AT&T Case Study Essay

1. IntroductionIn this report we leave al ace identify business line risk that AT&T experienced repayable to their divestiture in 1982. We pass on conduct our analysis based on monetary concepts, and finally recommend necessary actions that should apply been conducted when the company formulated its financial policy in 1983. 2. AT&T BackgroundAT&T was founded in 1876 by Alexander Graham Bell. Prior to the divestiture AT&T had been a force to be reckoned with for over a century within the telephone help industry. Before the divestiture the company served over 80% of the US telecommunications users. The sale of these services took place at their 22 local subsidiaries. AT&T was the king-sizedst enterprise in the world with total assets of $137.8 billion and revenue of $58.1 billion. precondition the size of the company they had hired a total of 1,060,378 workers. With a total number of 3,055,495 shareh quondam(a)ers, where 95.3% held less than 600 shares each. constantly sinc e 1885 AT&T had continued to pay its dividend to the shareholders, they never lowered the payment. The divestiture that AT&T experienced was a result of an agreement of the Justice Departments antitrust suit against the company in 1982, which withdraw a major rearrangement of AT&Ts roof structure.The agreement lede to several changes in the structure of the company, and one major change that had a significant impact on the company was how they managed their statistical dispersion channels. Prior to the divestiture they sold their services through their 22local telephone subsidiaries, the company would now be spun off into seven independent regional corporations NYNEX, (N.Y. Telephone and New England Telephone), Bell Atlantic (N.J. Bell, Bell of Pennsylvania, rhombus State Telephone and four Chesapeake and Potomac Telephone Companies), Bell South (South Central Bell and Southern Bell), Ameritech (Indiana Bell, international mile Bell, Illinois Bell, Wisconsin Bell and Ohio Bel l), U.S. West (Mountain Bell, Pacific Northwest Bell and Northwestern Bell), Southwestern Bell (Southwestern Bell) and Pacific Telesis (Pacific Telephone, Nevada Bell).3. historic Financial PolicyAT&Ts overall financial policy, including arse debt ratio and matter to coverage, was designed to maintain an AAA bond rating, which allowed them to reduce acceptance cost and in addition sterilize for sure that funds were available in periods of severe financial dislocation. The dividend policy was relatively conservative for a utility with a target payout ratio of 60% and an actual payout of 58-67%. Their low payout ratio was determined by AT&Ts large capital requirements and the desire to provide some protection for maintaining the stableness of dividends. Stockholders reinvested approximately one third of the dividends. Due to the increased competition and the volatile regulatory climate, AT&T returned to a more than conservative financial policy. Between late 1970 and 1980 the ma nagers were reluctant to issue more blondness through sales of stocks be pose the companys merchandise value was below its book value per share. However, the financial history shows that AT&T allowed investors to purchase invigorated stocks using their menstruation dividends at 95% of current market price.4. Principal ProblemAT&Ts principal problem was non the destiny to raise funds to pay investment fundss, but whether the debt and equity ratios were portion for the smart AT&T. This needs to correspond with the companys financial and strategic goals, and be equal to the market and uncertainties that the company is facing. AT&Ts strategic goal has been to please the potential stockholders categorized as widows and orphans. Widows and orphans are use to advert stocks with a relatively high degree of safety and a stable dividend income. Due to changes in the market and uncertainties that the company was facing, their strategic goals undeniable to be changed. The changewa s however not reflected in their commensurateness sheet. We will further discuss what led to this situation, and give a testimony on the changes that should leave been made prior to the divestiture in 1984.5. Pre Divestiture Business RiskAs a consequence of the governments intervention, the AT&T lawsuit settlement, as well as the shift in the telecommunication industry, it was clear that AT&Ts local telecommunication business was slowly moving away from a monopoly franchise surround. It was moving towards a more competitive environment characterized with more consumer choice and greater competition. Companies such as IBM saw the divestiture of AT&T as an opportunity to provide new telecommunication equipment and services, which would allow them to gain a higher market share. AT&Ts stock had up till then been regarded as a stable utility-type stock because of its arouse growth and consistent dividend yield. However, AT&T should have kept in mind that they would not have as muc h market control in the future as they did prior the divestiture, much due to the intensifying competition and regulatory environment changes. Firstly, the antitrust lawsuit followed by a sudden divestiture could cause uncertainties towards the companys future and might change the shareholders perception of AT&T in an unlucky way. Second, the seven new corporations would be highly independent, and therefore a major rearrangement of the capital structure would be vital.It is credibly that every corporation would differ in terms of e.g. management style and financial performance. These changes could blind drunk that AT&Ts reputation of being a safe and profitable investment could shift to become more volatile and riskier for its shareholders. Finally, AT&T had relied for a want time on their old and out-dated patents, which included old machinery, equipment and plants in order to create profit. As more and more competitors emerged with new technologies and services, AT&T necessar y to keep up with all changes in the market. As a result of the divestiture the R&D was rock-bottom at Bell Laboratories and the maturation-part was eventually intergraded into the occidental Electric division. After these changes many concerns arose relating to the future profitability of Western Electric (WE).Firstly, they were concerned that WE might not be able to attain marketing and product development skills that were vital in operating in thenewly competitive markets. The main reason for this is that the workforce was used to working in a captive market, where competitors were almost non-existent. Secondly, WEs manufacturing labor force had become inscribe at the same time, as their plants were old. This meant that WE would have to invest in R&D to guard sure that their competitors did not exceed them. Their unionized workforce would lead to a considerable increase in requital and WE would have to follow the regulations that were set by the labor union. As a consequenc e these factors would most likely affect both the firms market share and eventually the stock price in a negative way. 6. Analysis and Recommendation6.1 The New Capital StructureSpin-offs often provide a unique setting to assess various capital structures, because one observes the initial capital structure of a mature firm. In a spin-off, a subsidiary is fully divested from a parent and becomes a complete entity. Before this happens, the subsidiary is not able to issue new equity, and is dependent on the parent to finance its capital investments. When the divestiture has occurred, the firms assets are divided between the subsidiaries followed by a new capital structure of the independent firms. The total outstanding debt would be assumed divided between the seven regional operating companies, hence the sharply reduced total debt that is projected in the 1984 balance sheet.There is too reason to believe that AT&T chose to reduce $725 million of their total outstanding debt in 1982, which lead to the reduction in the debt ratio the same year. When aspect at the projected balance sheet one can see that the total debt would be stable at the sum of $9.3 billion from 1983 to 1988, which equals a come of $37.8 billon from 1982. However, due to tax deduction the cost of issuing new debt is lower than using equity. This would mean that AT&T should issue new debt in order to create a balance when financing the investment in R&D, and rather use more of the companys equity to set up an account with emergency funds that will function as a safety net disposed the unpredictable times ahead. 6.2 The New Distribution PolicyWhen establishing a distribution policy, one size does not fit all. Somefirms produce a lot of cash in but have limited investment opportunities. This applies for firms in profitable and mature industries where few opportunities for growth exist. Such firms typically distribute a large percentage of their cash to shareholders, thereby attracting invest ment clienteles that prefer high dividends. AT&T was in such an industry, but subsequently the removal of the monopoly, the market became more volatile. During periods of market volatility, there are investment opportunities if you vitiated where to look. In such markets the firms generally distribute little or no cash but enthral rising earnings and stock prices, and thereby attracting investors who prefer capital gains. AT&T should have adapted to the changes in the market, which required more financial flexibility and a stronger balance sheet. A strong balance sheet should consist of liabilities that are considerably outweighed by assets. If a company is having problems, the balance sheet (together with the cash flow statement) will tell you whether it can stand the strain. 6.2.1 Dividend Pay-outAs mentioned above, AT&T has had a unconstipated increase in dividends payout until the announcement of the divestiture in 1982. The company decided to reevaluate the amount of divid ends and keep it brace at $5.40 per share. AT&T had been a market leader in this industry for a long time, yet their equipment and patents were old, as they had not invested in R&D development. In order for AT&T to have a stronger balance sheet and become more financial flexible in the establishment of the divestiture, AT&T should have cut their dividend payout much former. The company might have been afraid to cut the dividend since this often gives a signaling effect that the firm does not expect high earnings in the future. However, disposed that AT&T was forced into this divestiture, changes had to be made. An alternative measure could therefore have been to make a change in the dividend policy. This could be seen as a risky move, yet if communicated in an appropriate and thoughtful way the shareholders might understand that this was necessary for the companys future growth. Another encouraging factor is that approximately one third of the dividends payout were reinvested b y AT&Ts stockholders, which shows that the current dividend payout was not very inseparable to some of the shareholders. 6.2.2 Repurchase of StockThe firm should overly have repurchased stock some years after the dividend cut, to bolster the share price. Repurchase have a tax advantage over dividends as a way to distribute income to stockholders. Repurchase provides cash to stockholders who want cash while allowing those who do not need current cash. Moreover, repurchase announcements are viewed as positive signals by investors because the repurchase is often motivated by managements belief that the firms shares are undervalued. Finally, repurchases is a effective way to produce large-scale changes in capital structures. 6.3 New Investment PlanThe company should at the same time start looking for new possibilities and investments in order to overcome these volatile times. An alternative could have been to invest in R&D e.g. by acquiring a small company with the knowledge and exper tise that were required in order to compete and be sustainable in the industry. By doing so they would expand their workforce with good deal who had more knowledge about the newer technology and therefore been better equipped when facing the challenges ahead. Not only would this allow AT&T to gain more human capital, but they would also gain newer equipment. It is also said that more good investments will most likely lead to a lower dividend payout, which supports our recommendation of changing the dividend policy. 6.4 Maintaining a Top-Level Credit RatingAT&Ts overall financial policy, including target debt ratio and interest coverage, was designed to maintain an AAA bond rating, which allowed them to reduce borrowing cost and in addition make sure that funds were available in periods of severe financial dislocation. As mentioned earlier AT&T worked hard to maintain the AAA rating, both through debt ratio and interest coverage. Although it should be noted that AT&Ts debt ratio o f 43% was close to fall under the AA ratings. This would have resulted in an increase in average interest cost of 0.7% equal an expenditure of $335.3 million in borrowing cost. Based on this one can conclude that this was a wise decision given the circumstances, and the company should therefore keep their focus on this in the future. A top-level credit ranking will not only give AT&T better conditions when issuing new debt, but also allow them to emerge as a more attractive investment to current and potential new shareholders.ConclusionDue to the antitrust lawsuit and the shift in the telecommunication industry, AT&T needed to adjust their financial and organizational strategy in order to adapt to the changing environment. The main heading of this report has been to identify the risk involved with the divestiture, and find ways to face the challenges ahead. The report recommends a new capital structure policy, where AT&T should issue new debt for further investments rather than usi ng equity. For the distribution policy, dividends should be cut and thereafter consider repurchasing stocks. Furthermore, the company should invest in a R&D through an acquisition of a small high-technology firm that will enable them to gain knowledge and be more innovative. Finally, AT&T should seek to maintain a top-level credit rating to reduce borrowing costs, to assure better conditions when issuing debt and last but not least to be a favored firm for investors.