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Polaroid

Polaroid In 1990, Boeing dominated the commercial-jet aircraft industry. In an effort to maintain its 54 percent market share and competitive position, the company had to decide whether or not to continue development on its newest airframe, the 777. Initial product demand seemed strong but escalating tensions in the Middle East made the demand for future air travel uncertain. Moreover, Boeing’s competitors had already begun development on similar airframes that would reach the market before the 777. In light of the company’s recent poor stock performance and its mission to raise its return on equity, the question of the new aircraft’s profitability became paramount. In March 1996, Ralph Norwood, treasurer of Polaroid Corporation, was asked to consider refinancing proposals from investment bankers of $150 million of debt due to mature in January 1997. Gary DiCamillo, newly appointed CEO of the firm,in reaction to the company's lagging share price, had set forth a new plan to agressively expoit the existing Polaroid brand, introduce product extensions, and enter new emerging markets. Before Norwood can choose a refinancing proposal, he must consider the funding needs of DiCamillo's new corporate strategy and the capital structure which would provide the lowest cost of capital and most financial flexibility. Norwood also needed to consider the maturity structure of debt. Polaroid Corporation has been engaged primarily in the business of designing, manufacturing, and selling instant photographic imaging products worldwide. Since 1948, this mission has led them to develop instant black-and-white film in 1954, instant color film in 1960, and the SX-70 camera in 1972 which no longer required users to coat the developing picture. However, most revenues generated from the instant photography market were not through camera sales. Cameras were often sold on low margins to encourage film sales. By increasing the base of instant camera users the company increased file sales, its primary margin product. However, the advent of digital photography in the 1990s threatened to erode Polaroid's base of instant film camera users. Demand for Instant Photographic Services In the consumer market, demand for film on newly purchased cameras tended to be highest and then tappered off to somewhat predictable patterns. Therefore film demand often correlated to camera sales. In the commercial market, demand was derived from instant photography for indentification purposes such as I.D. badges, as well as various applications in medicine and law enforcement. The market for instant film photography in the U.S. had matured. Sales in 1994 and 1995 had fallen 2 percent and 12 percent respectively. International sales, on the other hand, offered strong growth potential. With rising standards of living and no infrastructure to process 35 mm film in many emerging market countries, there was a large untapped market for instant photography. Polaroid's cameras were in high demand. Growth in international sales remained steady at 3 to 8 percent per year. Sales from Russia alone accounted for 9 percent of total sales. With these trends in sales growth, the mix of U.S. to international sales had actually reversed itself, making overseas sales the major source of company revenues. Structure of the Instant Photograhpy Industry The patents held by Polaroid insulated the company from any major competitive threat domestically. In 1976, the Eastman Kodak Company introduced an instant camera and film product to compete with Polaroid. In response, Polaroid sued Kodak and won $900 million in the largest patent judgement ever awarded. Internationally, Polaroid only faced one other competitor: Fuji. It produced a similar instant film camera that it marketed in Europe and Japan. Yet even in Japan, Polaroid dominated the market. By the 1990s, the instant film camera market was reaching maturity and companies began turning to new technologies. Digital photography became the new battleground for marketshare. In this arena, Polaroid faced stiff competition from several "deep-pocket" technology companies as Xerox, 3M, and Sony. Polaroid's Relative Strengths and Weaknesses Polaroid's innovation, determination and focus enabled the company to not only create the instant film camera industry, but also dominate it by continually building upon their technology. Unfortunately, the company's narrow focus on instant film photography may have been responsible for the company's late entry into the digital camera market. Likewise the company's efforts to develop instant motion picture film in the late 1970s proved to be misdirected as video camera technology took hold in the market. [bbb, brand equity, distribution network, technological expertise] Recently appointed CEO, Gary T. DiCamillo set forth a new plan to galvanize the company's financial performance in light of its lagging share price. His goal was to cut expenses and grow the company's core photographic and emerging electronic imaging business. DiCamillo began restructuring the company to reduce expenses by more than $150 million. He reduced the workforce by 2,500 positions and terminated projects with lower potential for commercialization such as the Captiva camera. DiCamillo also reorganized the management structure around three core areas: commercial, consumer and new business in an effort to more effectively focus on customer's imaging needs. The company's new market strategy centered on aggressively exploiting the Polaroid brand, introducing product extensions, and entering new emerging markets. In order to finance its new strategy, Polaroid maintained a five-year $150 million working capital line of credit. The company sought to lower their cost of capital by taking advantage of the tax shields debt provided. Yet they also wanted to maintain their financial flexibility so as not to lose their investment-grade bond rating. The firm also continued the steady stock repurchase program it had begun in the late 1980s in order to stave off a takeover threat. The topical problem facing Polaroid in late March of 1996 was that virtually all of the firm's debt was due within six years. Consequently all the company's borrowing would need to be repaid or refinanced in a relatively short amount of time. However, the company's treasurer, Ralph Norwood, needed to consider the company's optimum mix of capital in light of the new CEO's objectives before he could refinance the company's current debt. Specifically, what mix of debt to equity would yield the lowest cost of capital? How would this mix effect the company's bond rating? Currently, Polaroid had a Standard and Poor's rating of BBB, the lowest rating of investment-grade debt. Norwood needed to maintain the company's investment-grade rating due to the higher cost of issuing non-investment-grade debt. Moreover, a lower bond rating could have negative repercussions of Polaroid brand equity. According to exhibit 6, the sum of Polaroid's long term and short term debt requirements over the next five years is $726.8 million. However, Norwood needed to chose a target bond rating that would provide the lowest possible cost of capital and the most possible flexibility. Appendix A shows the maximum debt allowed for Polaroid under each bond rating. The firgures were derived by taking the maiximum debt to capitalization ratio for each rating in exhibit 9 and multiplying it by the company's book vaue of capital. As the chart shows, if the company maintains its current debt requirement it would not be able to maintain its investment-grade bond rating. The maximum allowable debt for Polaroid is $690.47. The company's debt rating would drop to BB. The decrease in bond rating would in turn cause an upward shift in the company's WACC over the next five years (See Appendix B). Moreover, the company's EBIT coverage ratio would shift downward. If Norwood, were to reduce the company's debt requirement to under $690.47, Polaroid would maintain its investment-grade bond rating and benefit not only from a lower cost of debt, but also from a lower cost of total captial as shown in Appendix B. In addition, Polaroid's EBIT would remain above 2 over the next 5 years. Norwood could also raise the bond rating to A if he were to reduce the required debt amount to $574.47 million. At this level of debt, the company's EBIT coverage ratio would shift upward even more and remain above 4 over the next 5 years. Yet, lowering the amount of debt used would also raise the company's WACC. Norwood should choose to maintain the company's current bond rating of BBB. Allowing Polaroid's bond rating to drop to BB could not only cause damage to the firm's brand name, but it would also increase the company's total cost of capital. Polaroids current level of debt financing surpasses the benefits of debt. Although it increases the company's credit worthiness as measured by their EBIT coverage ratio, it also raises their WACC do to the increased risk of default. Bibliography:

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