The case of Polaroid in 1996

The case of Polaroid in 1996 is a popular topic of discussion amongst finance specialists due to the complex issues involved. Specifically, after a long period of unsuccessful moves to discover a sales vehicle that will enable the company to resume its success of the early 1970’s, in the mid-1990’s the company is found on the verge of bankruptcy. Its new CEO Di Camillo is facing a very large debt, which is due to mature in six years.

Furthermore,although the company does not perform well in the US market, there seems to be still demand in some overseas emerging markets, including Russia. However, in order for the company to maintain and strengthen its position there, they must find a way out of their overdebting and this cannotb be done unless th3e debt is restructured.

Given the situation described in detail in the case study, there are a few steps to be taken on the part of Polaroid to avoid the immediate dangers they face. Specifically:

1. The company must stop repurchasing their sales as a defence against potential hostile takeover moves by predators.

2. A mixed structure should be adopted as for capital restructuring adjusted to the scenarios of decreasing profitability and increasing profitability. In the former, the restructuring proposal involves a 60% to 40% proportion of new debt/ new shares issued. The existing debt of the company will be rearranged with the use of either long-term bonds or new shares issued. This proportion of debt vs equity reflects the assumed risk by the debtors and the shareholders and the terms in which both groups are willing to contribute to this capital restructuring, given the risk factor they face.

3. In the case of increasing profitability, high expectations take over the increased rewards associated with high risks and a 50% debt over 50% equity scheme is proposed. Again, this scheme takes into account the high expectations of both parties and the ease of the shareholders with regards to the earnings per share as which may be reduced nominally due to the reduced leverage.

4. In any case, as the company is profitable, at least on an operating level, the amount of new capital is set close to the total debt of the company ($580mn) as less may have be insufficient to cover the company’s debts and more may jeopardise the company’s flexibility.

All that, without taking into account other needs rising from the strategic orientation of the company in its overseas concerns, or even its foreign exposure per se. It is believed though that, although digital imaging (which is a resource-intensive industry) may prevail in the near future, still, there is some breathing room for Polaroid in the foreign markets which, coupled with the debt restructuring may offer the company some valuable breathing space before competition catches up again.

All that provided that the company’s management would be more prudent now than what it was during the last 15 years .

Part I:

Factors for Consideration in Dealing with Polaroid’s Capital Structure Issues

In order to consider the factors affecting Polaroid’s Capital structure, one should address first the overall market conditions in which Polaroid operates and then proceed with the assessment of the financial problems of the firm.

A. Market Conditions

With this brief overview we will first allow for a broader perspective of the characteristics of the particular industry in which Polaroid operates. This will enable us to consider the possible courses of strategic action which Polaroid may undertake and which this financial restructuring will be called to serve. These characteristics at the time the events take place, i.e. mid 1996, are as follows :

1. Polaroid is lucky enough to have an exclusive patent in its hands, after having won a serious legal battle with one of their biggest competitors – Kodak. This constitutes a huge asset since the only concern for Polaroid may be the technological obsolescence of its products by the competition’s alternatives, rather than direct competition in its own turf, especially from competitors that might have simply copied its products without having to sustain start-up R&D costs.

2. In this case, Polaroid being, according to the words of its treasurer, “engaged primarily in one line of business”, is a market leader in the selling of instant cameras and film, which for the long term is a stable, low-growth business and, “an incredible annuity”. On the other hand, this undiversified focus in such a narrow industry segment may prove fatal in the long run, if the technology marketed with the Polaroid products becomes obsolete. The positive aspect though is that at the present time Polaroid’s competitors present an unwillingness to invest in and explore the instant camera / film market due to the opportunity costs involved, probably for fear of losing the edge in their efforts to penetrate the booming, highly competitive digital cameras market.

3. So, with this specialisation, Polaroid may have an edge for the medium run (i.e. 2 to 4 years), before digital and instant imaging technologies fully integrate and Polaroid faces direct competition. This gives Polaroid some breathing space in terms of not losing their existing clientele, which consists of large organisations in need of high volumes of particular types of photographs to be used for specific purposes. All that, in contrast to the generic use of digital cameras which, due to their high prices and mediocre resolution , may be not the first choice with regards to the heavy-duty specialised uses that Polaroid equipment has been proven reliable in serving over the years.

4. While the US economy appears to be on an ascending course, the related benefits may not be apparent as overall competition within the US withregards to the industry that Polaroid belongs to, is very high, and thus allowing some optimism only with regards to institutional and  organisational clients in need of large volumes of instant photography.

5. A rather interesting market niche is the one of the emerging and international markets where film-based photography as well as digital photography are either expensive or not supported by the technological environment of the specific countries. In this case, the ease of use of a Polaroid camera coupled with its standalone functionality enabling it to deliver the end product on the spot makes it the perfect choice for instant or quick photography . However, expanding into new geographical territories and establishing a presence there, may involve additional financing, especially in markets where the Polaroid brand name and product awareness is at a minimum, if at all, rendering advertising and promotion with the associated costs, an urgent issue for consideration.

Moreover, even with a phase delay which may range from a few months to a few years, competitors will eventually follow, especially in light of the upcoming integration of imaging technologies as described earlier. This makes the financing issues of such a venture even more urgent, depending on the rate at which the particular markets will mature. The situation may becoms more aggravated in the case that at the time competitors will attempt to seize the particular market, Polaroid’s market penetration or the establishment of a strong market presence is not as successful as planned.

6. The restructuring of the company’s organisation following a customer-centred philosophy with three divisions (Consumer, Commercial, New Business) is indicative of the intentions of the management for the long run. This new orientation prioritises market awareness and responsiveness, probably taking into account the current conditions with regards to competition and emphasizing on the long-term building of strategic value adding in addition to capital restructuring. Also, by adopting a more customer-centred approach instead of the profitability of the business per se, the way a “classical” departmental/ functional structure would indicate , a potential reduction of inter-departmental operating costs may be achievable.

So, in essence, from a Marketing point of view Polaroid’s restructuring must consider the undertaking of any action to not let the product’s uniqueness turn it into a sinking boat, mainly because of the introduction of new products from the competition. Thus, any changes in the capital structure of the company should reflect its effort to maintain its core strengths while expanding wisely to new segments that will not require excess leverage, thus resulting in the company’s deterioration of its current grade-bond rating.

B. Polaroid Finance Issues

At the moment, the financial situation of the company does not seem to be in its brightest moment. The reasons for this rather bleak image are as follows:

1. Polaroid’s current grade-bond rating is BBB according to the S & P standard which lies on the borderline limits of creditworthiness. This will obviously affect the cost of new debt finance would the management of Polaroid consider additional leverage.

2. In addition, the company at the time described in the case study was found to be highly indebted with a total of $567.5mn due in six years . The height of the total amount due and the tight time frame of the maturity structure of the debt require immediate action as to how this situation may be alleviated.

3. The above image is further aggravated by the fact that as per the year’s 1995 income statement , the company has recorded losses amounting to $140,2mn. Although this loss is directly related to extraordinary restructuring expenses incurred in 1995, the net result excluding the extraordinary items would still rise to a $106,8mn, which is, acceptable but still in need of improvement compared to the net earnings of the previous year ($115.2mn) .

4. The company has maintained a stable dividend policy, which guaranteed an uninterrupted $.60 per share dividend to its shareholders. It would rather not be advisable for the company to proceed to any changes with regards to this policy since Polaroid may be in need to capitalise on its reputation regarding the stability of its dividend policy in the case of the issue of new share capital.

5. The company proceeded in terminating projects which constituted liabilities or doubtful sources of income in order to achieve better economies of scale by concentrating in its existing most commercial ones. This was also accompanied by significant layoffs rising up to 20% of the existing personnel, curtailments of various expenses and other cutbacks, eventually resulting in reduced overhead costs.

What follows is the shaping of a financial plan based on the above facts.

Part II:

Recommendations for a Financial plan for Polaroid to Achieve Flexibility

To begin, based on the previous discussion, the main focal points of our actions can be summarised as follows:

1. Restructuring of the company’s debt, which is due within six years into a more rationalised and normalised payment scheme

2. Financing with a view to a changing orientation or diversification in what constitutes the core of Polaroid’s Business activity which may entail several entry costs in other diversified activities

3. Part of the financial plan should cater for the promotional budget in the international markets especially in countries where for various reasons, digital imaging may not expand in the same pace as the US, European or Japanese markets.

Of all the above, item #1 is the most crucial, as no serious expansion may be considered unless the company has some flexibility in order to counter challenges through leveraged means, or even possess the capacity to lure investors by merit of its future prospects. Also, this is the utmost priority due to the urgent nature of the company’s dents maturity structure. The options open in this case are as follows:

* Repaying the debt with 100% equity. In this case, if Polaroid attempts to issue shares over a period of six years, equal to the amounts owed, in theory, they may balance the situation without aggravating the company’s debt status. However this move will constitute an alarming sign to the general public as to NOT buy shares that may be overvalued and which will not used to produce financial yields. So, in the medium run, the company may jeopardise its real market value (which may already be overrated due to various analysts expectations) and lose face in the eyes of the public, something that may be paid dearly in the case the company chooses to merge later to avoid bankruptcy)

* Repaying the dept using 100% debt capital: A rational solution for Polaroid would be to issue long-term bonds (i.e. 15-year or longer) in an attempt to “spread” the debt over a longer period of time and treat it Regardless of the structure of this scenario, one should take into account the full implications in the company’s bond rating, as well as the duration of this new debt re-arrangement. Needless to say that it would be fair to assume that the markets may not respond given the risk factor associated with over-debting.

* Mixed solution – Debt and equity:

Using a mixture of debt and equity capital could be a solution, since it incorporates the advantages of leverage, while it allows the company some potential flexibility. Since the company is still profitable at an operating level (especially in its overseas operations), the amount of the financing should rise close to the total debt amounting to $567,0mn. In our scenarios, the figure of $580mn was chosen.

With regards to the equity part, Polaroid should immediately stop repurchasing its shares, proceed to selling some of their existing stock to alleviate the imminent costs of raising new capital, bond or share, while concurrently start issuing new shares. The finance scheme should take into account the following:

– In case of decreased profitability, the breakdown between share capital to debt should be such so as to balance the associated high cost of debt capital that will incur due to the undertaking of high risks on the part of the bond holders, while at the same time, to allow for the best possible gearing ratio in order for the public to buy the company’s shares at a combination where price and the expectations of earnings per share will justify the purchasing of the shares on their part.

Fulfilling both requirements may not be easy since they constitute conflicting parameters; on the one hand the bond holders will be willing to buy only if the bond yields are rewarding for the risk they undertake (considering that Polaroid at this time is rated BBB by S&P) and so, Polaroid may not be willing to issue many bonds at high cost, while on the other hand, issuing many bonds would enable high leverage and EPS expectations and attract large numbers of shareholders .

A possible time schedule for the above scheme can be as follows:

Figure 1: Polaroid Proposed Mixed Financial Scheme – Declining Profitability

Total amount 100% $580,00

(in $mn)

Equity 40% $232,00

Total (in $mn)

Debt 60% $348,00

Total (in $mn)

Equity Debt

Payment Amount % Yearly Amount Accrued Amount Amount

Year (in $mn) (in $mn) (in $mn) (in $mn)

1996 15% $87,0 $87,0 $34,80 $52,20

1997 20% $116,0 $203,0 $46,40 $69,60

1998 20% $116,0 $319,0 $46,40 $69,60

1999 20% $116,0 $435,0 $46,40 $69,60

2000 15% $87,0 $522,0 $34,80 $52,20

2001 10% $58,0 $580,0 $23,20 $34,80

Totals $580,0 $232,00 $348,00

(in $mn)

Note the escalation of the percentages of the total amount towards the middle of the repayment period so as to correspond with the volume of payments as per the debt’s maturity structure.

– In case of increased profitability, things may become relatively easier, since the company may allow for less leverage to alleviate the pressures on their credibility status and all that without exercising much concern for the risk taken by its creditors. A “mirror” approach involving 60% share capital and 40% debt may be the best alternative in this case. A timetable of this approach is given in as follows:

Figure 2: Polaroid Proposed Mixed Financial Scheme – Increasing Profitability

Total amount = 100% $580,00

(in $mn)

Equity 60% $348,00

Total (in $mn)

Debt 40% $232,00

Total (in $mn)

Equity Debt

Payment Amount % Yearly Amount Accrued Amount Amount

Year (in $mn) (in $mn) (in $mn) (in $mn)

1996 15% $87,0 $2.407,0 $52,20 $34,80

1997 20% $116,0 $2.523,0 $69,60 $46,40

1998 20% $116,0 $2.639,0 $69,60 $46,40

1999 20% $116,0 $2.755,0 $69,60 $46,40

2000 15% $87,0 $2.842,0 $52,20 $34,80

2001 10% $58,0 $2.900,0 $34,80 $23,20

Totals $580,0 $348,00 $232,00

(in $mn)

What is worth mentioning here is that the amount of capital to be raised may also depend on the strategic orientations of the company, especially with regards to its overseas operations. In any case, as Di Camillo, Polaroid’s CEO pointed out, there cannot be a “99 percent solution” and getting out of the yoke of overdebting while seeking means and resources to diversify may prove very difficult to serve at once.

REFERENCES

Brealey R, Myers S (2003), Principles of Corporate Finance, McGraw-Hill, USA

Meigs R, Meigs R F (1998), Accounting: The Basis for Business Decisions, McGraw-Hill, USA

MSc Finance, Unit Readers 1-3 – Finance III (Open Learning: Greece), University of Strathclyde

Puxty A, Dodds J (1991), Financial Management: Method and Meaning, Chapman and Hall, UK

ADDITIONAL WEB REFERENCES

Bizjournals.com (2005) “Polaroid’s debt rating cut because Second Quarter Loss”, in http://www.bizjournals.com/boston/stories/2001/06/11/daily42.html

Hyperstrategy.com (2005), “Case Study: Polaroid 1996”, in http://www.hyperstrategy.com/c5.htm

McCracken, M. E. (2005), “The Cost of Capital ” in http://teachmefinance.com/costofcapital.com

Reem Hackal (2005), “What is a Corporate Credit Rating”, in Investopedia.com http://www.investopedia.com/printable.asp?a=/articles/03/102203.asp