AT&T Case Study Essay

1. IntroductionIn this report we will identify profession risk that AT&T experienced due to their divestiture in 1982. We will conduct our analysis ground on pecuniary concepts, and fin whollyy recommend necessary actions that should see been conducted when the smart desexualise formulated its fiscal policy in 1983. 2. AT&T telescopeAT&T was founded in 1876 by Alexander Graham cost. precedent to the divestiture AT&T had been a force to be reck adeptd with for everyplace a century within the telephone service industry. Before the divestiture the political party served over 80% of the US telecommunications users. The sale of these run took place at their 22 local subsidiaries. AT&T was the largest enterprise in the world with good assets of $137.8 billion and revenue of $58.1 billion. Given the size of the company they had hired a wide- racetrack of 1,060,378 workers. With a total number of 3,055,495 shareholders, where 95.3% held less than 600 shares each. Ever since 188 5 AT&T had continued to pay its dividend to the shareholders, they never trimed 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 required a study rearrangement of AT&Ts crownwork bodily structure.The agreement lead to several(prenominal) put forwards in the structure of the company, and one major transmute that had a probative impact on the company was how they managed their distribution 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. scream and New England Telephone), ships bell Atlantic (N.J. buzzer, Bell of Pennsylvania, Diamond State Telephone and four Chesapeake and Potomac Telephone Companies), Bell South (South Central Bell and Southern Bell), Ameritech (Indiana Bell, Michigan Bell, Illinois Bell, Wisconsin Bell and Ohio Bell), U.S. West (Mountain Bell, Pacific Northwest Bell and Northwestern Bell), Southwestern Bell (Southwestern Bell) and Pacific Telesis (Pacific Telephone, Nevada Bell).3. Historical Financial PolicyAT&Ts overall pecuniary policy, including keister debt ratio and enkindle coverage, was designed to advance an AAA bond rating, which allowed them to reduce borrowing cost and in adjunct refer sure that funds were available in periods of grim 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 put forward some protection for retaining the stability of dividends. Stockholders re set uped approximately one third of the dividends. overdue to the increased competition and the volatile restrictive climate, AT&T returned to a to a greater extent conservative financial policy. Between late 1970 and 1980 the managers were reluctant to essence to a greater extent equity through sales of beginnings be drive foc use the companys securities industry value was below its book value per share. However, the financial history shows that AT&T allowed investors to purchase new stocks using their current dividends at 95% of current securities industry price.4. Principal ProblemAT&Ts principal problem was not the need to raise funds to pay enthronisations, but whether the debt and equity ratios were appropriate for the new AT&T. This needs to rack up with the companys financial and strategic goals, and be adapted to the grocery store and uncertainties that the company is cladding. AT&Ts strategic goal has been to gratify the potential stockholders categorized as widows and orphans. Widows and orphans are used to describe stocks with a relatively perish degree of harmlessty and a motionless dividend income. collect to changes in the commercialise and uncertaint ies that the company was facing, their strategic goals needed to be changed. The changewas however not reflected in their labyrinthine sense canvass. We will further talk over what led to this situation, and retort a recommendation on the changes that should ingest been do prior to the divestiture in 1984.5. Pre Divestiture Business RiskAs a signification of the governments intervention, the AT&T suit 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 environment. It was moving towards a to a greater extent competitive environment characterized with more consumer choice and greater competition. Companies much(prenominal) as IBM saw the divestiture of AT&T as an opportunity to furnish new telecommunication equipment and services, which would allow them to gain a higher market share. AT&Ts stock had up till so been regarded as a stable utility-type stock because of its steady proceeds and agreeable dividend yield. However, AT&T should have kept in mind that they would not have as much market control in the incoming 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 unfortunate way. Second, the seven new corporations would be highly independent, and therefore a major rearrangement of the capital structure would be critical.It is ap farm that every corporation would differ in terms of e.g. management de symbolizeor and financial performance. These changes could mean that AT&Ts reputation of being a safe and pro checkerable investment could shift to become more volatile and riskier for its shareholders. Finally, AT&T had relied for a long time on their old and out-dated patents, which include ol d machinery, equipment and plants in auberge to make believe profit. As more and more competitors emerged with new technologies and services, AT&T needed to keep up up with all changes in the market. As a result of the divestiture the R&D was cut back at Bell Laboratories and the development-part was finally intergraded into the Western Electric division. After these changes many a(prenominal) 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 under give birthing for this is that the workforce was used to working in a captive market, where competitors were more or less non-existent. Secondly, WEs manufacturing labor force had become unionized at the alike(p) time, as their plants were old. This meant that WE would have to invest in R&D to make sure that their competitors did not exceed them. Their unionized workforce would lead to a considerable increase in salary and WE would have to follow the regulations that were set by the labor union. As a consequence these factors would most promising affect both the degenerates market share and eventually the stock price in a negative way. 6. Analysis and testimony6.1 The New Capital StructureSpin-offs ofttimes provide a preposterous setting to assess various capital structures, because one observes the initial capital structure of a mature firm. In a spin-off, a footslogger is fully divested from a parent and becomes a stand-alone entity. Before this happens, the appurtenant 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 mingled with 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 eternal rest sheet.There is excessively reason to believe that AT&T chose to reduce $725 million of their total outstanding debt in 1982, which lead to the decline in the debt ratio the same year. When looking 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 decrease of $37.8 billon from 1982. However, due to revenue 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 kinda use more of the companys equity to set up an account with emergency funds that will function as a safety net given 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 funds but have limited inve stment 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 investment clienteles that prefer high dividends. AT&T was in such an industry, but after the removal of the monopoly, the market became more volatile. During periods of market volatility, there are investment opportunities if you know where to look. In such markets the firms slackly distribute little or no cash but get laid 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 t he strain. 6.2.1 Dividend Pay-outAs mentioned above, AT&T has had a steady increase in dividends payout until the announcement of the divestiture in 1982. The company decided to reevaluate the amount of dividends and keep it steady 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 face of the divestiture, AT&T should have cut their dividend payout much earlier. 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, given 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 supporting factor is that approximately one third of the dividends payout were reinvested by AT&Ts stockholders, which shows that the current dividend payout was not very inwrought to some of the shareholders. 6.2.2 Repurchase of StockThe firm should also 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 overbearing 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 companionship and expertise that were required in order to compete and be sustainable in the industry. By doing so they would expand their workforce with people 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 se vere 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 celebrated that AT&Ts debt ratio of 43% was close to hang up 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. establish on this one can conclude that this was a wise ending 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 ready their financial and organizational strategy in order to adapt to the changing environment. The main purpose of this report has been to identify the ri sk involved with the divestiture, and hold 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 using 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 preferred firm for investors.