On February 3, 1999, Amazon sold Amazon.com Inc., the online retailer, sold $1.25 billion of convertible subordinated 10-year debt to institutional investors.
Was this debt secured or unsecured? Is it senior or subordinated debt? What are the bond’s maturity and coupon rate? Does it have any early repayment option? If the bonds have a call feature, what is the call price?
Amazon.com sold $1.25 billion of convertible subordinated 10-year debt that was unsecured (Annual Report – Amazon.com). The company issued subordinated debt that was “subordinated to all existing and future Senior Indebtedness” (Annual Report – Amazon.com). The debt was issued with a 10-year maturity and the coupon rate was 4¾% (Annual Report – Amazon.com). The convertible subordinated notes were issued with an early redemption option.
The early redemption option permitted the company to redeem the entire or a part of the debt before February 6, 2002. The call price of the redemption option was “$212.60 per $1,000 note redeemed” (Annual Report – Amazon.com). The call price was calculated after deducting the amount of interest already paid by the company before it calls for redemption (Annual Report – Amazon.com).
If the debt is convertible, what is the conversion price?
The conversion price was $78.0275 per share (Annual Report – Amazon.com).
Why did it make sense for Amazon to issue convertible bonds?
Amazon.com issued convertible bonds to take advantage of the low coupon rate that investors were willing to accept due to the convertible option. The investors were keen to invest in the company’s debt because they believed that the company would outperform the performance benchmark set out by Amazon.com. Therefore, it was feasible for Amazon.com to issue convertible debt rather than borrowing from a bank or issuing regular bonds.
In December 2014, Amazon issued $6 billion of notes. It’s the firm’s largest bond offering to date. The offering has 5 parts: $1.5 billion portions of 4.95 percent, 30-year bonds; equal $1.25 billion parts of 3.8 percent, 10-year notes, and 4.8 percent, 20-year securities. The company also sold equal $1 billion pieces of 2.6 percent, five-year debentures, and 3.3 percent, seven-year obligations.
What is amazon’s capital structure like at the end of 2015? Specifically, what is the total amount of debt? What is Amazon’s D/V ratio or D/E ratio?
Amazon’s capital structure after it issued $6 billion of notes is determined in the following.
Current Debt = Nil (Amazon.com Inc.)
LT Debt and Capital Lease Obligation = $8,227.0 million (Amazon.com Inc.)
Total Debt = $8,227.0 million
Equity = $13,384.0 million (Amazon.com Inc.)
Debt to Equity Ratio (D/E) = Total Debt / Total Equity
D/E = $8,227.0 million / $13,384.0 million
D/E = 0.62
The value indicated that the company had $0.62 of debt for each $1 of equity. Although the value of the D/E ratio was less than one in 2015, the company could be considered as a highly leveraged company, and it should take steps to reduce its debt.
Assuming that Amazon’s $6 billion debt is not perpetual and that the corporate tax rate is 35%. Given the bonds’ interest rates, how much value does Amazon’s $6billion debt add to the firm? In other words, what is the present value of the tax shield generated by the debt issuance?
The tax shield for each part of debt issued by Amazon is calculated in the following table.
Table 1. The present value of the tax shield.
The total present value of the tax shield generated by the debt issuance was $917.489 million, which represented the value added to the firm.
In the framework of trade-off theory, do you think Amazon has too much debt? Can you increase Amazon’s value by changing its capital structure?
The trade-off theory states that the optimal level of leverage depends on the analysis of costs and benefits associated with extra borrowing. The companies should balance these costs and benefits to increase the firm’s value. The benefits of borrowing include a tax shield that companies receive from interest payments deductible from the operating profit before tax is calculated. It could be noted that Amazon did not have current debt in 2015 (Amazon.com Inc.).
Moreover, the value of the D/E ratio was less than one. The company could borrow more to take advantage of the tax shield. If the company increases its debt, then the company’s value will increase by the present value of the tax shield. However, it could be stated that the marginal benefit of additional borrowing will eventually decline and the firm’s value will not increase any further.
Works Cited
“Annual Report – Amazon.com.” Windows Server – Internet Information Services, 2000. Web.
“Amazon.com Inc.” MSN, 2016. Web.