Treasury & Risk's 7th Annual Alexander Hamilton Best Practices Summit — October 1 and 2, 2002
2002 — Corporate Finance Winners: Gold—Continental Airlines; Silver—PPL; Bronze—Pfizer
STAYING ALOFT AMID TURBULENCE
Continental Airlines soars its way to gold
GOLD CORPORATE FINANCE WINNER—On the morning of Sept. 11, members of Continental Airlines Inc.’s finance team drove from New York City to Newark International Airport to start a road show for the initial public offering of Continental’s commuter airline subsidiary, ExpressJet Holdings.
From Continental’s hub at the airport, we watched the towers collapse, says Gerry Laderman, Continental’s senior vice president of finance and treasurer. You just saw the [airline] industry collapsing as the towers collapsed.?
The finance executives ended up driving home to Houston, a trek that was just the start of their efforts to keep Continental solvent as it burned through millions of dollars a day in the wake of the terrorist attacks. Credit was unavailable, and airlines weren’t able to access the capital markets.
In dealing with the situation, Continental’s finance group could rely on state-of-the-art forecasting tools that it had put in place after the company’s early 1990s financial crisis, including a cash-forecasting model that provided detailed daily projections for the first four months. Within days after Sept. 11, its forecasts showed the company would run out of cash before yearend.
Stemming the financial crisis involved reaching out to government officials in Washington. On Sept. 21, 2001, Congress approved a $15 billion bailout of the airlines—$10 billion of it in loan guarantees. But attempts to limit the loan program led to further efforts by Laderman and other Continental executives to educate administration officials involved in the loan program about the airline industry and airline finance.
Executives made their case to investors, hitting the road in October to talk to investors around the country. The company also increased the amount of data it released. For example, in early October, it began providing passenger traffic updates biweekly instead of once a month.
Continental credits its efforts to reach out to investors with helping it regain access to the markets within months of the terrorist attacks. In late November, Continental raised $172 million through a common equity offering—the first by a major U.S. airline since Sept. 11. In mid-January it did a $175 million convertible bond offering, followed the next month by a $475 million enhanced equipment trust certificate deal that featured the added security of a triple-A-rated insurance wrap and was used to finance seven new aircraft. In April, Continental completed the ExpressJet IPO that it had been starting to market last September, and raised $450 million.
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SILVER CORPORATE FINANCE WINNER—Back in 2000, when utilities were spinning off their energy-generating subsidiaries at sky-high multiples, Allentown, Pa.-based PPL Corp. had a better idea. Reluctant to spin off its electricity generating business, but interested in providing it with more capital, PPL used some of the techniques employed in securitizing mortgages to fence off its regulated and low-risk electricity transmission business and raise additional capital on the strength of that business.
Separating the utility from the rest of the business required a number of measures, including appointing an independent administrator and arranging a long-term power-supply contract. PPL then persuaded rating agencies to allow it to boost the leverage of the regulated utility to 65% from 55% without altering its rating. The cash it raised by selling $800 million of six- and eight-year notes in August 2001 flowed back to the holding company to be used by the generating subsidiary.
“It was the first use of securitization techniques to segregate away from the riskier components of our business a whole operating business,” says James Abel, PPL’s treasurer. The lower cost of capital is a plus for both shareholders and ratepayers, he says, and PPL’s stock has performed better than the stock of energy companies that spun off their generating units, some of which are now flirting with bankruptcy.
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BRONZE CORPORATE FINANCE WINNER—Sometimes you get criticized even when you get and maintain the highest rating possible. Just ask the treasury at Pfizer Inc. The New York-based pharmaceutical giant is one of the few U.S. corporations still rated triple-A, reflecting both its strong performance and its limited use of leverage. Yet, thanks to current economic theory that contends that a company’s capital structure has no effect on its valuation except to the extent that debt reduces tax costs and financial distress raises costs, Pfizer sometimes has faced both external and internal criticism for its conservative capital structure.
It was time to come up with a better answer about why it made sense to do it this way. So treasury looked at a group of Pfizer’s peers, which it defined as big companies with high levels of intangible assets and R&D and above-average P/Es. The group included high-tech companies like Microsoft Corp. as well as other pharmaceutical companies. The analysis showed that all tended to have low levels of debt and big cash reserves—exactly like Pfizer.
Treasury then went further, focusing on the relationship between intangible assets and cash flows. Since the company derives more than half its market value from intangibles, such as drug patents, treasury felt it was important to protect its R&D funding of those intangibles and financial distress would limit that funding. Conclusion: Companies that derive a significant component of valuation from intangibles must protect against financial distress. That means keeping debt low and cash reserves high “as insurance against financial distress cost.”
—As seen in the October 2002 issue of Treasury & Risk magazine