Study Document
American Superconductor Case Study Founded in April Essay
Pages:3 (870 words)
Sources:3
Subject:Business
Topic:Debt Financing
Document Type:Essay
Document:#97936238
American Superconductor Case Study
Founded in April 1987 with $4.5 million in seed capital from an investment consortium (Google Timeline. American Superconductors. 2010); American Superconductor has grown into a "global leader in renewable energy, providing proven, megawatt-scale wind turbine designs and electrical control systems" (American Superconductors: Investors. 2010). The company works to "develop solutions and manufacture products to dramatically improve the cost, efficiency and reliability of systems that generate, deliver and use electric power" (AMSC. Annual Report 2003). Throughout its two decades of operation the company has needed capital to expand its operations, develop innovative technologies, and invest in capital projects with a design on profitability for the company and its shareholders; a feat the organization achieved for the first time with "$16.2 million, or $0.36 per diluted share, in net income for full year fiscal 2009" (AMSC. Annual Report 2010). The long road to profitability though is marked by difficult management choices regarding how to raise requisite capital. The 2003 article detailing the company's decision to raise capital through a stock offering rather than utilizing "a 50 million secured debt financing agreement" (Esposito, A. August 26, 2013) was characterized by management as "in the best interest of our shareholders" (Esposito, A. August 26, 2013). The management's decision provides an opportunity to explicate the positives and negatives of equity as opposed to debt, and whether the company's strategy was correct given their circumstances.
At the outset there is an important distinction to be made; companies rarely have strictly a one or the other choice between debt and equity, rather there is ratio of debt and equity referred to as the capital structure. For American Superconductor the company's balance sheet lists approximately liabilities of 11 million in 2003 and 119 million in 2009 respectively. The company prior to the stock offering reported 21 million and 20 million shares issued and outstanding respectively in 2003 (AMSC. Annual Report 2003). A company's decision on debt or equity also is not strictly a stock issuance or bank financing arrangement, an organization can also consider bond issuance as a form of borrowing. These components comprise what is known as the Weighted Average Cost of Capital; "a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt are included in a WACC calculation" (Investopedia. Weighted Average Cost of capital N.D.). This calculation in turn reflects an organization's requisite return on investment for projects. In determining capital budgeting decisions the WAAC provides the foundation for determining the hurdle rate for evaluating potential…
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The advantages and disadvantages of debt and equity are fairly straightforward however, their implications are critical to business success. In understanding the choice of American Superconductors it is necessary to look at the core differences between debt and equity: ownership of the business, assumption of debt load and required repayment or expected return, and tax deductibility of interest (Kansas Technology Enterprise Corporation. N.D.). These three pieces can then be analyzed in the context of the CEO Gregory Yurek's three factors leading to the decision to use an equity capital strategy: revenue momentum, profitability of the temperature superconductor motor and generator business unit, and the national energy grid upgrade debate (Esposito, A. August 26, 2003).
Ownership of the business is perhaps the most critical component in the differences between debt and equity financing. The public offering of 4,975,000 shares of common stock is the sale of a portion of company ownership held by the majority stock owners to potential buyers (MarketScreen. October 3, 2003). The stock issuance has two effects. First a reduction of the majority's percentage ownership of the firm and second a dilution of existing common stock outstanding as a result of the 4,975,000 increase in total issued shares to 26,359,920 (MarketScreen. October 3, 2003). Management "estimates the net proceeds to us of this offering to be approximately $44.0 million based on the public offering price of $9.50 per share" (MarketScreen. October 3, 2003). With expanded ownership of the business by additional shareholders, management will necessarily have to consider organizational decision making in the context of increasing shareholder value. Counter equity and its ownership position with debt which constitutes no ownership stake for the lender, and therefore the business owners are responsible only for repayment of the loan or bond offering according to the terms of the agreement.
Assumption of debt load underscores the financial liability which a firm undertakes with a loan or bond commitment in contrast to a scenario of no new debt if the firm pursues the equity route. With a debt transaction the borrower is legally obligated to pay the bank, lender, or bondholder an agreed upon sum, with interest, over a specified amortization period until the loan or bond is paid in full, called in, or refinanced. American Superconductor would consider whether their operating cash flow would cover the interest generated by the borrowing agreement. A particularly useful analytical tool for this purpose is times interest earned "a metric used to measure a company's ability to meet its debt obligations. It is calculated by taking a company's earnings before interest and taxes (EBIT) and dividing it by the