This case study deals with the financing options of Compania de Telefonos de Chile (CTC), a Chilean telephone company that was privatized recently. The company's chief financial officer, Sr. Garcia, should come up with an effective financing strategy.
Charles M. La Follette
Harvard Business Review (293015-PDF-ENG)
August 13, 1992
Case questions answered:
- Was Compania de Telefonos de Chile helped or hindered by the Bond’s group ownership after privatization? In light of the competing offers by other interested buyers, did it make sense for Chile to have selected Bond Group’s bid at the time of privatization?
- What are CTC’s external funding needs for the next three years? The next seven? Elaborate the assumptions you make when generating your forecasts. What are its most viable sources of financing over the same period?
- How effectively can the US ADR market meet CTC’s financing needs for the next three to five years? How attractive would CTC’s ADRs be for an American investor?
- As Sr. Garcia, what financing strategy would you propose for CTC? What would be your first step in implementing that strategy?
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Compania de Telefonos de Chile Case Answers
This case solution includes an Excel file with calculations.
1. Was Compania de Telefonos de Chile helped or hindered by the Bond’s group ownership after privatization? In light of the competing offers by other interested buyers, did it make sense for Chile to have selected Bond Group’s bid at the time of privatization?
As soon as Bond’s Company won the bid for the acquisition of Compania de Telefonos de Chile, it started working on the operations of the company by implementing various tactics to further improve the telephone network by installing cellular service, developing a high-speed data transmission, and other services.
However, the company faced difficulties and financial distress in meeting the expansion program targets, so being unable to meet the debt obligations, Bond sold its stakes, leaving CTC at a crossroads on how to finance the expansion program.
The bid took place in 1988, so judging from Exhibit 6 in 1989, there is an increase of 9% in the number of telephones, 5.7% increase in the number of telephones per 100 inhabitants, 26% increase in the number of lines installed, 9.2% increase in the numbers of lines in service and so forth which reflects the improvement of the telecommunication network which is supposed to continue in 1990 as well based on the estimates.
Looking at the balance sheet, we see that the liabilities have increased from 1988 to 1999, and too much debt can be very dangerous for the company and the investors.
Calculating the debt-to-equity ratio would give a clearer vision of the financial leverage of the company. The debt-to-equity ratio (total liabilities/total shareholders’ equity) for 1988 was 0.4624579 (37728+55824/202293). In 1989, it increased to 0.71717 (74841+85681/223824), which means that Bond Company has been aggressive in financing the growth of Compania de Telefonos de Chile with debt.
If we calculate the equity multiplier for both years, we see that in 1988, the EM (total assets/total equity) would be 1.462457 (295845/202293). Meanwhile, in 1989, the EM would be 1.71717 (384346/223824), which means that the Bond Company funded the assets mostly with debt rather than equity.
If we calculate the debt-to-capital ratio (total debt/ total debt + equity) for the year 1988, the D/C ratio would be 24.02483 % (37728+55824/93552+295845). Meanwhile, in 1989, there was an increase to 29.4607% (74841+85681/160522+384346).
These calculations demonstrate that Bond’s Company has relied on debt to finance the CTC operations, which increases its chances of financial difficulties or high default risk.
To sum up, everything stated so far, Compania de Telefonos de Chile was hindered by the Bond’s group ownership after privatization. Regarding the question of whether the Chilean government made the right decision to choose Alan Bond company’s bid among many other investors, we can see it from two perspectives.
Several bidders offered Chilean debt securities as payment, seeking to perform a debt-for-equity swap for the company. However, this would be risky for the CTC because the bidding company could ask for an equity interest with a much higher financial price than the outstanding debt that CTC has to repay. In addition, by giving a part of the company’s equity, CTC would lose control of the business.
On the other side, an all-cash offer suited best CTC even if it was lower in total value than the offers of other bidders because the roles of the two parties are clear-cut, and the exchange of money for shares makes the transfer of ownership even more simple.
This bid provided the Chilean government with no default risk since the acquiring shareholder (Alan Bond Company) would take on the entire risk if it failed to achieve the expected level of synergy. In addition, an all-cash offer provides the most liquid asset since it can most quickly be converted to other assets.
2. What are CTC’s external funding needs for the next three years? The next seven? Elaborate the assumptions you make when generating your forecasts. What are its most viable sources of financing over the same period?
With the aim to estimate the external funding of Compania de Telefonos de Chile for the next three years or the next seven, we should make assumptions regarding net income.
In order to calculate the net income, we must first make projections of…
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