Weekly Puzzle #10: Leveraged Recapitalization
What is it?
In a leveraged recapitalization, a company keeps its operations intact and changes its mix of debt and equity. That change usually requires borrowing money (which increases debt) and either buying back stock or paying dividends (both of which reduce the aggregate value of equity). The central question on whether a leveraged recapitalization is value adding, neutral or destructive boils down to whether the company doing the leveraged recapitalization was under levered, correctly levered or over levered prior to the transaction. If under levered, the recapitalization will increase value even though the financial standing of the firm will look worse after the recap (a drop in bond rating, an increase in both equity risk and default risk). If over levered, the transaction will make the firm worse off, with the increase in risk overwhelming any tax benefits from the additional debt.
The Walgreens tussle
Walgreens is a US retailer that sells a mix of pharmacy and consumer products. In 2014, Walgreens was targeted by activist investors as a company that could benefit from a recapitalization. The rationale for the activist investor push is at this link. You will see both the activist viewpoint (that Walgreens has too little debt and can borrow more) and the company's perspective (that its ratings will fall below investment grade).
Since both sides have agendas and neither side seems to be looking at the whole picture, it may be worth your time to look at Walgreens' financials on your own. You can get the most recent annual report for Walgreen at this link and a summary of their numbers over the last decade here.