The University of Chicago
Cases in Financial Management
Assignment 4 - MCI
January 26, 2010
MCI's convertible debt financing alternative differs from the debt + warrants alternative in a number of ways. First, the total size of the offering is much larger in the debt + warrants alternative ($1Bn vs $600MM), which would allow MCI to finance a larger portion of its cash flow deficit going forward - based on the given projections, MCI will have negative free cash flows of $442MM in 1984 and $872MM in 1985. MCI only has cash reserves of $542MM, so it needs to raise an additional $772MM to finance its projected cash flow deficits for the 2 years following the offering. The debt + warrants alternative would suffice to fully finance this immediate deficit, while the smaller convertible debt offering would inevitably have to be complemented with a subsequent offering sometime in the next 2 years. Considering the current low interest rate environment, the debt + warrant option seems like an opportunity to lock in relatively low interest rates.
Second, the maximum dilution to current shareholders relative to the proceeds raised on the offering is lower in the debts + warrants alternative. As seen in Exhibit 1, up to 18.2MM additional common shares would have to be issued in the debt + warrants alternative in case all warrants are exercised, diluting current MCI shareholders by up to 13.4%. In the convertible debt alternative, up to 11.1MM common shares could be created, diluting shareholders by 8.7%. However, the former alternative raises $1Bn for MCI, while the latter raises only $600MM. Had the convertible debt offering been of the same size ($1Bn), current MCI shareholders would have been diluted 14.3% - a 1% difference that at today's share price of $47 can be valued at close to...