Reason behind the explosive growth of Loewen during the early 90s

Discuss about the case study Essentials of Corporate Financial Management.

The Loewen Group essentially started as a family business during the year 1950 and experienced explosive growth in the 1990s. The acquirement of numerous small sized funeral homes as well as cemeteries in addition to the acquirement of a number of large recognized funeral chains in thickly populated urban markets can be attributed as a primary reason behind the enormous growth of the company Loewen Group.The organizational strategy that differentiated the Loewen group from that of the other major players operating in the market is the acquisition of the greater share of many small cemeteries as well as funeral homes. Furthermore, the company Loewen Group also successfully retained the expert managers who had thorough idea about the community in which they resided and are already well known in the local areas. The managers therefore could provide even transition of the business from a family business to a corporate big business. The management of the company Loewen Group also financed the businesses for the capital augmentation as well as merchandise. The high entry barriers into this business owing to the high fixed costs as well as huge capital requirements at the time of start up along with lack of social attachment with the community can be considered as a driving force behind the explosive growth of the company. 

Advantages of Debt Financing

The company Loewen has financed several projects by employing debt funds. The debt funds therefore fuelled the growth of the company during the early 90s to a great extent. The policy of debt financing helped the company Loewen to make greater amount of investments and make payments for the new acquirements and assets that can be utilized for the growth of the business. The debt financing of the Loewen thereby also helped the firm to acquire working capital and fulfill the short term needs of the company.

• Current Situation

The recent financial outcomes reflect a disappointing financial condition of the firm. During the second half of the year 1998, the company adopted the policy of the elimination of the acquisition progam in order to improve the financial results, liquidity as well as operational efficiency. The current situation also reflects the fact that the company also concentrated on the cash flow from different operative actions and mainly on the cash flow from diverse cemetery operations. In addition to this, the company also made efforts to lower the level of cost of the firm by closure of the Cincinnati of the company as well as Trevose offices and at the same time considerable consolidation of diverse management operations in Burnaby. The analysis of the current situation of the company reveals the fact that the sales revenue of the company has grown from $1141.1 recorded in 1997 to $1136.2 in 1998. However, despite the increase in the sales of the company the gross profit of the company declined by more than 21% during the year 1998. The financial declarations of the company replicate the fact that the total liabilities of the company increased by around 36% to $3768 million during the year 1998.

Advantages of Debt Financing

The financial performance of the company can also be checked from profitability ratio of Loewen. The return on equity recorded during the year 1998 reflects the fact that the profitability of the company has declined. The return on equity is registered to be -81.2% during the year 1998 that declined from 2.4% recorded during the year 1997. The profit margin ratio for the year 1998 enumerated by dividing the gross profit by the revenue is recorded to be (291.7/1136.2=0.25). On the other hand, the gross profit margin during the year 1997 was registered to be 0.33. Therefore, the operational as well as the financial performance has deteriorated during the 1998 as compared to the year 1997. Therefore, the current situation is leading to the position of financial distress as the revenues from different acquired corporations also declined to USD 29.1 million from the year ago figure of 187.6.

The funeral home and the cemetery business of Loewen Group faced imminent financial distress. The company experienced aggressive growth through the excessive use of the debt funds. The process of restructuring of the entire debt funds of the company is extremely costly to different creditors, suppliers, diverse suppliers as well as other company stakeholders. In addition to this, cross border as well as the accounting issues also impend the process of restructuring.

The financial distress exerts immense influence on the overall image of the company Loewen Group that is evident from the decline in the prices of the shares of the company. Again, the financial distress also gives rise to different legal issues and the company needs to bear cost for the legal as well as consultation fees that that makes it more costly. Again, due to the financial distress the assets of the corporation can be taken into consideration under the bankruptcy clauses and can also be undervalued by the government.

As mentioned in the case study, the company Loewen Group has huge accrued debt and as a result the viability of the cash is also low and the equity is also considered as an unusual circumstance even for different preferred shareholder of the company. Again in case of bankruptcy, the firm needs to spend the entire amount obtained on liquidation for repayment of the debt. Therefore, the equity shareholders can also incur losses owing to the financial distress of the company.

In addition to this, the company also faced the difficulty of decline in the overall rates of the stock from 25.75 to 9.44 within the period of a year. The company also experienced growth through a number of acquisitions that were financed by debt funds. The amount of debt of the company Loewen increased from $2.3 billion during the year 1998 and the company had no bank agreement regarding the restructuring.

Evaluation of the operational and financial performance of Loewen

The Loewen Group and the SCI competes for the properties as they operate in the same market. SCI acquired the British company Great Southern against an amount of $200 million where both the companies placed their bids. Again, the SCI made several offers to Loewen during the year 1996 that were finally declined. The SCI also made formal offers for the purpose of the acquirement of the common stocks of the company at USD43 per share that was substantially higher than the closing share price of the Loewen’s stock.  The management of Loewen rejected the offer citing reasons of unfavorable verdict of the jury as the primary reason behind the decline in the prices of the shares. However, during the year 1997, SCI cancelled its bid for the acquisition of Loewen due to growing concern regarding the anti-trust suit and several takeover defenses of the company and the high debt financing costs of the company.

SCI persistently made attempts to acquire Loewen and made several formal proposals to the management of Loewen. The formal proposals of the SCI for the acquisition of Loewen included bids that were rejected by the board of directors of the Loewen. The management of the Loewen rejected the formal proposal on the ground of the underestimation of the overall value of the company. However, declaration of the reason for rejection of the formal bid of the Loewen directed the management of SCI to increase the bid. This too revealed the desperation of the management of SCI for the acquirement of the Loewen. Therefore, different informal acquisition proposals reflect the viewpoint of the management of SCI in getting hold of the competitor firm Loewen and to ensure greater share of the market.

The intention behind the consistent attempts of the SCI for the aggressive takeover of the Loewen was primarily the acquirement of a rival firm in order to eliminate a competition.

The key factors that drive the valuation of Lowen include the net present value of the total cash flows that was accrued during the particular period as well as the terminal value where the terminal value is also discounted to the net present value. The value of the company is calculated by taking into consideration the equity value of the firm based on the free cash flow (Arnold 2012).

In case if the efficiency level of Loewen becomes equal to that of SCI, then the overall valuation of the firm will increase as the revenue and the profit of the company will rise. The free cash flow of the company will rise and at the same time the net present value of the FCFF (Poniachek 2013).

• Effects of the operational efficiency, financial policy and growth

The operational efficiency of the firm can improve the capability of the firm to generate larger amount of sales out of the available assets of the company (Arnold 2012). During the year 1998, the company Loewen was able to generate profit of USD 291.7 out of the available assets of USD 4673.9. Therefore, the operational efficiency of the company is (1136.2/4673.9=0.24). On the contrary, the operational efficiency of the company Loewen is also found to be approximately 0.24. Therefore, increase the sales of the company and raise the overall operational efficiency of the firm (Arnold 2013). Again, the financial policy of excessive use of debt also affected the overall financial performance of the firm. The use of debt increased the debt to USD 940 and the interest expense to USD 182 from USD 127 during the year 1998, thereby leading to the decline in the net income of the firm. The forecasted sales during the period 1999 are expected to be 1319.1044 where the growth % is recorded to be 16.09.  The growth in sales can therefore raise the efficiency of the operations of the company and increase the overall profitability of the firm as well (Eun and Resnick 2012).

The Enterprise value represents the economic value of the company. It is useful in comparing similar companies. This attempts to capture the firms operation and growth in a singular number by multiplying with the financial matrices to yield the result.  In the given case the Enterprise value of both the company are calculated based on the data of 1998.  The calculation of Enterprise Value is given below:

The enterprise value is calculated by adding Market value of equity with total debt and subtracting cash from that. As can be seen from calculation Enterprise value of SCI is more than that of Lowe. In this, case the financial metrics used is sales for calculating the enterprise value of Lowen based on the financial metrics of SCI. The enterprise value of metrics of Lowen comes to $5308.142. The increase in Lowens value is $2425.14.

References

Arnold, G. 2012. Corporate financial management. Harlow, England: Pearson.

Arnold, G. 2013. Essentials of corporate financial management. Harlow, England: Pearson.

Eun, C. and Resnick, B. 2012. International financial management. New York, NY: McGraw-Hill.

Poniachek, H. 2013. International corporate finance. London: Routledge.