CROWN CORPORATION In February, 1969, Mr. Walter Bennett, treasurer of Crown Corporation, was considering several financing alternatives. Crown’s decision to integrate back- wards into the production of primary aluminum ingot had resulted in very heavy capital expenditures. Its need for funds for working capital and for completion of a large aluminum plant now outstripped the company’s internal cash generation and it would be necessary to raise $30 million within the hext jonths to cover capit rE r. Bennett ho, a financing program that would meet the immediate and the longer-term needs without jeopardizing Crown's seventy-cent dividend rate. Company description A series of acquisitions and divestitures during the 1960's had totally trans- formed Crown Corporation from a mining company into a manufacturer of superalloy castings for aircraft and industrial uses and aluminum products for the building, packaging, and aircraft industries. Sales were evenly divided between castings and aluminum products. Crown’s castings were for the most part designed for operation in the “hot part” of the gas turbine engine. The company worked from designs prepared chiefly by aircraft engine manufacturers. These manufacturers, in their en- deavor to obtain greater thrust, designed parts that would function at engine operating temperatures ranging to 2,150 degrees Fahrenheit. The high tem- peratures required the use of precision castings for blades and vanes. The techniques and know-how involved in casting operations were important and the commercial success of such an operation was in large measure dependent upon achieving a low ratio of rejects. Crown’s constant emphasis on quality and technical excellence had established a high level of confidence among its customers. For adherence to a rigid standard of performance and quality, it had been selected to participate in the majority of United States jet engine programs in the past ten years. (Exhibit 1 provides information on jet engine production in the United States.) The other half of Crown’s sales comprised aluminum products, including a broad product line for the building and construction industry, Major efforts had been made to increase the company’s captive source of primary aluminum ingot for consumption by its fabricating operations. To assure a steady and 132 econ. 196. Kno. rou, nar tion- Pacit Apic Paci fully Conse alum fabs Produ alu a, a Purch: prime Ceo. Com, Cre in 196 ing o1 erratic alumi. share and p: showr couray new pr betweer dous bi rising , year, . @ poun marke’ Int 3 Th. and Fur 1971),CROWN CORPORATION 133 economical source, Soo had bce 2 goad payin in 1966 through participatio t known as Intalco. Crown’s share of Intalco’s output was 130 million pounds roughly 81% of its total need. In 1967 the decision was made to build a second aluminum ingot plant, named Eastaleo, at a cost of $50 million, Eastaleo was expected to start apera- tions in mid-1970, ith a city of 85 million pounds a year and incr 4 million. A planned addition of 85 million pounds in 1972 would raise Eastalco’s ca- pacity to 170 million pounds and would meet the company’s objective to be a fully-integrated producer. Actual (Millions of Pound) Ectimates (Millions of Pounds) BOS 66 «6768S 89STOSCSC Consumption of primary ‘aluminum by Crown's fabricatingdivisions.......94 107 6135160185290, Production of primary aluminum: atTntalco ene 0 166 BB HDHD. 30 atEastalco...-.. ° ° ° ° 0 8 170 Purchases (sales) of primar aluminum by Crown... ce a 7 47 0 G0) ao) Company performance’ Crown’s sales had risen sharply from $60 million in 1958 to $230 million in 1968 on the strength of 23 acquisitions, strong internal growth, and a firm- ing of aluminum prices. The company’s earnings had been considerably more erratic, however, with the volatility the result largely of instability in its aluminum business. After reaching a peak of $1.13 in 1959, earnings per share fell to $0.34 in 1963 as overcapacity developed in the aluminum business and prices of fabricated products were eroded. (Crown’s operating results are shown in Exhibit 2.) The “great growth potential” of aluminum had en- couraged major capacity additions by established producers and entry by new producers during the 1950’s. Domestic industry capacity rose by 79: between 1954 and 1960, American producers were also faced with a tremen- dous buildup in capacity elsewhere in the world. After a decade of generally rising prices, excess capacity began to take its toll in 1958. In April of that year, the producer price for American ingot was lowered from 26 to 24 cents a pound to match a similar reduction initiated by Canadian firms in the world market. By December, 1962, the quotation had dropped to 22.5 cents a pound. In oducts market the relative ease of entry hi 1 The history of the aluminum industry is drawn in large part from Aluminum: Past and Future, by Yvonne Levy (San Francisco: Federal Reserve Bank of San Francisco, 1971).134° CASE PROBLEMS, IN FINANCE brought inn many small medium-sized i nde tition, for 1 usin kee ris i List prices of fabricated products dropped on the average about 20% between late 1961 and late 1963. (Exhibit 3 provides data on aluminum shipments and prices.) The decline in actual market prices undoubtedly was even sharper because of a method of discounting—called “commodity pricing”—that was undertaken in order to penetrate new markets. This method, most prevalent in sheet, strip, coil, and plate products, involved selling a product for a specific application at a price lower than the published price. The seller then attempted to confine the lower price to specific product areas so as not to reduce reve- nues, However, in the late 1950's, the whole price structure came tumbling down and profits came tumbling after. Profits of the three major aluminum companies collapsed from $175 million in 1956 to a low of $88 million in 1960, Demand-supply conditions in the industry finally improved in the early 1960's and with the improvement came sharply higher earnings for Crown and other aluminum producers. Over the 1961-6 period, industry shipments of aluminum increased by 14% annually. Despite increases in supply, the rice of ingot went up four times between, November, 1964, from a loy 5 cents a pound. By ines continued at the fabricating level during this period. The hundreds of small fabricators lowered prices to obtain business for their idle machinery, while consumers increasingly came to disregard published mill prices. Prices of fabricated products remained weak until 1965, when strike-antici- pation hedge buying bolstered demand and pushed up operating rates. Pro- ducers raised prices several times early in the year, and then again after a new three-year labor contract was signed in June. For the next three years ship- ments of aluminum products continued to rise 8-10% annually and prices firmed further. Shortly after a new three-year labor contract was signed in 1968, producers raised the price of ingot by 4%, to 26 cents a pound, and the price of fabricated products by a comparable amount, After a brief period of discounting in the wake of the labor settlement, the new list’ prices apparently took hold. In January, 1969, producers raised the price of ingot from 26 to 27 cents a pound and prices on a wide range of mill products by an average of 5%, and further price increases were anticipated. The strong price situation i Profits of the three major aluminum firms rebounded from the 1960 low of $88 million to $230 milli (See Exhibit 4.) Crown’s record was no Tess dramatic. Rising from a low of $0.34 a share in 1963, Crown’s earnings reached $2.03 a share in 1967. Its stock, which had sold at less than $5 a share in 1963, reached a high of $51 in mid 1968 on the strength of record earnings and an increased dividend rate, Surpluses of the seventies? ‘The improved industry price structure in the late 1960's encouraged alu- minum producers to move forward to meet the demands and the opportunities | x”? Ieee ts 01CROWN ConPoRATION — 135 of the 1970s. Throughout the world, producers began to build new smelters and enlarge older ones. In the United States the expansion in capacity con- templated over the next three years seemed moderate in terms of past trends in demand, American producers were scheduled to boost their primary pro- duction potential from almost 4.2 million tons in 1970 to 5 million. tons by 1973, or at a 6.4% annual rate. This rate of expansion, although substantial, was below the 10% rate of growth of domestic aluminum consumption dur- ing the 1960's. ‘ In reducing their rate of expansion, U.S. producers recognized that they were facing the strongest counterattack from other materials in their history. Aluminum’s success in penetrating the territory staked out by other metals had been phenomenal. Shipments of aluminum ingot and mill products grew at more than twice the rate of durable goods output and construction activity . over the 1960s. The industry. was successful, through research and develop- ment and aggressive marketing techniques, in creating new uses for the metal and in displacing traditional materials in older applications. The steel industry, the giant of the metal field with 1968 ingot production of 130 million tons as against aluminum’s 3 million tons, had initiated a strong fight to ward off the lightweight metal’s further advances, In particular, steel was fighting hard to protect its position in the $3.5 billion can market and in the rapid transit market, which could evolve into a $10 billion outlet over the 1970's. The copper industry was also fighting to protect its markets and the plastics industry was challenging aluminum in each of aluminum’s principal markets—construction, transportation, and packaging. However, the most effective dampening influence on the domestic industry was the huge increase in aluminum capacity abroad. Plans in 1969 called for capacity elsewhere in the non-Communist world to rise at well over double t the U.S. rate between 1970 and 1973, as major European and Asian nations built up their own production in an effort to reduce their dependence on im- ports. With almost 4.4 million tons of new capacity—3.5 million tons over- seas plus 0.9 million tons in the United States—scheduled to come on stream in the 1970-73 period, world capacity could rise from about 9.4 million to 13.7 million tons, or at a 14% annual rate. This expansion in capacity would exceed the anticipated growth in demand, ince most industry analysts num consumption would not exceed the 9% rate of growth registered during the 1960-68 period. If all the capacity programmed was brought in on schedule, growth in consumption at the 9% level over the next several years could result in as consumpti ye much as 2 million tons of excess capacity by 1973, resenting about 15' of the industry's total production capability. —_ ~Before jumping to the conclusion that the industry's price structure was in danger of weakening, however, Mr. Bennett realized that the major aluminum producers might stretch out their expansion projects over a longer period, especially where expansion was scheduled through incremental additions to existing plants. Projects not yet started might be postponed or canceled. ae136 CASE PROBLEMS IN FINANCE Furthermore, he did not underestimate the ability of the industry to boost debe consumption above anticipated levels by imaginative research and develop- milli ment and marketing programs. yearr into ¢ Crown’s expected growth Mr Mr, Bennett expected that Crown's sales would ii at 6-8% annually, use exclusive of acquisitions, over the foreseeable future. No growth was forecast cove, through 1974 in the precision castings business as sharp reductions in defense the f procurement needs would offset the 15% per year increase in commercial year: sales. However, sales of aluminum products were expected to rise by 15-20% annually as the company broadened its penetration of major aluminum con- suming markets. This sales growth would necessitate heavy spending on alu- minum reduction facilities and fabricating capacity. Total capital expendi- tures, including the Eastalco project, were forecast at $39 million in 1969, you" 32 million in 1970, $7 million i illion 4 The heavy } capital spending would require that Crown raise $30 million in 1969, $22 to" million in 1970, and $30 million in 1972. att Year Financing alternatives \ Be Several alternatives, were open to Crown to meet its financing needs in 1948. 1969. (See the balance sheets for 1965-68 shown in Exhibit 5.) The com. 7” 1380 pany’s investment bankers believed that a $30 million common stock issue re was possible and pointed to the future financing flexibility afforded by the use oh 135) of equity financing. On the other hand, the dilution of earnings per share that 1953. would result from sale of additional stock was a matter of concern to Mr. 1954 Bennett. Crown stock had fallen from $51 a share in May, 1968 to a level of 1955, $30 a share as investors reacted to disappointing earnings in 1968. (Com- 1956. parative industry stock price data are provided in Exhibit 6.) Further near- 1957... term price weakness seemed likely as earnings per share remained depressed 1 as Crown absorbed heavy start-up costs for the production of the main land- 1960. ing gear for the McDonnell Douglas DC-10 in 1969. Under these conditions, announcement of a large equity issue would drive the stock price down to the Be low twenties, at which price it would be necessary to sell 1.4 million shares to 1963 raise the $30 million net to the company. Mr. Bennett wondered whether 1964... equity financing should be deferred until the company resumed its pattern of 1965... earnings gains. 1966 ‘As an alternative to equity financing, a consortium of commercial banks 1967 had agreed to lend the company up to $30 million at 714% interest. The term Joan would be repayable at an annual rate of $5 million beginning 970 and ending ij 1 provisions of the yrking capital -d $55 million, dividend payments were restricted to earnings ‘accumulated after the date of the loan agreement, and additional funded debt vas limited to $20 million. : Tt would also be possible to place a $30 million subordinated convertible debenture issue privately with the Northern Life Insurance Company. TheCROWN CORPORATION 137. debentures would carry a coupon of 6% with annual debt retirement of $2 million in years’six through twenty. The issue would not be callable for ten years, except at par for mandatory debt retirement, and would be convertible into common stock af $31. ‘Mr. Bennett was in the debt alternatives. Although the company’s use of debt had increased sharply and coverage ratios had narrowed, its coverage of interest costs was still considered adequate. On the other hand, - the flexibility afforded by use of equity financing could be valuable in future Mn Rom Gram Exhibit 1 3 het CROWN CORPORATION Pe num Dense. AIRCRAFT ENGINE PRODUCTION (Number of engines) Military Civit Toral Recipe Teal Recip- Year Total — Military roca = Jet Givil recall Jat 196 seeeeesseses 3407 2,585 1,680 905 «40,822 40,822 AMT cece 20,912 43361 2,683. 1,878 16,351 16,351 1948. Ss. 14027 4,988 23495 2.493 95039930391. IMI cs M972 7,990,981 5,009 3,982 3,982 : 1950... 1136 9,363,122 6239431444 ass. = 20,867 16,287 647194816 4,580 4,580, 1952 231,08 25,659 8,731 16,928 5,382,538 1953, 4,263 33,616. 13,365 20.251 66476647 1954... vss 26,959 TAO 71868 13,572 5,519 5,519 1955. 20s 13469 3,875 858473639 7,839 1956. + 2MB 9,892,663 7,186 11.499 11,499 . 1957, vies 2984 11,087 -2)429 8,658 10,897 10,859 38 1958, 518869 = «B12 1,452, 6,669 10,748 10,233.15 1959) 1 YR 4,66 "661 3,965.12 536 11,152,384 1960. +1618 3.673756. «2,917 12516-10891 1,625 1961 +1582 51724174755 10,660 9,669 ga 1962 s.15919 5441241 5,20 104789921557 IB. TABS 539015 5357S 32S. AWE ess 1935855380175 5,208.14, 205 133346859 1965... 1. B78 5,191 92 5,099 18,187 17,018 1,169 1966.0 se eeeeseeee 30,810,548 457,503 23,262 21,324 1967. + 28858 «8046s, 20,812 18,324 1968. 529,761 8542 852 2,719 17,806 Soute: der/pace Faas end Figures 1973/1974 (New Yor: Aerospace Tndsties Assocation of Ames ionsyyp aa " or138 CASE PROBLEMS IN FINANCE Exhibit 2 CROWN CORPORATION SELECTED OPERATING DATA, 1963-68 Mh, (In millions except per share data) quae B% 1962 63964196585 987 88 $ No $12 $12 $1H $176 $23 $230 y * he 1% Azo Net sales.. Operating profi......--. Bh SIL, 18S 6 278% 285 Yuer Other income expense} oa csi" 35 _ 08 3? G0 1942. Tacome before taxes. 5 $5 ea S71 B75 oe. Federal income taxes. 37 2 T6 123 138 toa Netincome........+++ . $4.2 29 4.7 $10.8 $14.8 $13.6 1945. Pr ShersDete 1946. Earnings. - $057 $034 $042 $0.66 $1.50 §2.03 $1.87 1947. Dividends 0 020 020 0.23 040 060 0.70 1948 Markee price: 1949 9, 1 Te Ugg Mpg Skye 3 1950. 37 56 fe GMS IgE 2th 5p ASD won WW ws 9 i 2 9 7 Hn * Atter deduction of depreciation expense ($5 million in 1968). 1 Other income and other expenses including intrest expense are offet against each other Nawume bales, Mo 4 ones Tiebyro SAA) 68K — yeeros DT. or Ta 71290040 Peak 4x7 Past ATR wh 048 as Dl By b% 7% 6% 268 gaan - 3B expo Ew . tng Vein2 Peder 2! fren, 32 Devele Route Exhibit 3 ‘CROWN, CORPORATION CROWN CORPORATION STATISTICS ON INDUSTRY SHIPMENTS AND PRICES: ToTAL ALUMINUM INDUSTRY SHIPMENTS, 1942-69 (Millions of pounds, net shipments) Total 1,452.7 207.2 2,566.4 1,886.4 1,672.4 2,040.1 2,282.0 1,654.1 2,460.6 2,506.6 694.5 3,276.8 3,036.0 4,035.1 4,154.6 3,880.1 3,681.2 5,061.0 4,732.5 4,970.1 5,772.5 6377.0 73 8,150.2 9,031.6 8,946.4 9.9774 + 10,825.0 19698... Notee 6 frat a oa Deuall may not add to tot Sources! Fagot and Board 1946 toda ‘Domestic Commerce, Au Indus ft Series M32, 1960 to date. 0 rund 2. ‘car Serigr MS Ingot 507.4 746 952.0 549.2 529.2 61.8 629.8 479.9 N46 709.8 au 982.9 920.2 1,205.4 1,223.5 1,161.6 974.0 1,575.0 1,608.6 1,536.6 1,858.6 2,032.6 2,228.6 2,387.3 2,340.1 2,486.4 2,694.8 3,050.0 tie: PAI1S—Aluminum and Magnesium Dis iment of Commetee, Bureau of the Census, Taduetry Di uh and Magnesium Industries Operation, Facts fr tndustty 1946-1958, and Current Domestic Mill Products 933.6 1,492.4 1,613.0 1,329.8 1,140.8 139 Imported Products 7 02 14 14 24 on i290. 16.1 2.6 40.6 329 65.7 29.2 379 45.3 409 0.1 100.1 m8 88.4 1027 87.2 107.8 133.5 B41 109.5 15.6 115.0 ny and Berens of ict, imported: U'S. Department of Commerce, Bureau of the Ceneus, Foreign Trade Division, and140 CASE PROBLEMS IN FINANCE Exhibit 3—Continued PRICE CHRONOLOGY T + T T Improvements Aluminum Association cartel in technology World War 1 Cartel dissolved; soaring imports Soaring imports; recession ‘Third European cartel Cents per pound ol 1895 1900 1905 1910 1915 1920 1925 Little over a century ago, aluminum was sill arare metal, costing $545 a pound in 1852, Yet after several decades of technological advance, the price dropped to $8 « pound in 1885. Then, with the developmenc of the electrolytic process for producing aluminum, the metal began to come within the reach of the average consumer . . . On the eve of World War I, aluminum was selling for 1994 cents a pound, thanks to the growth of a technologically advanced industry in Europe and North America—and despite the efforts of producers’ cartels to maintain a high price structure for the metal. As 2 consequence of this price decline, aluminum matkets were no longer confined to speciale items in the cooking, milicary, and surgical fields, but had spread also ro tonnage items in the fasegrowing electrical and automotive industries . . . During World War I, prices prac- tically doubled despite che rapid expansion of production facilities. Bur by the end of 1921, prices were back to prewar levels as producers here and abroad fought to find peacetime markers for Wartime-swollea supplies . . . During the next several decades, aluminum prices trended down- cape peerercaennnmeine = Te aocartel 1930 CROWN ConPonATION 141. Great Depression /Alliance aluminum cartel Strtkes ot U.S. plants World War It Excess capacity price control 1935 1940 1945 1950 1955 1960 1965 1970 + wards, In the 20's and 30's, industry cartels set prices and imposed output restrictions worléwide in an attempt to manage markets that had been unsettled by lagging demand and increasing capac- ity. In the 40's, as the domestic industry expanded rapidly co mect insatiable wartime demands, the government held the pric line by setting the ingot price at 14 cents a pound . . . Prices have generally moved upward since World War I. The surprisingly high level of civilian reconversion demand, plus the heavy Korean-war and strategic-stock-pile demand, helped push prices from 14 to 2534 cents a pound between 1947 and 1957. But then prices slumped, reaching 2234 cents a ‘pound in 1963, as military and civilian demand rorned sluggish in the face ofa tremendous buildup in capacity throughout the world, Finally, with the induserial expansion and the war boom of the late 60's, prices increased again. Source: Aluminam: Past ond Fatere, by Yvonne Levy (Sen Francisco: Federal Reserve Bank of San Fraacisco, agri}. 76142 CASE PROBLEMS IN FINANCE Exhibit 4 CROWN CORPORATION CHARTS SHOWING IMPROVEMENT IN PROFITS OF THE THREE MAJOR ALUMINUM FIRMS IN THE LATE 1960's ALONG WITH RISING PRICES Ratio scale ¥e se os 1950 1955 1960 1965 1970 Source: Aluminum: Pest and Future, by Yvonne Levy (San Francisco: Federal Reserve Bank of San Franciseo, 1971). Cast Ma, eouer) fe ‘Ort Inv ki Od Od Ac ‘Ace. re Dir Can ini oeoe . 2 we CROWN CORPORATION 143 we Exhibit 5 CROWN CORPORATION wen wn Yur BALANCE SHEETS AS OF DECEMBER 31, 1965-68 ’ tw (Jin millions) Ws es 1 > sacs Cash... $3 $3 $5 $4 Marketable securities. . 7 10 23 6 sed) fAccounteresivale co el Joventories...... . Bf 3844 4544 50 Hh we a2 8 tt Total current assets. $58 $74 $109 §1G Invesmentso alamioum plasts Tatalco. 32 29 M 36 34. Enstaleo., : 0 800 0g HM Other net property, plane and quipment.. 2B 31 os a er. 3 4 4 4 Tales Lg Be Haw wae vee ‘nourms ee bg, “Accounts payable. $10 $1) $4 Accrued liabilities. 7 7 10 ‘Accrued taxes. 3 8 6 Dividends payable. 1 1 1 Carrent maturities—long-term debe. . _2 _2 4 Total current liabilities . $2 $31 $35 Long-term debe... B68 RL Deferred federal taxes 2 3°43 ‘Stockholders’ equity (7,7 standing at year-end 1968). . 8 9 ys UR Total liabilities and net worth. $138 ‘$18l $19 rhe rely with several ie fnrance compan a fait aves coupon of a of ‘tnnuelly ‘beginning in 1968 and ending in 1981 ‘pen Carcett Retin ae ab 8S RY UT. DHE J equity WA 3S RD yuck Gok qd Ht Wel Mz Up MEL EB ole Hh Lea ak ate bem144 CASE PROBLEMS IN FINANCE Exhibit 6 CROWN CORPORATION COMPARATIVE DATA ON ALUMINUM COMPANIES ‘ Standard ot PH Poor's 425 Alcan — Alcea — Harvey Crown Brauni* Industrials io Earnings per share: AAAAA. 1962... - $114 $252 $19 $57 SLA $3.87 Lot 227 0 34 123 4.24 137 2n 7 a uss, 4.83 : 1.93 341 3 66 214 5.51 1966.22 2a 4.83, 24 1.50 3:30 5.89 3967.22 194 493 236 2.03 3.00 5.66 1968.2 2a 475 216087 281 6.15 B96 estes ce 230540 175 (L8St_ 3.00, 6.25 Price-carnings ratio: 1962... 152518271328 a7 1963... 20-28 SL TSM SE 18 wes ae 30 ag 18-27 18 1965.00 BAT 183 MT u ag66. TT tons 42093 TB 9G a5 1967 Wy 9s 513-20 18 1968.20 ots AT 25 SAT 18 Feb, 1969. - 2B 4 20 16 B 18 1968 sales Cin millions). $1,081 $1,353 $177, $230 «$850 ‘Book value per share 968), 23 $49 $20 s13 $25 Current dis rate $3.21 Debt rating Senior debe. A A not not rated rated Convertible sub- ordinated debt... BBB BBB 4 Before any new Enancing.