As Pfizer considered changing its business mix, the $67.8 billion pharmaceutical maker wanted to get a better handle on the best capital structure for the company. So treasury built a dynamic model that takes into account Pfizer’s balance sheet and cash flow forecasts to determine an appropriate capital structure.
Amit Singh, Pfizer’s senior director of capital markets, says standard models for a company’s capital structure focus mostly on tax benefits related to leverage and distress costs. The traditional analysis usually ends up suggesting the amount of leverage equal to a Triple-B credit rating is appropriate, he says.
Pfizer wanted to take into account many other factors, including cash on the balance sheet and its possible uses, the location of that cash and any challenges in repatriating it, changes in global taxes and payouts to shareholders.
Treasury built its model using a Monte Carlo framework that tested various combinations of cash and debt. The model started with earnings forecasts for each of Pfizer’s business units, estimated the volatility of each business’ growth rate, and took into account factors like regulatory issues, using interest-rate simulations to model macroeconomic changes.
Singh says one hurdle was simulating the activity of the various business units. “It’s always a challenge to cut the company into units and see how the units correlate,” he says. “We try to look for pure-play companies that match the operating performance and business performance of the business units, but often we didn’t find pure plays that matched very well.”
The model contributed to Pfizer’s recent review of its portfolio of businesses. And it also gave the company new insights into how far out on the yield curve it can invest its cash.
Singh says treasury will continue to work on the capital structure model. He expects that Pfizer will update the information and run the model once a year, in an exercise that tries to look two to three years in the future.
“Any changes you make in the capital structure take time to implement,” he notes.