M2 Group is a large wholesaler of communication services in Australia. The group has its presence in Australia, New Zealand and Philippines. It is a large employer having more than 3500 employees worldwide. Recently, the company has made acquisitions in energy and utilities sector to diversify and hedge its position. It has also bought assets in communication sectors that are believed to have a high growth in the future. All of these had an impact on the overall financial structure of the company which is going to be discussed in the coming parts of this paper.
Managerial Inertia theory is an important theory that can be related to all the companies in terms of their capital structure. According to this theory, the ultimate decision to adjust/tamper the capital structure depends on the value of stock returns. It must be kept in mind that, according to this theory, stock returns and pricing is the only driver for the company’s debt and equity financing decisions. The company analysis shows that as soon as return on stock/equity falls, the company moves to debt financing. This is shown by an increase in debt/equity ratio in the period when equity returns have fallen. It proves the capital structure inertia theory that states that equity and stock returns guide the company’s capital structure decisions. Deloitte.com, 2014). It can be seen from the above graph that only D/Equity ratio has fallen in 2007 when the company finds debt expensive and equity finance easier to obtain.
Interest coverage ratio has been decreasing showing increasing use of the company of debt financing this can be dangerous because in future creditors will not likely to extend loan to the company and the company will be more likely to rely on equity financing.
The security mispricing theory is another excellent explanation of capital structuring decision. It must be understood that all the assets of same classes or similar assets should have a similar price. Any variation in the price of similar assets means that the assets is mispriced or not efficiently priced in terms of the market. When a mispriced asset is trading in the market at a discount, firms usually buy that assets and this how the firm’s capital structure decisions are decided. It is an important concept and used as basis for the capital structure decision. The firm chooses the cheapest debt/equity mix to finance the company and the mispriced asset is usually bought and added to the capital structure mix of the company in order help the company become more efficient and being able to finance its operations at the cheapest debt/equity mix. In the case of M2 group, the year 2007 saw quite a drastic reduction and indicate that the company has found has some mispriced asset and has taken an advantage of it (Daniel, Hirschlifier and Subrahmanyam, 2000).
The pecking theory indicates that possible sources of finance for a company are its retained earnings, equity financing, and debt financing. The firm usually uses the same pecking order when it needs new capital. For example, it first runs down its retained earnings, then it uses equity financing and as a last resort it goes to debt financing. The company has recently acquired Dodo in the utilities market to hedge and diversify its position. The company’s acquisition and their financing is consistent with the pecking order theory. As for the acquisitions made in the fiscal year 2013, the retained earning balance was used to pay for these acquisitions. The retained earnings decreased and equity increased. This is perfectly in alignment with the pecking order theory (Wazenreid, 2014).
References
Daniel, K., Hirschlifier, D. and Subrahmanyam, A. (2000). Covariance Risk, Mispricing, and the
Cross Section of Security Returns. NBER, 25(2), pp.22-33.
Deloitte.com, (2014). Deloitte | Technology Fast 50: 2013 Winners’ Report. [online] Available at:
http://www.deloitte.com/view/en_AU/au/industries/tmt/8c44f654033ea310VgnVCM200
0003356f70aRCRD.htm [Accessed 23 Oct. 2014].
Wazenreid, G. (2014). Capital Structure Inertia and CEO Compensation. [online] Ideas.
Available at: https://ideas.repec.org/p/ube/dpvwib/dp0305.html [Accessed 23 Oct. 2014].
