to support its long-term stock repurchase program.
b) Deluxe's current financial policy hasn't made the best use of debt financing advantages.
As opposed to the projected income statement and balance sheet in Exhibit 2, Deluxe foreseen financing requirements in the next couple of years is going to increase much more as they did not assume major share repurchases programs, possible additional financing for working capital, possible competitor acquisitions, the repayment of short-term debt or the maintenance of at least constant absolute dividend payments . In short the forecast would need to be revised by the recommended changes Singh would apply to the new financial policy.
What are the main objectives of the financial policy that Rajat Singh must recommend to Deluxe Corporation's board of directors?
The main objectives of Rajat Singh new financial policy should address the following points:
a) Maximize the shareholder's wealth.
b) Achieve the optimal capital structure which also has the lowest cost of capital.
c) Maximise Tax benefits while avoiding distress costs.
d) Keep a certain flexibility for future…