Hutchison Whampoa Case

Q1. Assuming Hutchison Whampoa (HW) needs US$1 billion in financing at the end of 1996. Assume that equity can be raised at $48.80 per share and LT debt will carry an interest of HIBOR plus 70 basis points (bps), how would equity or debt issue impact HWL’s financial performance & position.

Hutchison Whampoa(HW) would need HKD 30205.1 million of capital commitments to finance its future projects and maintain its present growth rate. In the past, HW has relied mainly on its internally generated earnings to finance its past projects which were characterised by short and medium terms timeframe. Due to the short to medium nature of the terms, revenues could hence be forecasted with relative ease. However, the company is planning to undertake longer term projects with much larger capital commitments and outlays, therefore, it is imperative that HW look into external financing source since it is no longer feasible to finance its future longer term projects using its internal funds and short to medium term bank financing, which the firm has been all along relying on.  

Scenario that equity can be raised at $48.80 per share

This option would mean that HW will need to raise USD 1 billion at the price of HK48.80 per share. In other words, using the average exchange rate* for USD/HKD in 1996, the company will need to raise HKD 7.754 billion and this will translate to issuing roughly 158,893,442 new shares. With the present share capital of HKD 58 839 million, this will increase the total share capital to HKD 66 593 million.  

*The average exchange rate for US$1 to HK$ in 1996 was 7.7536. (This data is taken from http://www.majorexchangerates.com/hkd/1996-usd.html)

With this issuance of new shares, this large amount of new shares issued would result in the dilution of the current company shareholding structure. However, the financial position of HW will show an increase in equity equivalent to the amount of HKD 7.754.

From Exhibit 1, we notice that the dividends per share has been increasing every year since 1992. To prevent a negative reaction in the expectation of the shareholders, HW will need to increase the overall pay-out of the dividends by at least HKD 187,494,261. The increase in the overall amount of dividends is necessary since with the dilution, it will result in the decrease in EPS with its current profitability level.    

As for the effects on the future financial position of the company, it will be difficult to determine if it will be positive or negative as from Exhibit 10, the capital raised will be used to fund various different projects in the coming year.    

Scenario that LT debt issue will carry an interest of HIBOR plus 70 basis points (bps)

This option would mean that the company will incur an interest rate of 6.02% with the issuance of debt. In absolute terms, by borrowing the additional amount of HKD 7.754 billion, the company will increase its expense by HKD 467 million. Raising debt would certainly put on some stress on the financial performance of the company as interest will need to be paid on the borrowing. However, the advantage will be it allows the company to benefit from a tax shield since the interest that HW pays will be tax deductible. With good leverage, the value of the company will be more than the value of an all equity firm by the value of its tax shield.  However, it would be unwise to take on more debt than it can be benefitted by the tax shield.  

The impact on taking this option for HW will be an increase of HKD 7.754 billion on its long term liabilities. At present, HW has already HKD 26 billion on its balance sheet and with this debt issuance, the total long term liabilities would increase to HKD 33.8 billion. This will undoubtedly affect its gearing ratio. However, ratios like ROE, EPS and WACC will improve with debt issuance as compared to equity issuance.

Q2. Assess HW’s current capital structure in the light of its future financing needs.

The revenue for Hutchison Whampoa has been growing on an average of 15.3% for the past 4 years. In the past, HW has mainly financed its business either using short and medium term bank financing or with retained earnings. For the recent year of 1995, it can be seen in Exhibit 2 that HW has HKD 26, 174 million in long term liabilities and HKD 5,329 of current liabilities. From Exhibit 6, the total debt to capital ratio is 44.8% and the long term debt to capital is 28.9%.

As the firm is growing and more importantly, HW has already been contracted HKD 6,468.9 million of projects, with HKD 23,736.2 million also been authorised but not yet contracted.  These projects are of longer term in nature, hence the company will need to raise funds with a longer term nature.  Based on the current cash flows of HW, the company will therefore need additional external funds to support its future growth. We also cannot assume that the new projects are able to generate enough positive cash flows especially in the first few years to provide for the additional capital expenditures needed.  It will be highly risky to rely on that. Furthermore, HW would need at the very least HKD 30 billion to fund its future long term projects for the next 5 years.  Clearly, it will not be sufficient if HW fund its new long term projects using internally generated funds like retained earnings, which stands only at HKD 5,300 billion in 1995. This is clearly insufficient.  

Hence it is important for the company not to rely completely on internally generated funds.  Raising funds through previous short and medium term bank financing were also no longer be suitable since the new projects are of longer terms nature. The current capital structure was appropriate when projects were of shorter terms with lower capital commitments. To sum, the current capital structure cannot support the growth with longer term projects. Therefore, it is important for HW to look externally for financing the new projects.  

Q3. What bond rating do you think HW will get from Standard & Poor’s?

Based on our analysis below, HW will likely to receive at least a rating of BBB or an A from S&P. This would mean that its bond will be at least an investment grade bond. Since for Swire Pacific Limited and Wharf Holdings Limited, with similar ratios as HW, they both received an A for their ratings. We can see from Exhibit 6 that some of the financial ratios of HW are more favourable than its peers.  One will be its profitability ratios as HW outscored the other two companies. Furthermore, HW is synonymous with Mr. Li Kah Shing, who is substantial shareholder of Cheung Kong Holdings and became chairman of Hutchison Whampoa in 1981. In my opinion, it will be likely that his good reputation in the international business circle will be considered as a positive influencing factor in HW receiving a favourable investment grade bond rating.