Mci Case
1. What message is MCI trying to send to financial markets?
From 1993 until the start of 1995, MCI’s stock had outperformed the S&P. However, in 1995, the stock’s performance was poorer than the S&P. With shareholder’s getting restless, the idea of a stock repurchase was being considered. Depending on which option MCI chooses—stock repurchase with debt issuance or open market repurchase program—the message being sent could be different. Let’s consider option one—MCI issues debt and uses the proceeds to repurchase stock. According to the article “Raising Capital: Theory and Evidence” by Clifford Smith, the market would likely react very positively to this leverage-increasing event. Because of the information disparity between a company’s management and the financial markets, analysts believe a firm is more likely to repurchase stock if they feel it is undervalued. If MCI issues debt to finance a repurchase, they are implicitly making a statement that their stock is undervalued and they are better served with the tax or other benefits that additional leverage would provide. In addition, this option could be a signal to the financial markets that MCI is trying to change their capital structure to move closer to their minimum WACC. As we know, minimizing WACC will maximize a firm’s value. The second option, open market repurchase, would likely send the message that MCI feels the stock is undervalued. However, the price of the stock would not likely rise as much as it would under a fixed price or Dutch auction repurchase program due to the fact that there is so little regulation and disclosure behind the completion of the open market repurchase program. As we know, more positive, abnormal stock returns occur for fixed and Dutch auction repurchase programs where a company puts its “money where its mouth is.” Finally, the firm’s market-to-book ratio should be considered when determining the “believability” of undervaluation as the primary reason for the
From 1993 until the start of 1995, MCI’s stock had outperformed the S&P. However, in 1995, the stock’s performance was poorer than the S&P. With shareholder’s getting restless, the idea of a stock repurchase was being considered. Depending on which option MCI chooses—stock repurchase with debt issuance or open market repurchase program—the message being sent could be different. Let’s consider option one—MCI issues debt and uses the proceeds to repurchase stock. According to the article “Raising Capital: Theory and Evidence” by Clifford Smith, the market would likely react very positively to this leverage-increasing event. Because of the information disparity between a company’s management and the financial markets, analysts believe a firm is more likely to repurchase stock if they feel it is undervalued. If MCI issues debt to finance a repurchase, they are implicitly making a statement that their stock is undervalued and they are better served with the tax or other benefits that additional leverage would provide. In addition, this option could be a signal to the financial markets that MCI is trying to change their capital structure to move closer to their minimum WACC. As we know, minimizing WACC will maximize a firm’s value. The second option, open market repurchase, would likely send the message that MCI feels the stock is undervalued. However, the price of the stock would not likely rise as much as it would under a fixed price or Dutch auction repurchase program due to the fact that there is so little regulation and disclosure behind the completion of the open market repurchase program. As we know, more positive, abnormal stock returns occur for fixed and Dutch auction repurchase programs where a company puts its “money where its mouth is.” Finally, the firm’s market-to-book ratio should be considered when determining the “believability” of undervaluation as the primary reason for the