Williams - Case Analysis Williams -- Case Analysis

Why is Williams considering a $900 million one-year loan from Warren Buffett and Lehman Brothers?

Williams is a company based in Tulsa whose business operations are energy related, including exploration and production, energy trading, pipelines and telecommunications. In the present, the company is suffering from deterioration in the energy markets as a result of the crash and decline of Enron, in addition to pressure on profit margins in the telecommunications business sector due to oversupply and investigations by regulators with regard to suspected financial indecencies. Williams is considering a $900 million one-year loan from Warren Buffett and Lehman Brothers because of a number of reasons.

To begin with, an oversupply in the telecommunications business sector has resulted in deterioration in the profits generated as well as margins generated within the industry, which in turn, has instigated several players within the industry to exit. This prompted the Williams enterprise to give assurance for an indirect credit support for $1.4 billion of WCG's debt. Correspondingly, the decline in the energy industry led into stricter requirements for the credit rating of investment grade corporations. In reaction to these stringent terms, towards the end of the 2001 financial year, Williams instigated a number of initiatives to shore up its balance sheet with the purpose of maintaining the company's investment grade credit rating. These enterprises consisted of large assets that were to be employed to decrease the outstanding debt, capital expenditures and also the quarterly dividends paid to the shareholders on the common stock. In addition, Williams finalized the sale of $1 billion equity-based securities. However, irrespective of the aforementioned initiatives, the credit rating of the company was downgraded to B1.

This downgrading in credit rating had an adverse impact on the company as it hampered William's capability to raise cash from the market. This is anticipated to harshly impact the company's energy marketing and trading business, an area that Williams is largely reliant on to attain the accessible credit within the market. As a result, experiencing a loss in rating and also having a substantial amount of debt that is maturing, Williams is facing a forthcoming liquidity crisis. Another reason is that the significant decline of more than 90% of the company's stock price in about 12 months' time demonstrated further the level of financial distress Williams is facing considering the fact that it mirrors a deteriorating belief in the company's forthcoming cash flows.

2. What cash flows will the loan generate, assuming interest is paid in cash quarterly and the loan itself is fully repaid in one year?

a. Calculate the internal rate of return on the loan, assuming it is fully repaid in one year and there is no sale of RMT. (This is known as the loan's yield-to-maturity, effective annual yield, or simply yield. It is sometimes called the promised rate of return.)

Internal Rate of Return (IRR) is the rate of interest at which the net present value of the positive cash flows and the negative cash flows from a particular project or investment amount to zero. This interest rate is employed to assess the viability and desirability of an investment or a project (Atrill and McLaney, 2013).

700 / (1+ 1.18) + 900 / (1.18)> 1,026

IRR = 18%

3. Is repayment of the loan a sure thing? Is the expected rate of return on a loan higher, lower, or equal to the promised rate of return?

The repayment of the loans seems to be a sure thing as the expected rate of return is higher than the promised rate of return.

a. What will happen if Williams cannot repay the loan in one year?

If Williams is unable to repay the loan in one year and defaults, the lenders will have to take possession of capital stock and assets of RMT, which essentially consist of oil and gas properties of Barrett Resources.

4. The loan has a number of covenants and pre-conditions, which are listed in Exhibit 1. Can you explain what each requires and why the lenders have put the requirement into the agreement? What happens if a covenant is violated?

Williams must:

(1) Maintain interest coverage ratio greater than 1.5 to 1

The interest coverage ratio is a measure of the ability of a company to make interest payments on its debt in proper time. In essence, the lenders put this requirement into the agreement to ascertain that Williams is able to pay its...

For instance, in this case, the requirement is that Williams has to make 1.5 times more earnings compared to its prevailing interest payments. This will guarantee the lenders that Williams is able to pay the interest on its prevailing debt together with its principle payments. Having such an interest coverage ratio will not only imply that the company's risk is low, but also that Williams is generating sufficient cash to pay its debt.
(2) Maintain a fixed charge coverage ratio of at least 1.15 to 1

The fixed charge coverage ratio is a measure of the ability of a company to recompense all of its fixed charges or all of its expenses with its income, before the deduction of interest and income taxes. The main reason why the lenders placed this requirement in the agreement is for Williams to show that that it has the ability to make fixed payments. In this case, it implies that Williams has to have an income that is at least 1.15 times greater compared to its interest and lease payments. This ratio indicates the healthy status of Williams. The fixed charge coverage ratio will let the lenders know how many times greater William's income is in comparison to its fixed expenses.

(3) Limit certain restricted payments, including redemption of capital stock of Williams

The main purpose of placing this requirement by the lenders is to restrict the amount of Williams' cash or assets that leave the credit box with the main objective of preserving the lender's cash and assets that are available to repay the debt. In this case, the company is restricted from redeeming its capital stock. The overall basket is intended to be a function of Williams' profitability over the whole period from the time of issuance of the bonds. It is accumulative and might be employed for distributions cause to experience the lack of any imminent event of default on the bonds and acquiescence with financial covenants.

(4) Limit capital expenditures in excess of $300 million (except for capital expenditures of borrower, RMT)

In this requirement, the lenders expect Williams not to spend capital that goes beyond the fixed amount of $300 million with the exception of RMT. The main reason why this was set in the agreement is that a limitation on capital expenditure gives the lenders some amount of control over the amount borrowed and in simplicity, caps the amount that the company may spend as budgeted capital expenditure, over any given period. Basically, it restricts cash from leaving Williams and any sort of manipulation of cash flows (Christensen and Nikolaev, 2012).

(5) Give the lenders attendance rights to all of its board of directors meetings, as well as any meetings of any committees of the board

The reason why this particular requirement was placed in the agreement or covenant by the lenders is for it to function as a form of corporate governance. This implies that the lenders will be able to perceive any substantial input given and the approval of any final agendas before they are implemented. This is for the purposes of making sure that the directors and the board, with regard to the direction of the company, make the right decisions.

(6) Limit intercompany indebtedness

This requirement restricts Williams' discretion with regard to the operation of its business as well as a necessity for it to meet financial tests set by the lenders. This limits the company's use of its cash and cash equivalents generated.

(7) Maintain parent liquidity of at least $600 million, stepping up to $750 million over the year. If a default were to occur with respect to parent liquidity, Williams would have to, within two days, retain Lehman Brothers to sell RMT, with such a sale to be completed within 75 days. Liquidity projections to be provided weekly until the maturity date. . . . In the event of a company sale, the loan was required to be prepaid in full.

This is a requirement within the covenant set by the lenders to manage and supervise liquidity risk. Maintaining parent liquidity is basically, effectively monitoring the adequacy levels of liquidity of the parent company, and in this case of Williams, it has to be at least $600 million and by the end of the financial year, increase this level to $750. The other implication is that if Williams does in fact default with regard to this parent liquidity then the lenders would have to sell RMT within a time period of 75 days. The company is also mandated to provide the projections of their liquidity every week within the financial…