Swedish Match

EXECUTIVE SUMMARY

This report has been prepared for the exclusive use of Mr. Lars Dahlgren, the CFO of Swedish Match, to assist him to convince their board members and shareholders for a recapitalization share purchase funded by debt. In the analysis presented below, we took the existing financial condition of Swedish Match as of Dec’04, and predicted the results of additional debt of SEK 4 billion, which they would have to take up in order to finance the recapitalization, on this financial condition.

During our analysis we found out that taking up the new debt would give Swedish Match a tax saving of SEK 50.4 million every year amounting to a total debt tax shield of SEK 399 million. After the recapitalization though the book value of equity would reduce considerably i.e., by SEK 4 billion, the market value of equity will decrease by a lesser amount due to the debt tax shield leading to an overall increase in the share price.

The current leverage and coverage ratios of SM suggest that they have the ability to take up new debt without having huge repercussions. The team found out that the new debt would slightly raise the leverage of the firm, but they would have the full ability to pay the interest and not default even in the worst case situation of EBITDA falling to around SEK 1.5 billion, based on the coverage ratios of the firm. This would also reduce the credit rating of the firm from A- to a very well sustainable BBB.

Overall, we believe that SM can afford the additional debt of SEK 4 billion and the recapitalization intended. When compared to the risk associated with the debt and recapitalization such as cutback in acquisitions, in dividend payments, and increased government regulations, the overall benefit of share price increase and shareholder value appreciation is much more valuable. There is also an added benefit of Managers not being able to do value disruptive acquisitions just for the sake of growth as the overall cash flows of the firm would reduce due to the increased debt payments. Having said this, we also advice Swedish Match not to increase the size of their recapitalization, as it would reduce the credit rating of the below BBB, which can impose bigger problems in the future. This would also create a huge pressure on the firm, as any drop in the operating margins of the firm could lead to risk of default of payments leading to financial distress and even bankruptcy.

The report below gives a detailed analysis of the basic result presented above.

Q1. Assuming Swedish Match faces a 28% tax rate on income and can issue bonds at foxed krona yield of 4.5%, how much will the company save in taxes for SEK 4 billion recapitalization? What is the value of interest tax shield?

Tax Saving

Since the rate of interest to be paid on the debt (D) issuance of SEK 4 billion is 4.5% and the tax rate is 28% the saving in taxes would be – Rate of interest (i) * SEK 4 billion * tax rate = 4.5% * 4000 * 28% = SEK 50.4 million.