JAGUAR LAND ROVER PLC: BOND VALUATION Jaguar Land Rover Automotive plc (JLR), a wholly owned subsidiary of the Indian company Tata Motors Limited, announced, on March 3, 2015, an issue of Senior Notes (bonds) worth US$500 million and due in 2020 at a coupon rate of 3.5 per cent per annum (p.a.), interest payable semi-annually. The net proceeds of this issue were to be primarily applied to repurchase the company's outstanding Senior Notes worth $410 million, issued on May 19, 2011, and due on May 15, 2021(see Exhibit 1). These outstanding Notes carried a coupon rate of interest of 8.125 per cent p.a., payable two times per year. In March 2015, the indicative pricing of these Notes in the Luxemburg Bourse signaled an 11 per cent pre2mium over face value (see Exhibit 2). The reference treasury security for these Notes was the U.S. Treasury Notes due May 15, 2016, that carried a coupon of 0.25 per cent p.a. (see Exhibit 3). This issue was the company's second such refinancing in two months. The bond buyback was to be through a tender offer starting immediately and ending on March 30, 2015. Existing bondholders had an option to sell their holdings to the company or roll over their existing holdings to the new security. 3 No company would forego such an opportunity to halve its interest expenses and improve its bottom line. But can such a simple, positive-sum game exist in an efficient market? JAGUAR LAND ROVER PLC The 2008 financial meltdown in the United States proved especially cruel to the auto sector companies. As part of its corporate survival, revival and restructuring strategy, Ford Motor Company sold its Jaguar and Land Rover brands to Tata Motors Ltd., an Indian automobile manufacturing company on June 2, 2008, for a net consideration of $2.3 billion 4 (approximately GBP1.47 billion). - The volumes of these brands saw a 32 per cent drop in the 10 months after the takeover, and JLR posted a net loss of GBP402.4 million for the period ending March 31, 2009. By fiscal year (FY) 2011, however, the company had managed a turnaround and posted a post-tax profit 2 of GBP1,035.90 million. In 2011/12, JLR issued both dollar-denominated and pound-denominated debt to fund investments in its U.S. and European businesses respectively. This multi-currency funding also helped JLR to create a natural hedge for mitigating currency risk. The next four years saw JLR turning into the cash cow that supported the parent company in the face of a lackluster performance in the latter's domestic market. For the year ended March 31, 2014, JLR comprised more than 80 per cent of the consolidated automobile sales revenue for Tata Motors and was solely responsible for the consolidated company posting operating profits (see Exhibit 4). By September 2013, ratings agency Moody's Investors Service had upgraded JLR's bond issues from Ba3 to Ba2 with a stable outlook. Besides the impressive volume and revenue growth as well as earnings before interest, tax, depreciation and amortization (EBITDA) margins posted by JLR, the ratings upgrade was attributable to the company's positive free cash flows in FY2013 despite increased capital expenditures (capex) and dividend payments (see Exhibit 5). Another important factor contributing to this ratings upgrade was JLR's conservative financial strategy in terms of leverage and comfortably spread- out bond repayments (see Exhibits 1 and 6). 10 Analysts at Moody's, however, expected the next few years to see free cash flows turning negative on the back of increased capital investment and research and development. Both Standard and Poor's and Moody's rating services maintained JLR's credit rating at BB and Ba2 respectively, while revising their outlooks to positive in late 2014. With a capex of GBP3.6 billion to GBP3.8 billion lined up for FY2016, the chief financial officer of Tata Motors was quoted as saying the company optimistic about cash flow in JLR nex waseeautiously It was evident that JLR wanted to benefit from the impressive turnaround in its fundamentals. But would efficient bond markets allow firms to reap such benefits? Who gains and who pays in such deals? EXHIBIT 1: JAGUAR LAND ROVER'S FINANCING ARRANGEMENTS AS AT DECEMBER 31, 2014 Facility amount Annual Rate of interest Outstanding Undrawn GBP millions A. Senior Notes GBP500m due 2020 (first call Mar 2016) GBP400m due 2022 US$410m due 2021 (first call May 2016) US$500m due 2023 (first call Feb 2018) US$700m due 2018 US$500m due 2019 B. Revolving 3- and 5-year credit C. Receivable factoring facilities Total 500 400 263 321 450 321 1,485 225 3,965 8.250% 5.000% 8.125% 5.625% 4.125% 4.250% 500 400 263 321 450 321 0 0 0 0 0 0 1,485 32 1,517 193 2,448 Note: GBP - British pound sterling. The company has used the GBP/US$ exchange rate prevailing on the balance sheet date in annual and interim financial statements to convert the US$-denominated debt to GBP. Since the company earns approximately 17% of its revenue each in the United Kingdom and North America, for the purposes of this case, we assume that the natural hedge created mitigates any exchange rate risk. The average GBP/US$ rate for March 2015 can be taken at'4.50. Source: Jaguar Land Rover plc FY2015, Q3 Interim Accounts, p. 6, www.jaguarlandrover.com/media/59285/fy15-93-ifrs- interim-accounts-final.pdf, accessed March 13, 2015. EXHIBIT 2: JAGUAR LAND ROVER'S OUTSTANDING BONDS AND NOTES ON LUXEMBOURG BOURSE Coupon Rate; Security Start/End Dates 3.5%; USG5002FAE63 3.5%; US47010BAE48 3.875%; XS1195502031 3.875%; XS1195503351 8.125%; USG50027AB03 8.125%; US47009XAB55 8.25%; XS0765386627 8.25%; XS0765386973 06/03/201515/03/2020 06/03/201515/03/2020 24/02/2015-01/03/2023 24/02/2015-01/03/2023 19/05/2011-15/05/2021 19/05/2011-15/05/2021 27/03/201215/03/2020 27/03/2012-15/03/2020 Last Traded Date Price 12/03/2015 100 i % 12/03/2015 100 i % 06/03/2015 100 i % 06/03/2015 100 i % 04/02/2015 111.276 i % 07/08/2014 111.583 i % 30/01/2015 110.944 i % 30/01/2015 111.182 i % EXHIBIT 3: YIELD CURVE FOR THE U.S. TREASURY MAY 16, 2011 VERSUS MARCH 16, 2015 5.00% 4.00% 3.0666 1.83% 2.00% 1.57% 1.00% 0.00% 1 MO 3MO MO 1YR 2YR 3YR 5YR 7YR 10YR 20YR 30YR Maturity (Note: Primary axis is not to scale) 3/16/2015 5/16/2011 EXHIBIT 4: JAGUAR LAND ROVER INCOME STATEMENTS, 20122015 Figures in GBP millions Revenue FY2012 FY2013 FY2014 13,512 15,784 19,386 FY2015-9 months 16,040 Material and other cost of sales Employee cost Other expenses Development costs capitalized Other income Depreciation &amortization Foreign exchange gain/ (loss) Finance income Finance expenses (net) Share of loss from joint ventures Profit before tax Income tax expense Profit after tax (8,733) (1,039) (2,529) 751 37 (465) 14 16 (85) (9.904) (11,904) (1,334) (1,654) (3,075) (3,717) 860 1,030 70 153 (622) (875) (109) 236 34 38 (18) (185) (12) (7) 1,674 2,501 (460) (622) 1,214 1,879 (9,768) (1,427) (2,941) 850 150 (743) 58 36 1,479 (19) 1,460 (13) (24) 2,218 (482) 1,736 EXHIBIT 5: JAGUAR LAND ROVER'S CASH FLOW STATEMENTS, 2012-2015 FY 2012 1,460 FY 2013 1,214 FY FY2015-9 2014 months 1,879 1,736 466 69 96 622 (16) 475 875 100 577 743 (23) 610 Figures in GBP millions Profit for the year Adjustments for: Depreciation & Amortization Finance expenses/ (income) Others Cash flows from operations before working capital adjustments Net cash generated from operations Investment in joint ventures Investment in property, plant and equipment Cash paid for intangible assets Cash used for other investments Net cash used for investing activities Finance expenses and fees paid Proceeds from short-term debt Repayment of short-term debt Proceeds from long-term debt Repayment of long-term debt Payment of lease obligations Dividends paid Net cash used/generated from financing activities Net change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year 2,091 2,500 (1) (596) (814) (131) (1,542) (128) 105 (655) 1,500 (374) (4) 2,295 2,429 (71) (891) (958) (689) (2,609) (179) 88 (250) 317 3,431 3,422 (92) (1,201) (1,155) (288) (2,736) (269) 1 (158) 829 (746) (5) (150) (498) 188 3,066 2,572 (124) (1,147) (885) 131 (2,025) (97) 21 (6) 313 (4) (150) (178) (358) (4) (150) 77 624 444 1,402 1,028 2,430 2,430 2,072 2,072 2,260 2,260 2,884 EXHIBIT 6: JAGUAR LAND ROVER BALANCE SHEETS, 2012-2015 FY2015-9 months 4,137 4,769 817 Figures in GBP millions Property, plant &equipment Intangible assets Other non-current assets Total non-current assets Cash &cash equivalents Short-term deposits Trade receivables Inventories Other current assets Total current assets Total Assets FY2012 FY2013 1,586 2,335 2,801 3,522 595 771 4,982 6,628 2,430 2,072 775 662 927 1,497 1,795 646 640 5,235 6,209 10,217 12,837 FY2014 3,184 4,240 935 8,359 2,260 1,199 831 2,174 9,723 2,884 1,143 879 2,238 662 7,806 17,529 766 7,230 15,589 4,787 167 Accounts payable Short-term borrowings and current portion of long-term debt Provisions &other current liabilities Total current liabilities Long-term debt Provisions Retirement benefit obligations Other non-current liabilities Total non-current liabilities Total Liabilities 3,285 490 1,266 5,041 1,484 344 327 97 2,252 7,293 4,227 328 1,442 5,997 1,839 468 657 337 3,301 9,298 1,180 6,134 1,843 582 674 492 3,591 9,725 4,699 193 1,461 6,353 2,230 638 743 768 4,379 10,732 Ordinary share capital Reserves and surplus Equity attributable to shareholders Total Liability and Equity 1,501 1,423 2,924 10,217 1,501 2,038 3,539 12,837 1,501 4,363 5,864 15,589 1,501 5,296 6,797 17,529 QUESTIONS TO THE CASE STUDY ABOUT JAGUAR 1. Compute the price today (assume that it is May 16 2015) if these bonds were not callable? You could use either USD ($410 million) or British pound (263 million). The exchange rate between dollar to pound is USD1.5575/1 at the end of December 2014. (6 marks) 2. Based on your calculation in (2), what is the premium (discount) of this bond compared to the par value? Is this premium similar to the premium that is observed in the market today of a little over 11%? If there is a difference, why is that so? (6 marks) 3. If you are comparing between two bonds that are similar in every other aspect except for the callable feature, which bond would sell at a higher price: the one with callable feature or the one without callable feature? Why? (4 marks) JAGUAR LAND ROVER PLC: BOND VALUATION Jaguar Land Rover Automotive plc (JLR), a wholly owned subsidiary of the Indian company Tata Motors Limited, announced, on March 3, 2015, an issue of Senior Notes (bonds) worth US$500 million and due in 2020 at a coupon rate of 3.5 per cent per annum (p.a.), interest payable semi-annually. The net proceeds of this issue were to be primarily applied to repurchase the company's outstanding Senior Notes worth $410 million, issued on May 19, 2011, and due on May 15, 2021(see Exhibit 1). These outstanding Notes carried a coupon rate of interest of 8.125 per cent p.a., payable two times per year. In March 2015, the indicative pricing of these Notes in the Luxemburg Bourse signaled an 11 per cent pre2mium over face value (see Exhibit 2). The reference treasury security for these Notes was the U.S. Treasury Notes due May 15, 2016, that carried a coupon of 0.25 per cent p.a. (see Exhibit 3). This issue was the company's second such refinancing in two months. The bond buyback was to be through a tender offer starting immediately and ending on March 30, 2015. Existing bondholders had an option to sell their holdings to the company or roll over their existing holdings to the new security. 3 No company would forego such an opportunity to halve its interest expenses and improve its bottom line. But can such a simple, positive-sum game exist in an efficient market? JAGUAR LAND ROVER PLC The 2008 financial meltdown in the United States proved especially cruel to the auto sector companies. As part of its corporate survival, revival and restructuring strategy, Ford Motor Company sold its Jaguar and Land Rover brands to Tata Motors Ltd., an Indian automobile manufacturing company on June 2, 2008, for a net consideration of $2.3 billion 4 (approximately GBP1.47 billion). - The volumes of these brands saw a 32 per cent drop in the 10 months after the takeover, and JLR posted a net loss of GBP402.4 million for the period ending March 31, 2009. By fiscal year (FY) 2011, however, the company had managed a turnaround and posted a post-tax profit 2 of GBP1,035.90 million. In 2011/12, JLR issued both dollar-denominated and pound-denominated debt to fund investments in its U.S. and European businesses respectively. This multi-currency funding also helped JLR to create a natural hedge for mitigating currency risk. The next four years saw JLR turning into the cash cow that supported the parent company in the face of a lackluster performance in the latter's domestic market. For the year ended March 31, 2014, JLR comprised more than 80 per cent of the consolidated automobile sales revenue for Tata Motors and was solely responsible for the consolidated company posting operating profits (see Exhibit 4). By September 2013, ratings agency Moody's Investors Service had upgraded JLR's bond issues from Ba3 to Ba2 with a stable outlook. Besides the impressive volume and revenue growth as well as earnings before interest, tax, depreciation and amortization (EBITDA) margins posted by JLR, the ratings upgrade was attributable to the company's positive free cash flows in FY2013 despite increased capital expenditures (capex) and dividend payments (see Exhibit 5). Another important factor contributing to this ratings upgrade was JLR's conservative financial strategy in terms of leverage and comfortably spread- out bond repayments (see Exhibits 1 and 6). 10 Analysts at Moody's, however, expected the next few years to see free cash flows turning negative on the back of increased capital investment and research and development. Both Standard and Poor's and Moody's rating services maintained JLR's credit rating at BB and Ba2 respectively, while revising their outlooks to positive in late 2014. With a capex of GBP3.6 billion to GBP3.8 billion lined up for FY2016, the chief financial officer of Tata Motors was quoted as saying the company optimistic about cash flow in JLR nex waseeautiously It was evident that JLR wanted to benefit from the impressive turnaround in its fundamentals. But would efficient bond markets allow firms to reap such benefits? Who gains and who pays in such deals? EXHIBIT 1: JAGUAR LAND ROVER'S FINANCING ARRANGEMENTS AS AT DECEMBER 31, 2014 Facility amount Annual Rate of interest Outstanding Undrawn GBP millions A. Senior Notes GBP500m due 2020 (first call Mar 2016) GBP400m due 2022 US$410m due 2021 (first call May 2016) US$500m due 2023 (first call Feb 2018) US$700m due 2018 US$500m due 2019 B. Revolving 3- and 5-year credit C. Receivable factoring facilities Total 500 400 263 321 450 321 1,485 225 3,965 8.250% 5.000% 8.125% 5.625% 4.125% 4.250% 500 400 263 321 450 321 0 0 0 0 0 0 1,485 32 1,517 193 2,448 Note: GBP - British pound sterling. The company has used the GBP/US$ exchange rate prevailing on the balance sheet date in annual and interim financial statements to convert the US$-denominated debt to GBP. Since the company earns approximately 17% of its revenue each in the United Kingdom and North America, for the purposes of this case, we assume that the natural hedge created mitigates any exchange rate risk. The average GBP/US$ rate for March 2015 can be taken at'4.50. Source: Jaguar Land Rover plc FY2015, Q3 Interim Accounts, p. 6, www.jaguarlandrover.com/media/59285/fy15-93-ifrs- interim-accounts-final.pdf, accessed March 13, 2015. EXHIBIT 2: JAGUAR LAND ROVER'S OUTSTANDING BONDS AND NOTES ON LUXEMBOURG BOURSE Coupon Rate; Security Start/End Dates 3.5%; USG5002FAE63 3.5%; US47010BAE48 3.875%; XS1195502031 3.875%; XS1195503351 8.125%; USG50027AB03 8.125%; US47009XAB55 8.25%; XS0765386627 8.25%; XS0765386973 06/03/201515/03/2020 06/03/201515/03/2020 24/02/2015-01/03/2023 24/02/2015-01/03/2023 19/05/2011-15/05/2021 19/05/2011-15/05/2021 27/03/201215/03/2020 27/03/2012-15/03/2020 Last Traded Date Price 12/03/2015 100 i % 12/03/2015 100 i % 06/03/2015 100 i % 06/03/2015 100 i % 04/02/2015 111.276 i % 07/08/2014 111.583 i % 30/01/2015 110.944 i % 30/01/2015 111.182 i % EXHIBIT 3: YIELD CURVE FOR THE U.S. TREASURY MAY 16, 2011 VERSUS MARCH 16, 2015 5.00% 4.00% 3.0666 1.83% 2.00% 1.57% 1.00% 0.00% 1 MO 3MO MO 1YR 2YR 3YR 5YR 7YR 10YR 20YR 30YR Maturity (Note: Primary axis is not to scale) 3/16/2015 5/16/2011 EXHIBIT 4: JAGUAR LAND ROVER INCOME STATEMENTS, 20122015 Figures in GBP millions Revenue FY2012 FY2013 FY2014 13,512 15,784 19,386 FY2015-9 months 16,040 Material and other cost of sales Employee cost Other expenses Development costs capitalized Other income Depreciation &amortization Foreign exchange gain/ (loss) Finance income Finance expenses (net) Share of loss from joint ventures Profit before tax Income tax expense Profit after tax (8,733) (1,039) (2,529) 751 37 (465) 14 16 (85) (9.904) (11,904) (1,334) (1,654) (3,075) (3,717) 860 1,030 70 153 (622) (875) (109) 236 34 38 (18) (185) (12) (7) 1,674 2,501 (460) (622) 1,214 1,879 (9,768) (1,427) (2,941) 850 150 (743) 58 36 1,479 (19) 1,460 (13) (24) 2,218 (482) 1,736 EXHIBIT 5: JAGUAR LAND ROVER'S CASH FLOW STATEMENTS, 2012-2015 FY 2012 1,460 FY 2013 1,214 FY FY2015-9 2014 months 1,879 1,736 466 69 96 622 (16) 475 875 100 577 743 (23) 610 Figures in GBP millions Profit for the year Adjustments for: Depreciation & Amortization Finance expenses/ (income) Others Cash flows from operations before working capital adjustments Net cash generated from operations Investment in joint ventures Investment in property, plant and equipment Cash paid for intangible assets Cash used for other investments Net cash used for investing activities Finance expenses and fees paid Proceeds from short-term debt Repayment of short-term debt Proceeds from long-term debt Repayment of long-term debt Payment of lease obligations Dividends paid Net cash used/generated from financing activities Net change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year 2,091 2,500 (1) (596) (814) (131) (1,542) (128) 105 (655) 1,500 (374) (4) 2,295 2,429 (71) (891) (958) (689) (2,609) (179) 88 (250) 317 3,431 3,422 (92) (1,201) (1,155) (288) (2,736) (269) 1 (158) 829 (746) (5) (150) (498) 188 3,066 2,572 (124) (1,147) (885) 131 (2,025) (97) 21 (6) 313 (4) (150) (178) (358) (4) (150) 77 624 444 1,402 1,028 2,430 2,430 2,072 2,072 2,260 2,260 2,884 EXHIBIT 6: JAGUAR LAND ROVER BALANCE SHEETS, 2012-2015 FY2015-9 months 4,137 4,769 817 Figures in GBP millions Property, plant &equipment Intangible assets Other non-current assets Total non-current assets Cash &cash equivalents Short-term deposits Trade receivables Inventories Other current assets Total current assets Total Assets FY2012 FY2013 1,586 2,335 2,801 3,522 595 771 4,982 6,628 2,430 2,072 775 662 927 1,497 1,795 646 640 5,235 6,209 10,217 12,837 FY2014 3,184 4,240 935 8,359 2,260 1,199 831 2,174 9,723 2,884 1,143 879 2,238 662 7,806 17,529 766 7,230 15,589 4,787 167 Accounts payable Short-term borrowings and current portion of long-term debt Provisions &other current liabilities Total current liabilities Long-term debt Provisions Retirement benefit obligations Other non-current liabilities Total non-current liabilities Total Liabilities 3,285 490 1,266 5,041 1,484 344 327 97 2,252 7,293 4,227 328 1,442 5,997 1,839 468 657 337 3,301 9,298 1,180 6,134 1,843 582 674 492 3,591 9,725 4,699 193 1,461 6,353 2,230 638 743 768 4,379 10,732 Ordinary share capital Reserves and surplus Equity attributable to shareholders Total Liability and Equity 1,501 1,423 2,924 10,217 1,501 2,038 3,539 12,837 1,501 4,363 5,864 15,589 1,501 5,296 6,797 17,529 QUESTIONS TO THE CASE STUDY ABOUT JAGUAR 1. Compute the price today (assume that it is May 16 2015) if these bonds were not callable? You could use either USD ($410 million) or British pound (263 million). The exchange rate between dollar to pound is USD1.5575/1 at the end of December 2014. (6 marks) 2. Based on your calculation in (2), what is the premium (discount) of this bond compared to the par value? Is this premium similar to the premium that is observed in the market today of a little over 11%? If there is a difference, why is that so? (6 marks) 3. If you are comparing between two bonds that are similar in every other aspect except for the callable feature, which bond would sell at a higher price: the one with callable feature or the one without callable feature? Why? (4 marks)