The Delta Beverage Group is a bottling and canning company from the United States. Delta had some very strong brand names, like Pepsi and Mountain Dew, included in their franchises. Around 1988, a price war occurred and Delta suffered from compressed margins. About a year later situation became critical and a new management team from was hired. The new management stopped the fall in prices, the decline in market share and increased margins by changing the cost structure. Delta also acquired some other bottling companies at the same time increasing their sales and operating cash flow. After a couple of years operating profits increased by almost 100% and net income made a solid upward progress. However, net income was still negative due to high interest expenses. Despite growing profits Delta had problems on making payments on their bank loan. They were unable to make the payments without violating an interest coverage or leverage ratio covenant. Violating a covenant meant that Delta was in technical default!
To avoid defaulting on its debt, Delta restructured their debt. $30 million of existing senior notes were converted to subordinated notes, almost $90 million of senior notes and bank debt were retired at par using a new private placement debt issue of $105 million. The restructuring resulted in a lower total debt and an increase in the average maturity of the debt. The new debt issue came with five new covenants. Again a violating of a covenant meant technical default.
|Time period |Maintenance of senior leverage ratio (not in excess of) | |12/31/93 |5.15 x | |1/1/94-12/31/96 |5.00 x | |1/1/97-maturity |4.50x | | |Maintenance of total leverage ratio (not in excess of) | |12/31/93 |6.40x | |1/1/94-12/31/96 |6.25x | |1/1/97-maturity |5.75x | | |Interest coverage ratio (not less than) | |After 1/1/94 |2.00x | | |Debt service coverage ratio (not less than) | |Third quarter 94-second |1.25x | |quarter 95 | |
Because the price of aluminum increased by 30% during the first half of 1994 Delta was concerned about a further increase in the latter half of 1994. This raised the probability of a financial hedge on aluminum. Because there are no financial contracts available for PET or fructose we will not mention them again. Aluminum is subjected to an annual price volatility of 30.4%. The price of aluminum cans however had historically varied much less than the price of raw aluminum, in fact the cost of aluminum cans had fallen.
Bierbaum could hedge the increasing price of aluminum with a put option. Future contracts of aluminum are quite attractive for traders, these contracts can be bought and sold 24 hours a day, this possibility to trade constantly gave companies a level of flexibility. Traders on the LME can specify the delivery date themselves, as well traders can be confident about the quality...