Massey Case Solution

Corporate Finance, 15.402 (Assignment 5)

Team 12 -  Anjali Mathur, Jibing Zhang, Utkarsh Rawal, Yi Sha

Executive Summary

Based on a comprehensive review of Massey Ferguson’s financial performance, the company is recommended to do the following:

1. Government assistance: The Canadian government can provide a bridge loan at low interest rates to cover some of the outstanding debt. In addition to this, if the government provides a guarantee for the future equity investments into the company, then this would give confidence to a lot of investors. Employees would not lose their jobs, shareholders and lenders will be more secure and the government will not have to face the burden of the unemployed citizens. The management would appreciate the government’s help, however too much government intervention can hinder a company’s growth.
2. Converting debt to equity: Promise debt holders that coupon payments will be stalled for a while but will be paid with interest when the financial health improves. Then, having a debt-equity swap would be ideal for the management as it would reduce the leverage ratio and improve the balance sheets. The lenders need to be convinced by offering them seats on the board, so they have a say in future decisions. This would mean that there are few layovers and most employees retain their jobs.

Massey Ferguson: Industry Overview

As a top multinational producer of farm machinery, industrial machinery, and diesel engines, Massey-Ferguson Limited had manufacturing and assembly operations in 31 countries throughout the world, with predominated shares of sales in North America and Western Europe (68.8%). The products were manufactured in production facilities that were dispersed around the globe, and then sold throughout the world by dealers, distributors, and company retail outlets. In markets of North America, Europe and Australia, the company’s finance subsidiaries had primarily involved in financing the sales.

Key Factors For Success: The key factors to be successful in the industrial manufacturing business is to maintain a favorable cost margin, to finance with affordable capital costs, to target the markets with prospective demands for the products, to establish competitive sales and logistic strategies that align products and markets.

Massey Ferguson: Product Market Strategy

Massey is a multinational firm with its largest facilities located in Canada, France, England, and Australia. In North America, Massey finances its retail sales through wholly owned financial subsidiaries. In Europe and Australia, the financial subsidiaries financed sales to distributors and also financed dealer receivables in home markets. In 1975, the company aimed to expand its presence in North America. However, this strategy coincided with a depressed market, and hence low sales and a weakened distribution system. Moreover, the company is marred by a lack of alignment between the production sites and markets which leaves the company vulnerable to currency fluctuations (particularly in the case of engine production in London). However, matching product and markets comes with a high degree of political risk as well as inability to capitalise on ‘economies of scale’ in engine production in concentrated locations.

Massey Ferguson: Capital Structure

In 1976, Massey has a total asset of $2,305M, total debt including short-term, long-term and other debt of $1,502M, and a total equity of $803M. Total debt consists 65.2% of total liability. Comparing to the capital structure of Massey’s competitors like International Harvester (128.6% loan-to-equity) and Deere & Company (113.5% loan-to-equity) in the same year, Massey’s indebtedness is already very high. However, it was a much healthier debt ratio comparing to the company’s position today.  Since 1970s, the ambitious program of acquiring assets and expanding operations has brought the firm more debt, especially short-term debt.

Massey and its competitors: A Comparison

1. Product-Market Strategy: An economic recession in 1980 impacted all three companies -Massey, International Harvester, and Deere- negatively. These companies witnessed reduced sales and profits and sharp increases in short and long term debts. Massey’s lack of alignment in product and market, however, has resulted in a higher cost of goods sold compared to its competitors. This increased cost is primarily driven by currency fluctuations.
2. Capital Structure: In order to assess Massey’s performance and that of its two biggest competitors (International Harvester & Deere and Co.), we conducted a Dupont Analysis to compare three levers of performance: Profit Margin, Operational Leverage, and Financial Leverage. Through this analysis, we can conclude that Massey’s strategy has not entirely been successful. Massey’s ROE is the lowest of the three companies, and this is primarily attributable to the its poor performance in terms of profit margin and a high financial leverage. Massey’s current D/E ratio is the highest among the three companies at 214%, which is disadvantageous as this expands losses. In order to improve performance in the long run, it is crucial that Massey maintain a lower level of debt portion in its capital structure that is comparable to its competitors.

Problems after 1976

First, the economic recession lowered the demand for the farm machinery worldwide, including North America, Europe and third world countries. Second, the rise in interest rate further lower the demand and increase the cost of short-term debt. It hurts Massey more than its competitors because Massey has a much higher loan-to-equity ratio. Third, the price of pound increased, which intensifies Massey’s currency risk for its incompatibility between production and sale. All these factors hurt both Massey and its competitors, however they strike Massey more because the competitors strength to keep the total debt/capital under 50% and has kept a focus on the North American market. Thus, the increase in the interest rate and currency risk has not affected the competitors much immediately after 1976. Massey had have done some strategic moves like cutting labor and facilities, eliminating unprofitable production lines, lower the inventory. However, the cost cut in these areas has not offset the increasing leverage cost. Also, the effort to win back the North American market has failed with high cost. Afterall, Massey’s response has not worked directly towards lowering its leverage ratio and alignment of production and sale, which failed to save the company eventually.