Paste your essay in here…I. Summary
Deluxe Corporation is the largest printer of the paper check in the United States. In 2002, Deluxe retired all of its long-term debt since the company hasn’t issued any bonds in the last 10 years. It opened its door in 1915, became publicly traded in 1965, and then was part of the New York Stock Exchange (NYSE) in 1980. Deluxe Corporation is praised not only for being the largest printer of the paper check but also for its customer service through more than 10,000 financial institutions, having to distribute 100 million orders each year. Ten years into the public trading, in 1975 Deluxe was a gold mine creating revenue growth at a compound annual rate of 12% for 20 years constant. However, a decline in check demand started around the late 1990s at around 1% to 3%. The reason was technological change, impacting the corporation heavily due to the use of credit/debit cards to make payments. Even though Deluxe is the dominant player in the highly concentrated and competitive check-printing industry, the new payment strategies could have ended the core business of Deluxe.
Furthermore, the company has been doing a lot of share repurchases as they aim to fulfill new goals, which is to create value, to have flexibility, and to keep a good bond rating. Also, no goal is a priority; rather there should be a balance between all these goals. Thus, the recommendations would be to downgrade from the bond rating of A to BBB, this will creating a domino effect, increasing flexibility and debt capacity, and providing a better WAC C for a future project that will generate great value.
The paper will flow by first identifying the questions or problems the Deluxe have followed by an analysis of alternatives; the recommendations for Deluxe will be made. Briefly, after the recommendations are given, the relevance of the solution to the problem will be made.
II. Identification of Key Problem(s) and Question(s)
From time to time Deluxe has been able to work against difficult times. A vivid example is a reorganization that helped reverse Deluxe’s earnings slump in 1988. This was possible by reducing 62 printing plants to 13, reducing labor force from 15,000 to 7,000, and divesting nearly 20 separate businesses. Deluxe’s ability to reduce in difficult times has helped them become the great company it has become. Another struggle that Deluxe has gone through was selling directly to customers, which has become now only the lowest form of selling, percentage-wise. They have improved by adding Financial Services and selling checks to consumers through financial institutions with contracts and providing business services as well.
Currently, however, the corporation seeks to find which rating category will provide the lowest cost of capital. Going lower than BBB is not an option, Currently Deluxe has a grade of A rated by Moody’s and also by Standard and Poor. What would then be a good bond rating for Deluxe? The firm has generally focused on one thing above everything, to keep the core of its business. Such focus has helped them become fundamentally strong when decisions are made, but in the future can bring problems. The company knows that paper check will not last long in this new technological era; therefore raising another question, what will they do to keep up with new ways of payment. Studies show that 60% of people still use checks as non-cash payments but how long will this last until Deluxe decides to make big moves? And, what will those moves, or strategies be?
III. Analysis of Alternatives
Deluxe has few problems to fix, and even though it seems difficult to find solutions for each problem, it is more practical than that. The central problem of Deluxe based on the decision to change to a lower rating bond rate or not. However, one alternative would be to keep the Bond rate of A. This bond rate goes well with the philosophy of Deluxe Corp. due to the historic decisions made when the company goes through difficulty. Deluxe seems very passive since they have not had any long-term debt in the last ten years, also because one of their strategies to cut cost is to reduce the shares outstanding from the public. They have reduced labor force, printing plants; they have divested 20 separate businesses, etc. It’s almost as if Deluxe was a private company by how much share repurchase they have made in the last years. Therefore, an alternative that suits well with the company is to reduce its capacity of debt, which is a bad alternative and a weakness if the firm really wants to expand and keep up with the new technology. The only strength would be that the bond rate would be a representation of fear of new ideas and improvement to the company. The maximum debt capacity that Deluxe would have would be $840.05M, compared to $1294.37M if they had a BBB bond rate. Singh believed that BBB bond rate would not impact the firm harshly, and comparing the debt capacities it is also obvious that they will be much more capital to invest in the firm become a BBB rating.
Exhibit 1 shows the spread between each bond rate’s unused debt capacity, relatively to Junk bonds (BB). As the firm decides to have a better image and become a better bond rate, the firm also loses the opportunity to borrow capital and invest in projects, especially during conflicting years due to technological advances. For example, from the bond rate of AA, the firm loses the opportunity to borrow $1,324.59M compared to BB. From the bond rate of A the firm loses the opportunity to borrow $812.7M compared to BB. The bond rating of BBB the firm only loses the opportunity to borrow only $358.4M compared to BB. As the bond rate gets better, the budget gets tighter with fewer options for projects with high return. Furthermore, the company’s Total Debt/Capital ratio will increase, as the bond rating is lower. If the company decides to become AA the Total Debt/ Capital ratio will only be 15.52%, in A their ratio would be 27.31%, and in BBB the ratio will be 35.33%.
IV. Recommended Solution(s)
Deluxe’s current level of debt is not appropriate, and in order to expand and become a better firm that is basically all matured, the company should be willing to take risks. The recommendation will be for the company to borrow more money and become a BBB grade firm. This will cause a domino effect on all the smaller problems and provide solutions for improvement. The management motivations and key objectives in setting the firm’s financial policy were to improve their flexibility, have a good bond rating, be able to create value, and also be able to balance all these objectives without prioritizing any of them. Therefore, as the company intends to improve their strategies, having a bigger budget will come in handy in order to create new projects, also that BBB provides the smallest WACC compared to all the different bond ratings. Having a low WACC can increase the opportunity for projects with high returns, meaning that even though the risk is higher, the cost of high risk is still pretty low, in reference to the WACC. One of the financing requirements that will be recommended to the firm is to use almost if not all of their debt capacity to be able to produce growth for the company. As the company moves towards a lower grade bond this will only mean that the company is preparing to bring new ideas and willing to exploit their opportunities. Thus, the company should focus on acquisitions and mergers. The company knows that being too core focus will only lead to maturity and the end for the company. What acquisitions and mergers will do for the company is create a new cycle of life, not merging with something completely different from finances, as the paper check is one of them, be able to buy/merge with companies that provide similar value to consumers. It is important to keep in mind that downgrading to BBB will only help the company create more value due to the increase in budget. However, the idea is not to become a BBB forever, instead be able to use the new debt capacity as an opportunity to strive a better bond rating in the future, when the company has created a new life cycle through mergers and acquisitions.
V. Conclusion
Deluxe is financially stable and ready to take borrowings if the company strives to create new value. However, the dilemma has been to stay balance between three important factors: flexibility, bond rate, and value creation. As the recommendations are given now to the firm, the company will enjoy the outcomes, as the goals will equally be reached if the recommendations are followed step by step. It is important for a company that runs the risk to become obsolete, to be able to take the risk, especially at times where technological advances are taking over the market.