McI Case Rationale

1. How has MCI financed its needs in the past?  Why did MCI make the financing choices it did? MCI financed its needs with instrument dependent on circumstances 

• Like first equity issue when revenues were miniscule.
• Taking secured bank loan for project finance once equity (from IPO) was in place.  
• Sweetened second equity issue (with warrants attached) to keep surviving when losses were getting accumulated though revenue was increasing. Any kind of debt security (pain or convertible) was not possible due to technical default on credit agreement with banks.  
• Use of lease finance to add capex, when debt and equity markets both were out of reach.
• Use of preferred stock with call provision when revenue were growing fast and company was profitable. It was back door entry of equity, as same helped the company to not only avoid any negative reaction on issuance of common stock announcement but also eradicate any high expected costs associated of financial distress. Preferred stock issuance also provided enough room for profitability to grow (company had accumulated losses so tax shield from debt were not required) Preferential dividend  provided attractive return with a chance to convert security in to common stock. With rising stock price, company was able to convert all three convertible preferred issues in to common stock by 1981. This improved debt equity ratio significantly.
• Once there was enough equity available in the capital structure, company issued convertible debt. By this time accumulated losses were over and earning had become high so convertible debt was a preferred option vs convertible preferred. However, CFO was sure of  increasing stock price due to operational efficiency and increasing product demand. So convertible debt for new capex requirements made more sense than pure debt. However, converting short term and intermediate debt in to long term debt was a good decision (20 year subordinated debenture issue).
• Once company was large and established, and as finance needs intensified conversion of convertible debt into equity further enhanced equity in capital structure and room for more debt. Thus company added 400 million of straight debt in March 1983 . With spectacular stock performance of the company, larger convertible bond issuances also left a mark in the market. So company came up with  further issue of convertible of USD 209.9 million in July 1983.

1. How much external capital is MCI likely to need over the next several years (FY84 - FY88)? By how much could they reasonably be expected to vary? 

FY 84-88

MCI will require substantial external capital.

One of the key assumption for financial projections

*In March 1983, each extra dollar of revenue required about $1.15 worth of investment in fixed plant and equipment.  This factor was expected to fall to about $1.00 by FY1990 as improved electronic technology reduced equipment costs.  The expected yearly pattern is shown on line (12).  It was possible, however, that in the latter part of the period (post-FY1987), this factor would fall substantially below $1.00.                                                                

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We expect a variation of 10-20% from the planned financials. However a lot depends on AT&T pricing policy and market activities, being a dominant player/

1. What capital structure policies should MCI adopt?  Consider a target leverage ratio, a target coverage ratio, and a target debt rating.  You might find the "S&P ratios" worksheet in "MCI Exhibits.xlsx" useful.    

MCI should realise that having a large exposure to convertible securities in their capital structure may lead to a dangerous scenario once stock starts falling. As the real benefit of converting the security in to common stock will go away and then company will face high costs of financial distress (in case of convertible debentures). In case of falling stock scenario, convertible preferred stock will also remain preferred only, eating preferred dividend and leading to very low or nil dividend to common stock holders. Thus MCI should move towards more balanced capital structure with optimum straight debt and sufficient equity.