WorldCom, Inc Corporate Bond Issuance

This case raises many interesting questions concerning the record condition issuance of corporate debt by WorldCom, Inc. (WorldCom). Both the surprisingly voluminous structure of the proposed issuance and the foreboding macro-economic mode in which it was slated spark concerns everywhere the risk and cost of the move. One of the first questions that must be communicate is whether WorldComs timing was appropriate. Next, the smart go unders choice of structure for the chemical alignment issuance must be analyzed.Finally, the cost of issuing each tranche of debt must be estimated in order to determine how much WorldCom is rattling giving up to achieve the $6 billion in funds. Timing of the Bond Issuance Advantages In determining whether the first week of August 1998 was the most opportune m for WorldCom to foodstuff such a large bond issuance, the advantages of this time must be weighed against the disadvantages. First, we provide cover the advantages.The announcement of WorldComs monumental merger with MCI had recently boosted awareness and interest in the firm in a positive way of life (as evidenced by the surge in stock-price). This was especially important since the merger was set to be financed by the offspring, frankincense incentivizing investors to partake. WorldCom would not have had sufficient funds to complete the merger without the issue, and a WorldCom and MCI merger would be extremely advantageous for all parties involves. Post merger, WorldComs credit rating was expect elevate, which would enable the company to borrow at a lower rate.Finally, the macro-economic crisis in Asia had recently shifted investors interest away from equities to corporate bonds and treasuries, thus drawing even more interest in the WorldCom opportunity. Timing of the Bond Issue Disadvantages Although the advantages are numerous, the disadvantages of WorldComs timing are seemingly more persuasive. WorldCom had chosen to grocery store the issuance in a time when corporate yield spreads over treasuries had increased, thus granting investors the ability to demand more return. In addition, WorldCom was not the exclusively company issuing a large supply of bonds at that time.In fact, there were many issues set to hit the market around the same time. The sudden influx of corporate debt into the market would apply constrict on the price of the bonds while granting investors a wide range of opportunity and control. In addition, the economic tumultuousness in Asia at the time had caused a great deal of uncertainty about the future of the fixed-income market and the overall scrimping, thus pushing investors towards default-free treasury securities and away from corporate debt. Structure of the Issuance WorldCom has the option to fail its bank loan credit facility or to issue this large $6 billion in debt. It plans to use the rolling commercial paper program to pay British Telecommunications for MCIs share purchases, and and then use bond proceeds to pay off the commercial paper program. This signals that WorldCom does not need the bullion immediately for a single corporate purpose, and does not need the money immediately. Therefore, perhaps it makes sense for WorldCom to issue the bonds in smaller installments rather than flooding the market with $6 billion in debt all at once.The first reason for this is that, if an underwriter must first purchase the bonds before selling to investors, an underwriter may demand greater spread in order to justify taking down an entire $6 billion in debt using the banks capital assets. The sulfur reason is that, regardless of underwriting structure, market demand might not match market supply. If WorldCom is planning to issue $6 billion on top of other issuance this week, traders might not have sufficient inquiry to justify purchase large amounts of bonds. Choosing a Bond Issue Instead of a Direct Bank Loan WorldCom could overly choose to increase its bank loan use. However, us e of a direct bank loan has associated with it several(prenominal) drawbacks for an issuer. First, WorldCom (or any corporate issuer) is often required to post collateral. Second, banks often require restrictive covenants which posterior be either positive or negative for example, requiring a company to maintain a certain rate-setting functioning (positive), or preventing a company from engaging in a leveraged buyout transaction (negative). Estimated Cost of the Issuance From the covenants contained we can see that there are no embedded options in WorldComs proposed bonds.Thus, we can use the effected 3-step approach to price the bonds. The first step is to estimate the cash flow that WorldCom could expect to receive over the life of the bonds. If the coupon rate is equivalent to the yield required by the market, then the bond go out sell at par value. Thus, we set the coupon rate equivalent to the yield required by the market because we believe the bonds would sell at par. The next step is to determine the appropriate interest rate. Investors pass on require a yield premium over the U. S. Treasury security (Exhibit 1).This yield premium reflects the special risks that investors will accept. For WorldCom, who was currently rated Baa2 by Moodys Investors Service and BBB+ by Standard & Poors, the 3-years, 5-years, 7-years, and 30years bond spread over Treasury security should be 66BP, 75BP, 82BP, 107BP respectively (see Exhibit 2). Accordingly, the interest rate would be 6. 14%, 6. 26%, 6. 38%, and 6. 80% respectively. The final step is to determine the present value of the expected cash flow calculated in the first step, using the interest rate computed in the second step.Since we have used the yield that the market required as our coupon rate, the bond will be issued at par. So, using the information gathered, analysts may come up with a yield of 6. 14%, 6. 26%, 6. 38%, and 6. 80% for the 3-years, 5-years, 7-years, and 30years bond respectively (Exhibit 3). The deal was marketed to investors and the book was built. Compared with the data on the recent prices of the bonds of telecommunications and media firms (Exhibit 4), this cost of financing was not so high. However, it was the beginning of financial crises.In times of recessions, investors may concern that issuers will face a decline in cash flow that would be used to service its bond obligations. As a result, the credit spread tends to widen and the price of all such issues throughout the economy will decline. Conclusion Overall, it appears that the cost of financing will be reasonable. However, there are individual market factors that occur on the date of issuance that will still be determined. Underwriter preference, market demand, out of the blue(predicate) market dislocation, Federal Reserve action or announcements and other factors could suddenly uproot WorldComs plans for a smooth issuance process.