STONE CONTAINER CORPORATION

Submission by Group 8
 Srishti Goenka G021`
 Kushagra Gupta G023
 Rahul Gupta G024
 Amruta Kandukuri G032
 Shubham Saurabh F048
1. Explain the provisions of the convertible subordinated note. What option is embedded
in the convertible? If the linerboard business recovers, will the convertible behave more
like debt or equity? If it continues its slump?

Convertible subordinate notes of value up to $300 million can be sold for the purpose of
repaying senior bank debt.
1.1. These convertible notes that will be sold bear a coupon of 35/4 % maturing in
7 years.
1.2. These notes have a provision for conversion:
1.2.1. Notes that are converted into Stones common stock are at a 20% higher than
the market price of Stone common stock at the date of the offering.
1.2.2. Prices that are fixed during the time of issue for each note, remain the same
throughout the life of that convertible irrespective of the share market price
movement.
1.3. The option embedded in the convertible is that one can convert there note
into stone common stock with the conversion ratio specified for that offered
convertible note ex. In 1993 conversion price was $18 per share, and a conversion
ratio 55.56 (i.e. shares of stock per $1000 par value convertible bond).
1.4. If linerboard business recovers, the convertible behave more like equity.
1.5. If it continues to slump then it will behave like debt.

2. Why did the market greet the announcement of a new financial plan so negatively?
Announcement of new financial plan was taken so negatively by the market due to the
following reasons:

 The new financial plan involved heavy debts to acquire new companies, hence
increasing the financial leverage of the firm.
 High financial leverage magnifies the profit but magnifies the loss as well.
 Acquisition of Consolidated-Bathurst has already created a debt of $3.3 billion on
the firm.
 Stone Container also tried to refinance the loan by issuing high yield junk bonds,
but at the same time the junk bond market was facing serious liquidity issues,
hence the idea did not worked out well.
 All these factors increased the interest burden on Stone Corporation making it
difficult to cover their interest out of the operating profit.
3. What are other challenges there to resetting Stone's capital structure to its optimal
level? What are the broader implications for raising capital and setting capital
structure? For the global financial crisis and for the global economy during a period
of deleveraging?
A. Challenges to raise Stone’s Capital Structure:
 There is no guarantee that bank will agree for re-structuring of debt, given
the high leveraged situation of the company and low percentage share of the
owners (30%).
 There is no definite way to determine how long the trough would exist and
how much time it would take for the company to start realizing positive cash
flows to repay its debts.
 The acquisition of Consolidated Bathurst of Canada dictates the mandatory
compliance to secondary waste treatment regulations through capital
expenditures worth 100 mn on priority basis which would require immediate
capital generation apart from what is required to fulfil its debts.
 The fact that the company is drawing close to the coverage and indebtedness
covenants on its various credit agreements can cause damage to the image of
the company and might affect the willingness of future creditors whom the
company would approach for money.
 The company had become excessively dependant on junk bonds and since
there happened to be severe liquidity issues and a media and political
bonanza leading to the shutting down of many junk bond traders including
Michael Milken, its permanent junk bond trader thus leading to the complete
elimination of the option of using the junk bonds for refinancing purpose.
 The capital structure would be improved if the share of the company is
increased. The available options are subjected to various factors of
unpredictability within the immediate requirements of meeting the
covenants and compliance. Only after fulfilling these will there is a possibility
of recovery and generation of capital to increase the share of the family in the
company. This would make the time required to achieve the optimal capital
structure long and far-fetched. It is not clear whether the economic and
industrial conditions would be favourable to allow the same.

B. Broader Implications of raising capital and setting capital structure during period of
deleveraging

 During Period of Deleveraging, business entities reduce the level of debt

on their balance sheet by sellings one’s assets.
 On a macroeconomic aspect, during the Economic crisis a decline in
corporate revenues of firms could have led to a possible reduction in need
for working capital financing and requirements of funds for further
expansion activities. A reduction in revenues may have been followed by
effects like a fall in receivables and reduction in inventory and hence a
reduction in need for short term bank credit faciility.
  For a long term financing needs of a firm, a reduction in revenues could
have an impact on the ability of the firms to serve the loans on time i.e
instalment payments and interest serving. During the Financial crisis , the
financial debt obtained to serve long term investments could not be met
in its stipulated time frame and hence required more time to be properly
served thus requiring banks to increase debt duration.
 Selling off assets in the period of deleveraging and not financing other
long term assets for the firm could have negative broad term implications
affecting recovery of firms in Revenues.
 In these scenarios, not financing assets could be detrimental for the
business entity and alternate source of financing one’s capital structure
can be considered.
 In the given case, Stone Container Corporation had considered
o Negotiating bank loan agreements at a restructuring cost between
the range of $70-$80, or
o Selling off assets for cash ,
o Issuing more equity stock,
o Issuing convertible senior subordinate notes
o issue inter mediate senior notes

4. What should Stone do now?

As mentioned in the case, Stone has below mentioned alternatives to choose from to
come out of this situation:-

 Loan Restructuring
 Selling Assets
 Selling Intermediate-term senior notes
 Selling Convertible Subordinated notes
 Issuing Common Stock
Stone should choose Loan Restructuring and Selling of Convertible Subordinated notes

 The option of selling $300 million of convertible subordinated notes for purposes of
repaying senior bank debt will be rewarding as later the notes can be convertible into
Stone’s common stock at 20% higher price than the market price and the
shareholders could earn good return on their equity. Also, as the notes will mature in
7 years, so the longer time would allow Stone to spread out its risk farther than any
other alternatives. In this alternative, the Return on Equity is also higher.
 Renegotiating would provide the Stone Corp. more room to restructure its debt
portfolio and it will also not dilute the family’s equity share in the organisation. In all
other options, the family will lose significant amount of shares in the company and
their stake will be reduced.