Harvard Case - HYFLUX LTD.'s PERPETUAL CAPITAL SECURITIES: DEBT OR EQUITY?
"HYFLUX LTD.'s PERPETUAL CAPITAL SECURITIES: DEBT OR EQUITY?" Harvard business case study is written by Jian Ming, Tan Kai Guan Clement, Nandini Vijayaraghavan. It deals with the challenges in the field of Accounting. The case study is 20 page(s) long and it was first published on : Jul 12, 2020
At Fern Fort University, we recommend that Hyflux Ltd. issue a hybrid security that combines elements of both debt and equity. This approach would allow the company to access capital while mitigating the risks associated with traditional debt financing and preserving equity ownership.
2. Background
Hyflux Ltd. is a Singapore-based water treatment company facing financial difficulties. The company is seeking to raise capital to fund its expansion plans and repay existing debt. The case study presents a dilemma: should Hyflux issue debt or equity'
The main protagonists in this case study are:
- Hyflux's management: They are responsible for making the decision on how to raise capital and need to consider the financial implications and potential risks.
- Investors: They are interested in the return on their investment and the potential risks associated with Hyflux's financial situation.
- Creditors: They are concerned about the company's ability to repay its existing debt and the impact of any new financing on their claims.
3. Analysis of the Case Study
The case study can be analyzed using a framework that considers both financial and strategic aspects:
Financial Analysis:
- Financial Statements: Hyflux's financial statements reveal a significant debt burden and declining profitability. The company's balance sheet shows a high debt-to-equity ratio, while the income statement reflects declining net income. The cash flow statement highlights challenges in generating sufficient cash flow to cover debt obligations.
- Financial Performance Measurement: Key performance indicators like return on equity, debt-to-equity ratio, and interest coverage ratio indicate a deteriorating financial position.
- Cost Analysis: The case study mentions Hyflux's focus on cost accounting and activity-based costing to improve efficiency. However, these efforts have not been sufficient to offset the financial challenges.
- Risk Management: Hyflux faces significant risks, including operational risks, regulatory risks, and financial risks. The company needs to develop a robust risk management framework to mitigate these risks.
Strategic Analysis:
- Corporate Strategy: Hyflux's growth strategy relies on expanding into new markets and developing innovative water treatment technologies. However, the company's financial constraints are hindering its ability to execute this strategy.
- Business Model: Hyflux's business model is based on providing water treatment solutions to both public and private sectors. The company needs to assess the viability of its business model in light of its financial situation and the competitive landscape.
- International Business: Hyflux operates in various international markets, exposing it to currency fluctuations, political risks, and regulatory differences. The company needs to carefully manage its international operations to mitigate these risks.
- Sustainability: Hyflux's operations have a significant environmental impact. The company needs to consider environmental sustainability in its decision-making process and develop strategies to minimize its environmental footprint.
4. Recommendations
Hyflux should issue a hybrid security that combines features of both debt and equity. This approach, often referred to as Perpetual Capital Securities, offers several advantages:
- Access to Capital: The issuance of hybrid securities will provide Hyflux with the necessary capital to fund its expansion plans and repay existing debt.
- Reduced Financial Risk: Compared to traditional debt financing, hybrid securities offer a lower risk profile for Hyflux. This is because they typically have a lower interest rate and do not have a fixed maturity date.
- Preservation of Equity Ownership: Issuing equity would dilute existing shareholders' ownership. Hybrid securities allow Hyflux to raise capital without diluting its equity base.
Key Features of the Hybrid Security:
- Fixed Interest Rate: The security should offer a fixed interest rate to provide investors with predictable returns.
- Convertible Option: The security should be convertible into equity at a predetermined price and time, giving investors the potential to participate in Hyflux's future growth.
- Perpetual Maturity: The security should have a perpetual maturity, meaning it does not have a fixed maturity date. This will reduce Hyflux's debt burden and provide flexibility in managing its cash flow.
5. Basis of Recommendations
This recommendation considers the following factors:
- Core Competencies and Consistency with Mission: The issuance of hybrid securities aligns with Hyflux's mission of providing sustainable water treatment solutions. It allows the company to access capital while maintaining its focus on long-term growth.
- External Customers and Internal Clients: The hybrid security will provide Hyflux with the resources to meet the needs of its external customers and internal clients.
- Competitors: Hyflux's competitors are also facing financial challenges. The issuance of hybrid securities will help the company maintain its competitive position.
- Attractiveness: The hybrid security offers a compelling investment opportunity for investors seeking a combination of predictable income and potential growth.
- Assumptions: This recommendation assumes that Hyflux's management will effectively manage the risks associated with the hybrid security and that the company will be able to achieve its growth targets.
6. Conclusion
Hyflux Ltd. is facing a critical juncture. The issuance of a hybrid security offers a viable solution to the company's financial challenges. This approach allows Hyflux to access capital while mitigating the risks associated with traditional debt financing and preserving equity ownership. By carefully structuring the hybrid security, Hyflux can attract investors and achieve its growth objectives.
7. Discussion
Other alternatives not selected include:
- Issuing Equity: This option would dilute existing shareholders' ownership and could lead to a loss of control for management.
- Seeking a Bank Loan: Obtaining a bank loan would increase Hyflux's debt burden and potentially limit its financial flexibility.
- Mergers and Acquisitions: This option could be complex and time-consuming and may not be feasible in Hyflux's current financial situation.
The key risks associated with the recommended approach include:
- Interest Rate Risk: If interest rates rise, the cost of the hybrid security could increase, impacting Hyflux's profitability.
- Conversion Risk: If the conversion price is too high, investors may not exercise their conversion option, limiting Hyflux's ability to raise capital.
- Market Risk: The market value of the hybrid security could fluctuate, exposing Hyflux to potential losses.
8. Next Steps
To implement this recommendation, Hyflux should take the following steps:
- Develop a detailed prospectus: This document will outline the terms of the hybrid security and provide investors with all necessary information.
- Engage with potential investors: Hyflux should engage with institutional investors and other potential buyers of the hybrid security.
- Obtain regulatory approvals: The issuance of the hybrid security will require approval from relevant regulatory authorities.
- Issue the hybrid security: Once all necessary approvals are obtained, Hyflux can issue the hybrid security to investors.
By taking these steps, Hyflux can successfully issue a hybrid security that will provide the company with the capital it needs to overcome its financial challenges and achieve its growth objectives.
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Case Description
Hyflux Ltd., a Singapore Exchange (SGX) listed sustainable water and energy solutions company, declared losses for the first time since its listing more than a decade ago, and expressed its inability to service its debt and pay distribution to holders of its perpetual capital securities and perpetual preference shares. These investors were in a state of shock and disbelief when barely 5 months later, in May 2018, Hyflux suspended the trading of its shares on SGX and opted for a court-supervised debt reorganisation process. Where had Hyflux, the erstwhile poster child of Singapore's innovation and entrepreneurship capabilities, erred?
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