Capital Structure Analysis: Mattel, Clorox and MGM Essay

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Capital Structure Analysis: Mattel, Clorox and MGM Resorts

According to a report in the Journal of Applied Economics, companies with earnings/price ratios that are higher than their estimated after-tax borrowing costs, like Mattel, demonstrate that managers of publicly traded companies are in fact reluctant to make capital structure changes. Clorox, and MGM Resorts International also fit into this category, per my hypothesis. I suggest a radical move for these risk-averse managers based on my analysis of their balance sheets: paying down debt with cash-on-hand for all three of these companies and eschewing the tax lawyers' advice -- conventional wisdom from a time when interest rates were higher -- that has gotten them into this unsustainable level of debt at the current moment. These companies are paying junk bond prices the interest rates for their debt. They shouldn't have to do so.

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COST OF CAPITAL ANALYSIS OF MATTEL

U.S.-based Mattel Inc. (NASDAQ: MAT) is the planet's largest toy company, based on revenues. A simple SWOT analysis shows that it company's strengths include: (a) being the global leader in its market and (b) an innovator, but its weaknesses are: (c) a reliance on few products and (d) a low concentration of buyers. The products Mattle produces include Barbie dolls, Hot Wheels and Matchbox cars, Masters of the Universe, American Girl dolls.

The firm's name is derived from Harold "Matt" Matson and Elliot Handler, who founded the organization in 1945. Handler's wife, Ruth Handler, became president, later on, and is credited with establishing the Barbie product line for the company in 1959. Mattel closed its last American factory, originally part of the Fisher-Price division, in 2002, outsourcing all production to China, the beginning of a chain of events that led to a scandal involving lead contamination. On Friday, September 3, 2010 a mini "Flash Crash" occurred in Mattel shares which plunged 22% in pre-market trade for no apparent reason, only to recover shortly afterwards.

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According to a report in the Journal of Applied Economics, companies with earnings/price ratios that are higher than their estimated after-tax borrowing cost, like Mattel, demonsrtrate that managers of publicly traded companies are in fact reluctant to make capital structure changes. (1)

According to a report in Long-Range Planning magazine, corporate raiders do not tend to slash R&D budgets of firms they acquire. At least that's what happened to Mattel in 1979 when it was taken over. (2)

Today, Mattel's weighted cost of capital is 9.0% -- a pretty steep price to pay for money.

Weighted Average Cost of Capital for Mattel: Source: Mattel, Inc.

The company also has a huge amount of shares outstanding, though there are a small number of holders of the shares, according to data from the Securities and Exchange Commission.

Mattel Fiscal Year 2011 Data Source: Mattel, Inc.

The company has a large amount of capital on hand -- more than $9 billion. Its debt to equity ratio is 9.0% and its debt to capital ratio is 8.3%.

Mattel's Cost of Capital Analysis: Source: Mattel, Inc.

Mattel has a huge amount of debt for a company of its size -- $752 million.

Mattel Debt, FY 2011. Source: Mattel, Inc.

STRATEGIC RECOMMENDATION

I recommend the following to restructure Mattel: with the $9 billion plus on hand, pay down the $752 million in debt immediately. This will leave the company with approximately $8 billion in capital, and will immediately reduce the weighted cost of capital. At a time when housing mortgages are commonly going for just over 3.1%, there is no reason for Mattel to pay nearly three times that price for capital.

2. COST OF CAPITAL ANALYSIS FOR CLOROX

Clorox (NYSE:….....

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