Executive Summary:
This Analysis will give you some insights and able to take some critical decisions up on
the funding to Williams Companies, Inc. Since we have decided to offer a loan to the
Williams on a whopping sum of $450 million from Lehman Brothers and Berkshire
Hathaway each. We believe that this loan could potentially save Williams from financial
stress due to collapse of its telecommunications business and softness in the energy
markets. I had analyzed the various covenants and required payments of our deal and
found that the rate of return to us would range between 35.5% - 65.40% under various
circumstances and also risks associated with it.
Introduction to The Williams Companies, Inc.
Williams has been large player in the energy industry since it moved the company to
Tulsa in 1918. Williams (and all of its subsidiaries) business line can be categorized as
4 segments:
1) Energy Activities: Williams’ energy activities, including the purchase, sale,
transportation, and transmission of energy related commodities.
2) Refining & Exploration : Williams focuses on the exploration and refining in
international energy projects located in South America and Lithuania.
3) Trade & Marketing : Williams’ energy marketing and trading business that
buys and sells a variety of energy products and some of the associated financial
contracts. This unit had high profits during 1998-early 2001.
4) Tele Communications: Williams’ growth during the 1990s could be attributed
from this unit which began in 1985 when Williams started to run optical fiber
through old natural gas pipelines to deliver telecommunications services.
While Williams has seen success in the past, their recent financial strategies and the
overall environment surrounding energy and telecommunications in 2000-2001 has led
to a decline in their business. Amidst their financial struggle, Williams still acquired the
assets of Barrett Resources Corporation, amidst a deal estimated to be worth $2.8
billion in 2001. These assets went into Williams’ RMT subsidiary, which would be the
Collateral or asset back security of our proposed $900 million loan. Even while they
were struggling, the balance between their four business areas seemed to have been
quite helpful to Williams in maintaining some financial power.
Raising Cash and access to Cash for Williams: (How did Williams get into this
situation)
Williams’ problems began soon after the spinoff of WCG. The communications business
had not fared well in the economic downturn, resulting in a well-publicized shakeout in
the telecom sector because of oversupply in the Industry and due to non-usage of 95%
of the fiber-optic lines in the U.S. Bandwidth prices decreased drastically by 90%
between 1998 and 2002. As a result, many firms reduced investment and laid off
workers. Financial conditions worsened in 2001, as news about problems in Enron
Corporation’s broadband unit and Global Crossing exposed significant weaknesses in
the telecom sector. Although WCG had made the required interest payments, its
inability to meet certain covenants with its secured creditors, Williams
telecommunications business was under financial stress. Williams provided indirect
‘Credit support’ for $1.4 billion of WCG’s debt in case of default or inability to raise cash
to replace maturity debt. So, Williams took a one-time accounting charge of $1.3 billion
related to guarantees and payment obligations related to WCG. Prior to the spinoff,
Williams acknowledged that WCG’s debt burden might prevent it from raising new
funds.
Also, Williams Energy Marketing and Trading experienced a loss, resulting in
deteriorating credit ratings and rising yields on Williams’ debts. The consecutive decline
of Williams’ credit rating further limited their ability to participate in the energy
marketing and trading business. During 2002, Williams’ financial distress can be seen in
their plummeting stock price almost down by 90% in the past year with only
$2.95/share in June 2002 as per the Exhibit .As a result, Williams has cut back on
capital spending, planned the sale of many of their assets, reduced the company’s
dividend payment by 95%, and has raised funds in a variety of forms. It may be Issue
bonds which is very difficult at this juncture because of Poor credit ratings and Sell
assets which may also leads to decline in credit ratings and utilizing the Credit line for
that meeting certain norms.
Another hurdle that the Williams company is facing an inquiry by the SEC about its
Financial reporting which was reported by ‘The Wall street Journal’ in April 3, 2002.
The Principal terms here in for proposing this deal to Williams is as follows
apart from the required payments :
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CFO of Williams had to certify about the solvency of the company and assure it
would be after the loan got sanctioned or issued.
Maintain Interest Coverage ratio of greater than 1.5 to 1.
Give the lenders attendance rights to all of its board of directors’ meetings, as
well as any meetings of any committees of the board.
Limit intercompany indebtedness and should maintain liquidity of parent
company of at least 600 million at the beginning and stepping up to $ 750
million during the end of the year and if in case of default sell the assets of RMT
to Lehman Brothers within 75 days.
Provide liquidity projections on weekly basis till the maturity of the loan.
In case of bankruptcy or sale of the company, loan was to be prepaid in full.
Should not exceed the Capital expenditures of Williams and subsidiaries of $ 300
million, except RMT.
Maintain a fixed charge coverage ratio of at least 1.15 to 1.
Limit certain restricted payments, including the buyback or redemption of
capital stock of Williams.
On the closing date, parent company was required to borrow at least 5 million
under its revolving credit facility.
Effect of these aforementioned terms to mitigate risk :
 Most of the covenants related to maintain the liquidity and solvency to make
sure Williams must oblige the required payments and there would be a risk
associated if it doesn’t maintain liquidity.
 The ability of cash flows to cover current debt and dividends is very low as of
2001.
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Free Cash flows for Williams is in negatives which suggests company doesn’t
have capacity to finance operations and Capital expenditures. So, we mentioned
to maintain a minimum liquidity of $600 and stepping up to $750 million.
Total Debt/Equity ratio is very high in case Williams which is 5.43 as of 2001
which is very high than its competitors, suggests that company is using all of its
sources of debt. That’s why we considered as $ 2.8 billion worth collateral.
If Williams would maintain the Interest Coverage ratio and fixed coverage ratio
as mentioned, we don’t have to worry about the future payments.
Calculation of Rate of return :
The loan was guaranteed by William Companies as well as by certain subsidiaries of
worth $ 2.8 billion.
(a) Cash Interest Payable = $ 900 million * 3 * 5.8
12 * 100
= 900*3*5.8
12*100
= $ 13.05 million per Quarter
(b) Accrued Interest
(c) Deferred Setup Fee
= 14% * 900 million
= 126 million.
= 15% * 900 million (Assets are not sold)
= 135 million
(d) Deferred Setup Fee Max = 21% * (2800- 900) million (Assuming all 2.8
billion worth Assets are sold)
= 399 million.
Amount of return
= Principal amount + Pre-conditions amount
= 900 + (13.05*4) + 126 + 135
= 900 + 52.2+ 126+ 135
= 1213.2 million or 1.213 billion
IRR = 7.90% per Quarter which can be shown in below Exhibit 1.
Annualized IRR = (1+ 7.90%)^4-1
= 35.52%
Overall return to BH relative to the risks:
We mitigated or totally minimized the risk of offering a loan agreement to Williams
with our own required payments and covenants. We are successful in completely
leveraging the Williams to adhere the terms and conditions. The Rate of return for our
investment is 35.52%. Usually, our company BH will invest in longer terms but in this
case as short-term. I don’t feel any company would made this profit within short time
provided 3 times loan valued collateral and satisfying the covenants. Also, Williams
doesn’t have any options because of consecutive decline of Williams’ credit rating
further limited their ability to participate in the energy marketing and trading business.
Further sale of assets would even maker stock prices of Williams worst.
As per the Exhibit 2 A & B:
The B rating which was the current position of the bond Yields and rating compared to
the market. As per July’02 the Williams Bond rating is B with Yield of 24% and as per
the market it is approx. 15% but as per our deal the Yield will be 35.52%, which is big
benefit to us and of course it’s cost to Williams. We can say overall risk is minute
compared with the returns.
Money requirement for Williams to Overcome Financial Stress:
The Cash required for the Williams is approximately $ 1.2 billion for the second half of
the year and break-up for the cash flows was given below. Cash flow from Operating
activities and Investing activities taken as Zero because, if we calculate the 10 years
average from CFO is $ 733 million per year and it is $ 365 million per half year which
was offset in the balance sheet of the Williams because it’s already exceeded the
amount. Cash flow from Investments is $ 3 billion and can be segregated as $ 936
million for first half and $ 2.4 billion as second half approximately but Williams in need
of cash they won’t spend on it.
Reasons to Invest in Williams:
The reasons to invest in Williams but not restricted to the following:
1) Our CEO : Being a Value investor, ready buyer, who always leverages on buying
assets at rock-bottom prices and holding them until they paid off. Oftentimes, he
provided a ‘lifeline’ to companies experiencing financial distress.
2) Plenty of Cash : Following the collapse of the Internet bubble, we had so much
cash in hand and started investing/purchasing assets especially in the troubled
energy industry and we can spend up to $15 billion in next few years.
3) Potential Opportunity : Despite Williams many difficulties, its asset-based
businesses, including its interstate natural gas pipelines, midstream operations,
exploration, and production, all continued to meet performance expectations.
Between 2000 and 2001, Williams revenues had increased $1.4 billion, due to
higher gas and electric power trading margins, higher petroleum product
revenues, and higher natural gas sales prices.
4) Existing relationship: We already purchased $275 million of Williams
convertible preferred stock and also pipeline assets worth $ 960 million.
Exhibit 1 :
Cash Flow Analysis on Investment as per required payments
CFO
CF1
CF2
CF3
CF4
-900
13.05
IRR
13.05
13.05
1174.05
7.90%
Annualized IRR
35.52%
CF1 to CF4 are the series of cash flow returns on a quarterly basis as per our pre-requisite
condition and CF4 is the minimum amount assumed under deferred set up fee. I just
discounted back the cash flows to arrive the IRR(quarterly) and annually.
Cash Flow Analysis on Investment as per required payments
CFO
CF1
CF2
CF3
CF4
-900
13.05
13.05
IRR
13.41%
Annualized IRR
65.41%
13.05
1438.05
CF1 to CF4 are the series of cash flow returns on a quarterly basis as per our pre-requisite
condition and CF4 is the maximum amount assumed under deferred set up fee. Assumed
total $ 2.8 billion worth sold which is practically not possible. I just discounted back the
cash flows to arrive the IRR(quarterly) and annually
Exhibit 2 A & B :
Exhibit 3 :
Cash required from June i.e. Second Half of the Year
Cash Flow from Operating activities
0
Income before extraordinary
0
Change in Working Capital
0
Extraordinary items
0
Depreciation, Amortization, & other
0
Cash Flow from Investing Activities
0
Net Change in Investments
0
Capital Expenditures
0
Acquisitions and divestments
0
others
0
Cash Flow from Financing Activities
Dividends paid
1230
10
Short-term Debt
711
Current Portion of LT debt
174
Preferred Stock
335
in
million
in
million
in
million