American Superconductor Case
Capital Structure
Since equity and debt financing solely do not provide all advantage of earning profits for a firm, therefore, a mix of both in capital structure is often opted by most firms. Companies with high debt to equity ratio are often expected to earn higher returns since the interest payments on debt are tax deductible thereby, lowering the cost of debt. Also the debt raised by a company generates liquidity as well more avenues to invest in.
The interest payments from a debt holding firm are constant irrespective of profits or losses and therefore, save a lot of cost during period of profits. In case of high debt to equity ratio, the firms management reserves most of the rights regarding decision to be taken in firm as well as retain as much earnings as they want for future projects since there are less claims from equity holders. The ownership of business also remains in few hands. On the other hand, a capital structure inclined towards equity raisings face a number of challenges for firms that are in less liquid position and require cash injections for business expansion. However, this argument has its own limitations. The debt capital structure is more valid for firms with profitable income statements so that the debt costs are met on time. Whereas, a firm facing huge losses cannot bear the burden of constant interest payments that have to be paid irrespective of companys profitability position. The burden of payments to creditors can result in bankruptcy and reputation sabotage for less profitable firms. Lack of ability to pay debt payments is also most likely to result in disability to pay the limited amount of shareholders their earnings.
Equity financing is suitable for organizations that have weak financial position and profits are witnessing a hit affecting debt costs and therefore, earnings. A higher equity percentage in the capital structure impacts the financial ratios of the company positively.
100 equity financing
During 2003 blackout, the demand for relieving agents for overload on power grids resulted in high demand for American Superconductors stocks and the result was a 42 surge in companys stock. The investors expected that the demand for AMSCs wires will increase to control the power grid congestion. The company took this situation as an opportunity and the managers and board of directors decided to forgo debt financing of 50 million and adopt an equity financing strategy.
AMSC improved its balance sheet by raising around 51.1 million from sale of shares, thereby increasing the liquidity position of company. Despite huge losses, the conversion to equity based capital structure resulted in minimization of interest costs, savings millions of dollars for AMSC.
There are several benefits that AMSC gained from converting to 100 equity. Firstly, the company being in hole of losses was unable to generate returns for its shareholders and to worsen that, the interest payment put a huge burden on companys already worse financials. The conversion to 100 equity resulted in huge gains from sale of shares and released the firm from interest payments saving millions of dollars.
Secondly, the reputation and credit ranking of firm was secured which in turn saved the firm from insolvency or bankruptcy. Thirdly, the increase in demand for AMSCs products generated first profitable quarter for the firm which could be positively utilized instead of interest payments. The Debt to Equity ratio would have increased and debt would have gotten more and more expensive for the company thus increasing the interest expense of the company and it may have never became profitable.
Financial Highlights
Analysis of firms decision regarding new capital structure can also be analyzed from financial perspective by looking at its income statement and balance sheet.
AMSC Income Statement (Amt in millions)
SalesEBITDepreciationTotal Net IncomeEPS0308112.4-22.5710.1-25.45-0.65030752.18-34.784.8-34.68-1.04030650.87-30.887.48-30.88-0.94030558.28-19.666.55-19.66-0.7030441.31-26.736.31-26.73-1.1030321.02-87.638.01-87.63-4.21030211.65-56.995.51-56.99-2.79030116.77-21.684.32-21.68-1.08030015.06-17.62.25-17.6-1.11Source Msn Money
The table above indicates an increase in sales revenue of AMSC from 15.06 million in 2000 to 112.4 million in 2008. On the other hand, the EBIT of AMSC decreased from -87.63 million to -22.57 million. The net losses have decreased though not completely covered due to less earnings of firm. The EBIT and Net income are similar due to exclusion of interest payments.
AMSC Balance Sheet (Amt in Millions)
Current AssetsCurrent LiabilitiesLong Term DebtShares Outstanding0308261.2352.780.041.5Mil0307132.4330.810.035.0Mil0306133.4718.370.032.9Mil0305158.9215.410.032.5Mil0304129.914.450.027.6Mil0303101.9814.160.021.3Mil0302197.7925.630.020.5Mil0301239.9312.360.020.3Mil0300248.917.970.019.7MilSource Msn Money
As indicated in table, long term debt continues to be zero whereas the number of outstanding shares can be seen increasing from 19.7 million shares to 41.5 million shares.
American Superconductor is a technology related firm that undertakes several projects, resulting in both profits and losses. Such list of successful and unsuccessful ventures pose negative impacts on the balance sheet and income statement of company. Since the company was facing huge losses, it was not feasible for the firm to continue with debt financing since the interest costs were too high. With conversion to 100 equity, the management has undertaken a wise decision, considering the declining credit rating of company. The company has already posted a positive return for the quarter and after a series of such profitable quarters it can improve its financials and later optimize its capital structure utilizing both equity and debt financing.
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