FINANCIAL MANAGEMENT – 2

CASE STUDY

Asahi Glass limited: Leverage, a double-edged sword

SECTION: 2

GROUP: 4

TEAM MEMBERS:

S.No Name DM No.

1. Amit Kumar Biswal DM21213
2. Hrithik Jajodia DM21229
3. Nanditha K R DM21247
4. Paras Mittal DM21252
5. M Shaalini DM21266
6. M Siva DM21270
Q1. Analyze AIS's current capital structure.
Ans:
From 1987 to 2013:
The company did not make any equity infusions since its IPO in 1987. It completely relied on its
retained earnings and borrowings for all the capital expenditures. Even though, the Indian primary
market for equity remained very active and attractive, AIS continued to use the internal funds and the
borrowings to fund all its expansion.
The company’s share capital consisted of 1.85 million equity shares in 1997. Its share capital increased
to INR74 million through two successive bonus issues11 in the ratio of 1:1 in 1998 and 2002. The
company’s share capital increased further in 2002 to INR80 million, following its merger with
Floatglass India Limited. AIS made its third bonus issue in the ratio of 1:1 in 2005.
The company has been having a very aggressive debt-equity ratio since the beginning. Its very first
project was funded with a debt-equity ratio of 5.5:1. As per the Indian Income tax act, 1961, the interest
was tax-deductible. To use this as an advantage, the company ended up borrowing more funds for all
its expansion and capital expenditures. This reduced the profitability as the interests were mentioned as
revenue expenditures after the facilities were put to use.
A large portion of the loans were secured with the company’s assets as collateral. Many of the
company’s loans were in foreign currency including interest-free loans from AGC. The interest rate on
foreign currency loans was usually lower than the interest rate on rupee loans. However, the
depreciation of the rupee against foreign currencies led to foreign-exchange losses, raising the real cost
of the foreign currency loans.
Due to the economic slowdown (recession) in 2008 that occurred globally, the company’s borrowings
increased further to ensure that they still stayed in business. This increased the interest burden on the
company further. The company went on to reduce their long-term borrowings by borrowing funds for
short-term which did not decrease their liabilities considerably, though. But, by 2010, the company was
able to reduce its debts considerably.
The uncertain environment, dwindling profitability and increased level of borrowings also reflected on
the company’s credit rating. The credit rating for its long-term borrowings declined from CARE BBB−
in 2012 to CARE BB in 2013. Likewise, the credit rating for its short-term borrowings was downgraded
from CARE A3 to CARE A4 in the same period. Further downgrade of ratings would result in higher
borrowing costs for existing and future borrowings.
2013:
The debt-equity ratio of the company is 13.28:1, which is much higher when compared to the industry
debt-equity ratio od 2.87:1. This is very much visible from the balance sheet of the company in the year
2012-13. At the end of March, 2013, the company had shareholders’ funds INR 2.548 billion and
borrowed funds worth INR 13.921 billion.The company issued rights issues of their equity shares in
August, 2013 to its existing shareholders. This helped in raising equity funds of 2.5 billion. After this,
the company’s debt-equity ratio became 3.92:1, which is still very high for the company when compared
to the industry.
Q2. What are the consequences of high financial leveraging for AIS-both positive and negative?
Ans:
Advantages

• Favourable tax treatment. In many tax jurisdictions, interest expense is tax deductible, which
reduces its net cost to the borrower.
• Enhanced earnings. Financial leverage may allow AIS to earn a disproportionate amount on
its assets.
• Increases the liquidity available to the company because when company takes loan or debt it
receives cash from the lender and that cash can be used by the company for variety of
activities which will help in increasing the efficiency of the AIS.
• If AIS do not want to dilute their ownership this route of financing is good because in case of
debt financing or loan company has to repay the principal amount on maturity along with
periodical interest and there is no risk of giving equity to anybody resulting in complete
control of the company by the owners of the company.

Disadvantages

• Risky form of finance. Debt is a source of funding that can help a business grow more
quickly. Leveraged finance is even more powerful, but the higher-than-normal debt level can
put a business into a state of leverage that is too high which magnifies exposure to risk.
• Due to leverage AIS may make decisions which it would not have made if there was leverage.
So, for example, a company sitting on cash due to leverage may acquire a loss-making
company or purchase assets even when they are not required. In short, it can result in the
company making irrational decisions which can haunt the company for many years
• Limited Growth Potential - Lenders require borrowers to pay back their loan in a timely
manner. If payments come due before the AIS starts seeing returns, loan repayments can be a
crippling expense. Paying back the loan on a regular basis means less money to finance
operations and invest in growth opportunities.
• Inability to Increase Debt - Just like with individual lending, banks scrutinize corporate credit
reports before doling out more loans. Banks are unlikely to provide further funding to highly
leveraged organizations. Not only are these companies at high risk for bankruptcy, the new
lender might not get paid back if the company goes under. Older loans typically carry higher
seniority compared to newer loans, so lenders are hesitant to put themselves at the bottom of
the list for recouping their investment. In the event a bank does issue a loan, the interest rate
will be high enough to account for that increased risk
• Inability to Attract Equity - One of the options a AIS has to reduce its financial leverage is to
increase the amount of equity capital. However, investors rarely give money to highly
leveraged businesses. Investors avoid highly leveraged companies for all the same reasons
lenders do, plus they're the last in line to get repaid. If an investor is willing to issue to invest
in a highly leveraged company, they'll expect to receive an especially large percentage of
ownership in exchange for their money.
Q3. What should AIS management do now? Identify the difficulties of deleveraging.
Ans:
The management of AIS has to take significant measures to prevent the company from going into more
debt in the future. Therefore, to reduce their financial leverage in the future they should focus on the
following measures:
1. They should aim to reduce their borrowing through issue of more shares of the company to
existing investors or some other method which will be beneficial to the company on the long
run. They should get rid of their borrowing and maintain a healthy debt to equity ratio. This
will further help them in improving their credit rating and hence improve their credibility and
hence borrowing power in the future.
2. Introduce efficient initiatives. Just like their initiative ‘Look within: Look Beyond’ they should
give way to further initiative which will help strengthen the company’s core competency and
enhance their waste management through following methodologies such as Kaizen, which will
help in preventing redundancy in the working cycle of the company.
3. Focus on cost management of the company. AIS should focus on reducing their costs by
efficient cost management techniques and preventing wastage of resources and time. Just like
how they switched to cheaper alternatives of input fuel to prevent the risk faced by the volatility
of crude oil in the market.
4. Switch to efficient methods and invest in new machines and technologies to help with their top
line while reducing their costs and in return get an acceptable profit for their company.
5. Along with investing into new technologies and capital expansion of the company, they should
also focus on liquidating the assets which will be no longer required in the future and hence
take advantage of the salvage value of these assets.
6. Look for prospective markets to expand further. Although a major portion of their revenue is
through float glass and through automobile industry. They should look for markets which will
have a good synergy with their existing products and also will have less risk for the company
to invest in.
7. Reducing the working cycle of the company will also be beneficial to the company and the time
taken to get their trade receivables will also be less hence helping the company deleverage their
company.
Difficulties of deleveraging:
1. Choosing methods of efficient infusion of equity becomes difficult for the company because if
they want to issue shares in the market through normal means, a potential investor won’t keep
AIS in high regard as it has a high risk for the investor. In such a case the brand equity of the
company and value of the firm plays a crucial role. Also, there Is no guarantee the existing
shareholders will accept the tender offer of the company.
2. Rights issue and public issue will also contain a certain amount of cost to it (floatation cost).
3. Since there is a very high potential for the glass industry in the future, selling of their existing
assets might turn out to be detrimental for the company in the long run.
4. As the glass industry is a capital-intensive business, deleveraging will hider their operations of
the company and hence might reduce their top line in the future.