Corporate Finance Test

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School of Management Studies

Finance Advanced Topics
[BUS4083W]

Corporate Finance Test
23 September 2010

Time Allocation: 120 minutes

Total Mark Allocation: 90 marks

Case Study: Anglo American

On the 20th of February 2009, Anglo American announced that it would cut 11% of its work force and suspend its share buyback and dividend in the face of a poor economic outlook marked by "unprecedented" uncertainty. The miner said it was reducing its headcount by 19,000 workers, or 11% of its work force of 170,000. The share price fell 16.9% on the back of the announcement to close at $19.88. "The results are below what the market expected and the most telling thing is that they decided to suspend the dividend with no indication as to when it will be reinstated," said Sam Catalano, an analyst at Macquarie in London.

Anglo also outlined cuts in capital spending and production. Anglo American Chief Executive Cynthia Carroll said the company was taking the steps to preserve cash so it could emerge from the downturn in a position to resume steady growth in 2011. Chief financial officer Rene Medori said the dividend move and actions already taken to cut costs would mean that the firm would not have to ask shareholders for cash. "With the actions that we have taken in terms of cash flow preservation and the level of debt that we have, we don't believe that we need to contemplate a rights issue," he told analysts in a conference call.

Anglo's confidence about its funding situation was in contrast with rivals Xstrata and Rio Tinto, which are more highly geared than Anglo and had recently unveiled plans for a rights issue ($5.9 billion) and assets sales ($19.5 billion), respectively.

A few short weeks later, on April 16th, Anglo was forced to follow suit in a bid to “strengthen the balance sheet”. The company planned to raise $2.9 billion by means of asset sales and to raise a further $3.5 billion by means of either a bond or rights issue. "This series of measures will further diversify our funding sources and provides us with additional financial flexibility, positioning us strongly to weather the current economic environment," Chief Executive Cynthia Carroll said.

“Anglo will be able to cut interest costs, using some of the funds to replace $2.4 billion in South African debt with steep interest rates of 12 percent”, analyst Michael Rawlinson at Liberum Capital said. The firm estimated that new debt could be issued at a semi-annual coupon of between 4.25 and 4.75 percent. There was some concern in the market, however, that Anglo’s current debt levels left it unable to take advantage of any bargains in the currently underpriced market. Ms Carroll said the company would focus on developing existing projects, many of which were due to start production around 2011. The firm was also slightly concerned about the prospect of a rights issue in the current financial environment, particularly as Xstrata had been forced to discount the share price of its rights issue significantly in order to ensure the full issue was subscribed. Shares in Anglo American were trading at $21.13 on the announcement day.

(Adapted from various web sources)

Questions:

1. Comment on the financial position of the company based on its financial statements and the information provided. What are the implications for the company’s performance going forward?

[30 Marks]

2. Assuming Anglo American does decide to undertake a rights issue, what would be a fair price for the shares to be issued to the market? Is the company likely to issue new shares at this price? There is no single correct answer to this question, and you therefore need to ensure that you motivate and explain your thinking in your valuation(s) clearly.

[40 Marks]

3. Briefly discuss the merits and demerits of both funding options to the company. Which factors should the company consider in...
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