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Michellee Marie B.

Chavez BM 222 – Financial Management CASE STUDY ON FLOWER INDUSTRIES, INC

2004-39460

I.

POINT OF VIEW: In analyzing the case study, the point of view of the chief financial officer of Flower Industries, Inc., Mr. Matty Wood was taken in consideration. He is looking at the possibility of issuing convertible debt rather than straight debt or equity because of the opportunity of leveraging the company’s balance sheet during a period when the company did not immediately require the capital.

II.

TIME CONTEXT The scenario took place in early March 1985 when the CFO realized that there are various opportunities for the company that takes place in the food industry. .

III.

STATEMENT OF THE PROBLEM Flower Industries, Inc. is one of the largest wholesale banking companies which grew to a Fortune 500 company. The company is looking towards the means on how to expand its product line and increase its market share and geographic penetration through acquisitions. The company’s CEO must decide whether to issue convertible debt rather than straight debt or equity based from the advantages and disadvantages of each alternative that will be presented.

IV.

OBJECTIVES At the end of this study, the following objectives of Flower Industries should be met: a. Assess the current situation of the company and analyze the internal and external environment of the company; and b. Evaluate the three alternatives formulated based on its advantages as well as disadvantages and choose which of the three should be pursued in its plan of issuing $50 million long term securities.

V.

AREAS FOR CONSIDERATIONS The internal and external environment of Flower Industries should be taken into consideration in analyzing this case study. The company has various strengths and opportunities which are beneficial for them and can be taken advantage of. However, there are also weaknesses and threats that works against them and hinders their growth and success in the food industry. Strengths:  One of the largest wholesale baking companies.  Low cost producer of its food products.  Beneficial programs for employees are being provided.  Efficient distributor of products.

Weaknesses:  The company has inadequate resources for new product development.  Uncompetitive in the market dollar basis relative to competitors.

Opportunities:  Acquisition of underperforming, often unprofitable, small food companies that can provide immediate capacity and customers.  Improving acquired turnaround situations had been a more profitable means of expansion.  Possibility of future expansion and market development.

Threats:  Stiff competition against the more established and resource-rich firms.  Low growth characterized in the baking industry.  Earnings per share in the baking industry decreased at an average of 6% per year.

VI.

ALTERNATIVE COURSES OF ACTION: 1. Common stock issue Advantages: Source of financing that has minimal constraints in the firm. Common stock has no maturity, thus, future repayment obligations are eliminated. Has the ability to increase the firm’s borrowing power. The more common stock the firm sells, the larger the firm’s equity base, thus, long term debt financing can be cheaply obtained.

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Disadvantages: Potential dilution of voting power as well as earnings. It can only be avoided if rights are offered and exercised by recipients. Most expensive form of long term financing because dividends are not tax de-ductile and because it is a riskier security than debt or preferred stock.

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Analysis: Total Issue Expected issue price - $50 million - $20 million

Number of shares issued- 2,500,000 Dividend yield - 1.95%

Total shares before issue – 23,606,612 Total shares after issue - 26,106,612

2. Straight debt issue Advantages: From a standard to poor rating, the company is expected to garner a BBB rating for a bond issue that will yield $50 million.

Disadvantages: The company will have to pay an interest of $6.9 million computed based on the $50 million yield multiplied by 13.8% annually times 20 years. To ensure profitability, earnings should be or more than $6.9 million annually.

Analysis: Face Value Term Rating Yield - $50 million - 20 years, maturity is on year 2005 - BBB- 13.8%

3. Issue of convertible subordinated debentures. Advantages: A convertible bond protects investors from major loss during market downturn. Convertible bonds give the investors more flexibility, especially in cases when a company succeeds, bonds can be converted into stocks of higher value. Convertible bonds are less unstable than common stocks.

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Disadvantages: Dilution of the control on the company if a large part of the issue is purchased by an investment banker or insurance company. Convertible bonds are riskier in the sense that when a company declares bankruptcy, the holder of the bond has a lower priority claim on the company’s assets after the secured debt holders have been paid off. Convertible bonds are complex securities and have the characteristics of both bonds and stocks that may be confusing for decision making. Bond holders usually receive substantially lower yield to maturity in comparison to the non-convertible bonds.

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Analysis: Face Value Term - $50 million - 20 years

Convertible anytime at a price of $24 per share Conversion premium - ($24-20) / 20 = 20%

Each bond is convertible to 41.667 shares

Number of shares before conversion – 23,606,612 Number of shares issued in conversion – 2,083,333 Total shares after conversion – 25,689,945 Coupon rate Rating - 8.25% - BBB-

VII.

CONCLUSION / RECOMMENDATION :

In anticipation of its continued acquisition of small food companies, the company should opt to issue common stock relative to its plan of raising the $50 million long term securities. This alternative has been chosen over the other alternatives considering the advantages and conservatism that this option portrays. In the case of Flower Industry, issuing of a common stock will be beneficial since it is purely equity based. Admittedly, they are not the most profitable in the industry, thus, they have to monitor its cash flow. They will not think of monthly payments and interest that should be paid by the company. In the long run when the company will be expanding and developing new markets, as what is being planned, they can go on bank loans since the company’s borrowing power increased already. On top of the equity, they can have additional working capital line through bank financing.

VIII.

ACTION PLAN: Flower Industries Inc. should constantly monitor the opportunities for expansion and market development in the industry. The CFO, hand in hand with the staff of Flower Industries, should look at various companies that are possible for acquisition to enable the growth of the company.