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Boeing Sacrifices Stakeholders’ Value by Raising $25 billion

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What happened?

Boeing just announced its decision to raise $25 billion via bonds, which came just after its declaration to lay off 10% of its workforce. This decision was not entertained by the shareholder which was observed by the fall in the share price by almost 5.4% and there’s the likelihood that its shares will fall further over the coming weeks.

Boeing

So What?

Same day brought huge losses to the company’s supplier in the stock market. Extreme speculations were done on whether Boeing will take assistance from government under CARES act or not before this decision of selling the bonds was made. Any such help would bring along restrictions on CEO pay, dividends, share buybacks and layoffs. This decision of Boeing’s clearly doesn’t go with safeguarding the shareholder’s value. Boeing’s share price fell by 5.4% in comparison to the market decline of 2.8% the next day. An abnormal return of -2.6% was observed by Boeing after the bond sale occurred.

Spirit Aerosystem holdings one of Boeing’s suppliers reacted even more adversely after this new outbreak as it lost 7.6% market value on this decision. Hexcel corp. another supplier lost almost 8% in a span of single day. Though suppliers should be happy with this decision as Boeing could fulfill its immediate obligations of paying the suppliers but they aren’t as Boeing already had a debt of $40 billion before the sales which now added to it a $25 billion extra debt during the struggling phase by airline industry clearly puts Boeing at high default risk.

Operating cash flow Q1 2020 of Boeing came out to be negative at $4.3 billion as deliveries of aircraft were postponed due to corona virus pandemic.Boeing’s leverage has gone beyond the limit where adding extra debt could have improved the overall value of the company as there is negative reaction in the stock market. Boeing’s credit rating was also downgraded to BBB by S&P which if gets further downgraded into the junk bond category; Boeing would have to pay a comparatively higher coupon rate to the investors. Boeing was also loaded with huge amount of other liabilities which included accounts payable and losses on lawsuit of 737 max accidents.

 

The liabilities graph of Boeing has only been rising from past years but as it was mentioned earlier that Boeing Company has passed the optimal point because of which adding extra debt will only degrade its value instead of improving it.

Now What?

A number of debt contracts will probably become binding on Boeing which will restrict its financial and operational flexibility in the coming future. Impact of all these future possibilities can be seen in the current valuation of stock market. Corporate bond market is inclined towards proving Boeing with capital even at this phase of economy as there is an increase in hunger for credit risk in the market because Fed which is Federal Reserve Bank desires to buy credit sensitive instruments. By entering the bond market, Boeing can enjoy the advantage of government assistance that too without handing over any power to the government. On one hand it resolves Boeing’s issue of short term liquidity but on the other hand considering long run a higher leverage will not be favorable to its stakeholders.

Drastic decline in the value of Boeing can be observed.

Boeing could have also raised some amount of fund from equity be it private placements or public issues. In order to keep the default risk low Boeing could have considered these possibilities also increasing its increasing its equity capital. Keeping the default risk lower helps the firm to balance its investment plans also satisfying its labor force. But in the process the managers of Boeing must be inclined towards foregoing some power and diluting the stake of already existing stakeholders. Boeing plays an important role in the economy. The long term survival of the company is way beyond than the problems of shareholder’s return and managerial control.

It is advisable for the company to preserve a desired limit of equity in order to stay away from financial distress or bankruptcy. Top managers of the firm should have the willingness to dilute their control so that they can benefit all its stakeholders and not only the bond investors and top managers which are possible by considering equity capital to lower their default risk. In the whole process as it appears to be it is the bond investors who are benefiting through government intervention and top managers who are enjoying full control of power in the firm as funds are raised by bonds.

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