Free Sample: Market reaction to spin-off paper example for writing essay

Market reaction to spin-off - Essay Example

Although BT’s revenues during this period were rising at an increasing rate, its asset turnover was falling significantly mainly due to the increase in non-income generating assets on account of the goodwill paid on acquisitions (mostly overseas) and expensive telecom licenses. However the asset turnover levels remained competitive on average with the industry comparables. Its interest coverage ratio was also becoming worse due to mounting debts. The group debt-equity ratio rose to 2.197 for year ended 31st march 2001, up from 0.442 year ending 31st march 1998. The increase in borrowings between 31st march 2000 and 31st march 2001 itself was nearly �19.2 bn.

Considering the flux BT was in, its management undertook a wide restructuring plan to reduce debt and spin-off divisions that were not ‘non-core activities’ and in the management’s opinion, unreliable for cash flows and concentrate its focus on the broadband business in the fixed line division. In its annual report, it stated a goal of reducing its debt by atleast �10 bn by 31st December 2001 and ‘create a new holding company to enhance corporate flexibility, and provide scope for further subsidiary floatation’s where advantageous to shareholders’.

The decision to demerge BT Wireless was taken in view of the tough competition in this segment from other Mobile operators. There was also an increasing threat of new entrants resulting from sale or additional issue of licenses and available spectrum. Fast changing technology environment and high levels of required investment also contributed in making the business more unreliable. Other factors included – continuing downward trends in prices, reduction in switching costs resulting in more power in the hands of the customer, difficulty in keeping high retention rates and slicing up of the market share.

In short, the management were not very confident about the future of BT Wireless and wanted to keep any future adverse impact of the division off its Balance sheet and Income statement. Already the group was feeling the pinch of the high payment for the 3G telecom licenses. The management also had some concerns over health studies showing harmful radiation to users of mobile phones that they thought might affect consumer demand and increase chances of legal compensation suits.

Besides the spin-off, the comprehensive restructuring plan included: Reduction of net debt by approximately �10 billion and Rights Issue of approximately 5.9 billion. Separating the UK fixed network business into two businesses (wholesale and retail). Create a new holding company called Future BT (this was actually named BT Group Plc.) for corporate flexibility and to facilitate other potential acquisitions, demergers, disposals and IPOs. This was to be created at the same time as the demerger of BT Wireless.

Future BT would comprise mainly of four separately managed businesses, namely BT Retail, BT OpenWorld, BT Wholesale and BT Ignite. The goal for Future BT was to focus on the European network and retail business concentrating on voice and data services and also to develop and market higher value broadband and internet products and services. Sell off holdings in various other companies e.g. Japan Telecom, J-Phone, Airtel etc. to finance the debt reduction program. Halt dividends for the time being.

Market reaction to spin-off: The announcement of the demerger along with a massive rights issue was made on 10th of may 2001. In our analysis, we have carried out an event study to observe the impact of announcement of BT’s spin-off on its share prices. . We have used the FTSE 100 as our benchmark index. The daily share prices and FTSE 100 data for the period -241 to +40 have been obtained through datastream. We have then used this daily share price and the FTSE 100 to compute the return on share prices (Rt) and the return on market (RMt).

The abnormal return has been calculated by first calculating the Expected return E(Rt) by using (beta) equal to 1 and ? (alpha) equal to 0. The difference between the return on share price (Rt) and expected return E(Rt) is the abnormal return (ARt). The abnormal return is now used to compute the T-test. The results for period -2 to +2 is shown below: