Introduction
Recapitalization is generally regarded as a compulsory measure, and it may be stimulated by numerous factors and reasons. Considering the instance of Stephenson Real Estate Company, it should be stated that recapitalization is quite reasonable, as the projected profits are impressing. Nevertheless, the reasonability of issuing shares and debts requires deep reasoning and analysis of the market realities. Therefore, the key aim of the paper is to analyze the opportunity of recapitalization, the necessity to issue debts and shares, as well as analyze the benefits of such recapitalization.
Debt or Equity
Considering the fact, that if the purchase is successful enough, and annual earnings will approach the projected $14 million, the company will need at least 4 years for covering the expenses for purchasing the land. Therefore, additional investments will be required for making the purchase. In fact, the key aim of recapitalization is the necessity to diversify the company’s debt-to-equity ratio, so, the liquidity will be improved. Therefore, issuing a share will improve the company’s liquidity, and attract additional investments for purchasing the tract. On the other hand, issuing a debt will decrease the earnings per share, and may stimulate further debt growth. Therefore, if a company’s debt decreases, the leverage of the company lowers, and earnings per share should decrease.
Capitalization in perpetuity is generally featured with the necessity to issue a debt share, and further lowering of the debt by purchasing shares back. This capitalization method is rather effective for real estate companies, as debt shares increase the capitalization security by repackaging existing assets.
Therefore, the most reasonable decision will be to issue an equity, thus, attracting additional investments. Nevertheless, the price per share will change, as the amount of shares will have to be increased sufficiently. Security measures will involve changing the proportion of equity shares in comparison with residual interests, nevertheless, the potential benefits of purchasing the land overwhelms the possible risks of issuing additional shares.
Issuing Equity
Considering the fact that the purchase will require $ 60 million of investment, the amount of shares after issuing equity will be as follows:
Therefore, if the company issues an equity, the amount of shares issued will be 1690140.85. Therefore, the balance of company’s assets and liabilities will be changed that will inevitably cause the changes in the equity security share issuing principles. Therefore, as it is stated by Boehmer (2009, p. 117):
Preferred shares have some rights that are preferential to common shares, but they are also limited. Preferred shares basically are higher in the pecking order in terms of who gets dividends or distributions first. Dividends are paid out of earnings to shareholders. Distributions, on the other hand, are paid out of capital. There are special rules for distributions, but not necessarily for dividends.
In the light of this statement, it should be emphasized that issuing equity shares will cause inevitable changes in the capitalization structure of the company. Therefore, the equity issuing is closely linked with considering the factors below:
- Buildup of e equity
- Changes in the investment values
- Holding period
- Selling expenses
Therefore, real estate investment will be featured with the increase mortgage rate, as well as improved leverage. This is required for increasing the liquidity of the investment, and attracting additional investments by issuing shares.
Issuing Debt
Corporate debt issuance is helpful if the market share of the company is low enough, and the company is not able to attract investors by issuing equity shares. Therefore, is Stephenson Real Estate Company issues debt for financing the purchase, the market share will inevitably decrease. This will involve the debt sum, as well as interest rates for the period stated. As a rule, companies with stable financial structure attain higher credit rating, which means that interest rate will be lower.
Without considering the interest rate, the price per share will be 32.92, and lower, depending on the interests paid. This is explained by the fact that the amount of shares stays the same, however, the company has to pay the debt, as well as the interests – i.e. the total market value of the company will be lowered. It will be $ 658.4 million.
Recapitalization measures associated with issuing debt will lower the total value of the company, therefore, its shares will be less liquid, which will inevitably cause the decrease in the amount of investments. Investors will be frightened by the measures taken. Debt issuing is often used as the alternative exit strategy be venture capitalists, however, Stephenson Real Estate Company is not going to exit business. Though, it may be a reliable protection from hostile takeovers.
Method Discussion
Comparing the price per share with equity and debt issuance, it should be stated that 70/30 variant also requires assessment and analysis. Therefore, of 30% of the required investment will be taken as debt issuance ($ 18 000 000), and 70% as equity issuance, the calculations will be as follows:
Therefore, the price per share will be higher in comparison with previous two variants. Kim Weyand considers that the capital structure will be even more valuable if debt components are included. Considering the fact that the actual necessity of attracting investment is the expansion of the incomes, and increasing the liquidity of the company, the increased value may be regarded as the key objective of the entire operation.
Therefore, this method will involve all the merits of equity and debt issuance, and help to get protected from the risks presupposed by each method. In the light of this fact it should be stated that dividing capitalization strategies into equity and debt issuance will help to achieve maximum capacity from the entire capitalization process, and attract sufficient amount of investors who will be sure that the company is protected against risks.
As for the leverage factor while issuing debt, it should be emphasized that it will not be large if using 70/30 proportion, however, lowered interests rates will help to avoid some risks, and the company will protect the shareholders’ value by increasing the total value of the company, as well as by increasing the liquidity rate.
Conclusion
Finally, it should be stated that the actual importance of recapitalization is explained by the necessity to get protected from the risks of issuing equities or debts. Both methods have their own disadvantages, while the properly analyzed proportion of debt and equity will help to avoid some.
Reference List
Boehmer, E., (2009). Managerial Bonding and Stock Liquidity: Analysis of Recapitalization Strategies. Journal of Economics and Finance, 28(1), 117.