CASE 4-2 Futuram's Risk Management Strategy This story, all namex, chanacters, and incidents described are fictitious HEDGING FOREIGN CURRENCY RISK No identification wilh actual persons, companies, places, or products is inlended or should be inferred. Futuram chose to use derivatives for hedging foreign currency risk, or foreign-exchange risk-the risk a change in currency exchange Normally, when Futuram is mentioned in newspapers, it's usually rates will adversely impact a business. for a new genetically engineered seed. Yet this agricultural biotech In particular, the company focused on at-the-money exchange firm, based in California, has turned to financial engineering to options. These options would lock in the exchange rate close to the ensure its profits. current spot rate. At its January 2017 annual meeting. Futuram announced a profit For example, the US\$- exchange rate stood at a spot rate of of over \$1B from its agricultural products and technology solutions $1.33 per C. If Futuram bought one-year put options on the U.S. designed to improve farm productivity and product quality. And dollar, at a strike of $1.31 per C, it would have the right to sell U.S. while investors were pleased with this number, they were absolutely dollars one year from now at a predetermined exchange rate of $1.31 stunned by the fact that Futuram made an even larger profit (\$1.8B) per C. In this way, the company locked in a minimum amount of from financial derivative transactions. Futuram, in order to protect euros it would obtain per U.S. dollar during conversion. Of course, its profits against a weakening dollar, made large trades in foreign the company did not have to sell the U.S dollars at that rate and exchange options. These trades doubled Futuram's profits! time, but this offered Futuram a level of protection that it wanted. Some investors lauded management for making shrewd finan- Futuram decided that it would hedge its sales against negative cial decisions. Others expressed concern that the company was movements in the exchange rate for the next two years. To do this, deviating too much from its mission, citing that Futuram was the company bought and rolled over a portfolio of put options never intended to be primarily a financial institution. So, do you with various maturities of up to two years. As of June 30 . 2015. think that Futuram is making wise financial decisions? Or is Futuram held options with a notional amount of C billion and a the company heading down a new path that might endanger its market value of about co.5 billion. This means that if Futuram had bottom line? exercised these put options on June 30,2015 , it would sell about BACKGROUND es billion worth of dollars at the predetermined exchange rate eiven by the strike of the put options. That amount (C8 billion) With headquarters in Sacramento, California, Futuram is a market was rouqhly two times the company's annual sales outside of the leader in agricultural biotechnology. As of 2017. its product line- United States. So, the company's goal of hedging against exposure two years out would be met. focused on crop science and agricultural biologicals. It produces genetically modified (GM) seed for soybeans, sugar beets, and Feign exchange risks. While Futuram did not believe you could ever corn. In addition, it provides fertilizers and herbicides to ensure outwit the market, certain competitors, such as The B. W. Group. more successful crop production. Its seed division is one of the top determined that their computer models could fairly accurately foresuppliers of vegetable and fruit seeds worldwide. cast exchange rates. Those competitors did not choose to hedge The company started in the late 1940 s as a chemical company apainst foreign exchange risks as heavily as Futuram did. and focused its research on antiseptics and pain relievers. Its owner, Thomas Warder, responding to the increasingly competitive pharmaceutical industry, refocused Futuram's research efforts on herbicides and fertilizers that would improve farm yield. As In October 2014, Futuram acquired a 25 percent stake in Gordon, of 2008 , Futuram was recognized as a world leader is helping the England-based world leader in animal husbandry and related farmers grow foods more sustainably, while protecting our natural computer hardware and software design. This move surprised anaresources. lysts, who believe that the company should stay focused on its core Futuram is a publicly traded company, with 6 million ordinary business of crop science. Gordon, a much larger and more promishares held by the Warder family and 9 million shares held primar- nent company. was struggling to improve profitability. Its sales ily by institutional investors. topped \$3B, while Futuram sales were less than $1B. Futuram management believed they had a strong case support- RISK MANAGEMENT POLICY ing this decision. They had several objectives: Futuram's risk management policy was developed in response to 1. Prevent outside investors from taking over and dismantling poor performance and earnings in the 1990s. Management learned the company because Futuram depended on Gordon for its lesson, responding to access to specific computer hardware and software that aided agricultural development. In fact, Gordon's programs I. Lack of long-term debt and high cash balances. In fact, the offered the primary support for Futuram's agricultural company's liabilities consisted of minimal bank loans. innovations. 2. Exposure to a weaker dollar in the foreign exchange mar- 2. The two companies also were developing sustainability ket. The company was promoting and selling its product programs, which they deemed critical to future corporate worldwide but had not focused attention on a weakening growth. Any takeover or breakup of Gordon by an unrelated U.S dollar. party would jeopardize these developments. CS4-6 Part 6 Supplementary Material Critics noted that this seemed to be less about future develop- EVALUATING FUTURAM'S RISK ment than about two companies protecting each other from possible hostile takeovers or capital market pressures for improving MANAGEMENT DECISIONS profitability. Futuram's foreign exchange hedges and the acquisition of the EngGordon was a potential target for takeover and breakup, as land-based Gordon stake dramatically increased Futuram's bottom it had been struggling for many years to achieve and maintain a line in 2017. On sales of about $4 billion, Futuram reported pretax satisfactory level of profitability. Many analysts argued that the profits of $2.8 billion, up from $1 billion in 2016. Profits from its company suffered from large inefficiencies. In particular, analysts Gordon stock option trades accounted for $1 billion of these profcriticized the use of profits from its animal husbandry division to its. A further $.8 billion came from Futuram's share of Gordon's support expansion of its technology division. profits, and thus "only" about $1 billion from its core business. For many years, the company had benefited from an old English Notice how much more profit came from trades in financial derivalaw limiting the voting rights of any shareholder to a maximum of tives than from its basic business. 25 percent. Futuram was counting on a repeal of that mandate by Needless to say, these results garnered praise from many anathe European Commission. And, indeed, that was what happened. lysts. Some, however, criticized Futuram's management, noting that In February 2016, Futuram acquired additional stock, raising its this was a matter of luck, not skill. This group believes that Futuram stake in Gordon to 29 percent. risks much by not focusing on its core strengths and mission. It also announced that it had purchased enough call options on Gordon's ordinary shares so that it faced no price risk in this CONCLUSION planned increase in its stake. Then, in November 2016, Futuram announced that it had exercised options for the acquisition of an Futuram had been considered a company that emphasized cautious additional 3.5 percent of ordinary shares of Gordon, increasing its risk management. However, the enormous profits garnered from stake to 32.5 percent. transactions in financial derivatives led some analysts to question Increasing its stake above 30 percent triggered, by law, a its risk management approach. Should Futuram be involved in requirement to make a mandatory offer for the remaining Gor- derivatives transactions on this scale? Was its approach to growing don shares. Futuram, however, offered only the minimum price, its stake in Gordon a wise decision? as legally required: 85.30 per ordinary share, 16 percent below the prevailing market price at the time. Not surprisingly, few QUESTIONS shareholders were interested in this offer. So, Futuram still held 1. Chapter 18 , "Pricing for International Markets," discusses the 29.8 percent of Gordon's ordinary shares and had options to buy financial side of marketing, including currency fluctuations and another 3 percent. The mandatory offer expired in March. This foreign exchange variations. Discuss the risks and benefits of left Futuram free, should it choose, to increase its stake in Gordon financial activities outside the scope of traditional marketing. up to 50 percent. As you can see, Futuram used call options on Gordon stock 2. What do you think of the Gordon purchase? Does it help the Futuram international marketing effort? extensively to build its stake in the company. Management cited this choice as one that helped it hedge against the risk that its actions 3. Futuram is a recognized leader in its field. Does making money would cause Gordon's stock price to increase. It was unknown how in nonmarketing ways have a negative impact on its image? many options Futuram held; however, analysts believed it to be a 4. Finally, what do you think of Futuram's financial decisions significant number. in this case? How do these decisions matter to the company's long-term success? CASE 4-2 Futuram's Risk Management Strategy This story, all namex, chanacters, and incidents described are fictitious HEDGING FOREIGN CURRENCY RISK No identification wilh actual persons, companies, places, or products is inlended or should be inferred. Futuram chose to use derivatives for hedging foreign currency risk, or foreign-exchange risk-the risk a change in currency exchange Normally, when Futuram is mentioned in newspapers, it's usually rates will adversely impact a business. for a new genetically engineered seed. Yet this agricultural biotech In particular, the company focused on at-the-money exchange firm, based in California, has turned to financial engineering to options. These options would lock in the exchange rate close to the ensure its profits. current spot rate. At its January 2017 annual meeting. Futuram announced a profit For example, the US\$- exchange rate stood at a spot rate of of over \$1B from its agricultural products and technology solutions $1.33 per C. If Futuram bought one-year put options on the U.S. designed to improve farm productivity and product quality. And dollar, at a strike of $1.31 per C, it would have the right to sell U.S. while investors were pleased with this number, they were absolutely dollars one year from now at a predetermined exchange rate of $1.31 stunned by the fact that Futuram made an even larger profit (\$1.8B) per C. In this way, the company locked in a minimum amount of from financial derivative transactions. Futuram, in order to protect euros it would obtain per U.S. dollar during conversion. Of course, its profits against a weakening dollar, made large trades in foreign the company did not have to sell the U.S dollars at that rate and exchange options. These trades doubled Futuram's profits! time, but this offered Futuram a level of protection that it wanted. Some investors lauded management for making shrewd finan- Futuram decided that it would hedge its sales against negative cial decisions. Others expressed concern that the company was movements in the exchange rate for the next two years. To do this, deviating too much from its mission, citing that Futuram was the company bought and rolled over a portfolio of put options never intended to be primarily a financial institution. So, do you with various maturities of up to two years. As of June 30 . 2015. think that Futuram is making wise financial decisions? Or is Futuram held options with a notional amount of C billion and a the company heading down a new path that might endanger its market value of about co.5 billion. This means that if Futuram had bottom line? exercised these put options on June 30,2015 , it would sell about BACKGROUND es billion worth of dollars at the predetermined exchange rate eiven by the strike of the put options. That amount (C8 billion) With headquarters in Sacramento, California, Futuram is a market was rouqhly two times the company's annual sales outside of the leader in agricultural biotechnology. As of 2017. its product line- United States. So, the company's goal of hedging against exposure two years out would be met. focused on crop science and agricultural biologicals. It produces genetically modified (GM) seed for soybeans, sugar beets, and Feign exchange risks. While Futuram did not believe you could ever corn. In addition, it provides fertilizers and herbicides to ensure outwit the market, certain competitors, such as The B. W. Group. more successful crop production. Its seed division is one of the top determined that their computer models could fairly accurately foresuppliers of vegetable and fruit seeds worldwide. cast exchange rates. Those competitors did not choose to hedge The company started in the late 1940 s as a chemical company apainst foreign exchange risks as heavily as Futuram did. and focused its research on antiseptics and pain relievers. Its owner, Thomas Warder, responding to the increasingly competitive pharmaceutical industry, refocused Futuram's research efforts on herbicides and fertilizers that would improve farm yield. As In October 2014, Futuram acquired a 25 percent stake in Gordon, of 2008 , Futuram was recognized as a world leader is helping the England-based world leader in animal husbandry and related farmers grow foods more sustainably, while protecting our natural computer hardware and software design. This move surprised anaresources. lysts, who believe that the company should stay focused on its core Futuram is a publicly traded company, with 6 million ordinary business of crop science. Gordon, a much larger and more promishares held by the Warder family and 9 million shares held primar- nent company. was struggling to improve profitability. Its sales ily by institutional investors. topped \$3B, while Futuram sales were less than $1B. Futuram management believed they had a strong case support- RISK MANAGEMENT POLICY ing this decision. They had several objectives: Futuram's risk management policy was developed in response to 1. Prevent outside investors from taking over and dismantling poor performance and earnings in the 1990s. Management learned the company because Futuram depended on Gordon for its lesson, responding to access to specific computer hardware and software that aided agricultural development. In fact, Gordon's programs I. Lack of long-term debt and high cash balances. In fact, the offered the primary support for Futuram's agricultural company's liabilities consisted of minimal bank loans. innovations. 2. Exposure to a weaker dollar in the foreign exchange mar- 2. The two companies also were developing sustainability ket. The company was promoting and selling its product programs, which they deemed critical to future corporate worldwide but had not focused attention on a weakening growth. Any takeover or breakup of Gordon by an unrelated U.S dollar. party would jeopardize these developments. CS4-6 Part 6 Supplementary Material Critics noted that this seemed to be less about future develop- EVALUATING FUTURAM'S RISK ment than about two companies protecting each other from possible hostile takeovers or capital market pressures for improving MANAGEMENT DECISIONS profitability. Futuram's foreign exchange hedges and the acquisition of the EngGordon was a potential target for takeover and breakup, as land-based Gordon stake dramatically increased Futuram's bottom it had been struggling for many years to achieve and maintain a line in 2017. On sales of about $4 billion, Futuram reported pretax satisfactory level of profitability. Many analysts argued that the profits of $2.8 billion, up from $1 billion in 2016. Profits from its company suffered from large inefficiencies. In particular, analysts Gordon stock option trades accounted for $1 billion of these profcriticized the use of profits from its animal husbandry division to its. A further $.8 billion came from Futuram's share of Gordon's support expansion of its technology division. profits, and thus "only" about $1 billion from its core business. For many years, the company had benefited from an old English Notice how much more profit came from trades in financial derivalaw limiting the voting rights of any shareholder to a maximum of tives than from its basic business. 25 percent. Futuram was counting on a repeal of that mandate by Needless to say, these results garnered praise from many anathe European Commission. And, indeed, that was what happened. lysts. Some, however, criticized Futuram's management, noting that In February 2016, Futuram acquired additional stock, raising its this was a matter of luck, not skill. This group believes that Futuram stake in Gordon to 29 percent. risks much by not focusing on its core strengths and mission. It also announced that it had purchased enough call options on Gordon's ordinary shares so that it faced no price risk in this CONCLUSION planned increase in its stake. Then, in November 2016, Futuram announced that it had exercised options for the acquisition of an Futuram had been considered a company that emphasized cautious additional 3.5 percent of ordinary shares of Gordon, increasing its risk management. However, the enormous profits garnered from stake to 32.5 percent. transactions in financial derivatives led some analysts to question Increasing its stake above 30 percent triggered, by law, a its risk management approach. Should Futuram be involved in requirement to make a mandatory offer for the remaining Gor- derivatives transactions on this scale? Was its approach to growing don shares. Futuram, however, offered only the minimum price, its stake in Gordon a wise decision? as legally required: 85.30 per ordinary share, 16 percent below the prevailing market price at the time. Not surprisingly, few QUESTIONS shareholders were interested in this offer. So, Futuram still held 1. Chapter 18 , "Pricing for International Markets," discusses the 29.8 percent of Gordon's ordinary shares and had options to buy financial side of marketing, including currency fluctuations and another 3 percent. The mandatory offer expired in March. This foreign exchange variations. Discuss the risks and benefits of left Futuram free, should it choose, to increase its stake in Gordon financial activities outside the scope of traditional marketing. up to 50 percent. As you can see, Futuram used call options on Gordon stock 2. What do you think of the Gordon purchase? Does it help the Futuram international marketing effort? extensively to build its stake in the company. Management cited this choice as one that helped it hedge against the risk that its actions 3. Futuram is a recognized leader in its field. Does making money would cause Gordon's stock price to increase. It was unknown how in nonmarketing ways have a negative impact on its image? many options Futuram held; however, analysts believed it to be a 4. Finally, what do you think of Futuram's financial decisions significant number. in this case? How do these decisions matter to the company's long-term success