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1. Higher share price volatility

This was the single most important factor. When investors buy a convertible they have the right to convert their bond into shares in the issuing company at a set price which is set at a premium to the current market share price.

We can work this out from the conversion ratio which is the number of shares that a convertible bond can be converted into. For example, if the conversion ratio is 40, then an investor will be able to convert every $100 nominal value of the bond issue into 40 shares in the issuing company. This would mean that the conversion price would be $2.50 ($100/40). This conversion price is normally set at a premium to the company's current market share price. So in this case the market price might be $2.00 which means that the conversion premium is 25 per cent.

2-5°-2-00=0.25or25% 2.00

A final important term associated with a convertible bond is the conversion value of the bond. This is the value of the bond assuming it was converted into shares at the current market share price.

In this case the conversion value of the bond would be $2.00 x 40 = $80.

A company clearly wants to be sure that the bond will convert into equity finance which will only happen when the share price at least rises to the conversion price level. When share prices are static or even worse falling, any conversion is much less likely. This brings the potential risk to the issuing company that they might have to redeem a bond which they had assumed would convert into equity finance. So we need to see rising share prices to encourage issuers to launch new convertible bonds and for investors to be willing to buy them.

2. Demand from hedge funds

Hedge funds have become big players in the fund management industry. The Financial Times reported that they were using complex arbitrage operations that involved buying a company's convertible bond and at the same time shorting (selling) its shares. It seems that the hedge funds' traders had identified a price anomaly in the market which created this opportunity for them to make profits through these arbitrage trades.

3. An ever growing stream of new innovative products

We have also seen the clever 'financial engineers' employed by the investment banks designing new and innovative products. One such instrument is the 'liquid yield option note' (lyon). The Financial Times article provides a clear description of them. 'These are convertibles that are issued at sub-par thus generating a yield despite the zero coupon.' Put simply, this means that you buy the bond at a discount to its redemption price so that the resulting capital gain compensates for the lack of any coupons. The great attraction of these new products is that they were issued at a time when Japanese money market interest rates were at last starting to increase. With these new products companies have been able to issue their zero-coupon bonds to meet their funding requirements before any sharp increase in bond yields which would inevitably follow the tightening in Japanese monetary policy.

The article ends by claiming that a final boost to the market would come from reduced regulation. There is one particular rule that investment bankers argue has held back market. This is the so-called 'seven day rule', which means that a convertible issuer ha wait seven days before setting the conversion price. It represents a significant risk for issuer since if the share price falls during this period the final conversion price might much lower than expected.

■ Key terms

Convertible bond These are bonds which provide the holders with the right to convert t bonds into shares in the issuing company. This conversion option will be at an agreed price a set date in the future. Initially this will not be a worthwhile transaction as the conversion share price will be set well above the current market share price. However, as the market share p rises in value over time so the conversion will soon be a valuable option for the bond holder. Convertibles are a classic debt equity hybrid product. One way to explain their attraction is to compare them to swimming in the sea. Most people would love to dive straight into a w ocean for a relaxing swim. However, if they are told that there are sometimes sharks around the sea they will become much more cautious. So instead they may prefer to paddle in breaking waves until they feel more confident that the risk of sharks is over. Only then will | be willing to swim further out into the ocean. In the same way buying convertible bonds way for risk-averse investors to start with a relatively safe bond investment. And then when I feel more confident about the prospects for the company they can convert the bonds into more risky shares.

Hedge fund This refers to a particular type of investment management where the manager will employ a range of different investment tools in an attempt to maximise returns or try to make gains even in a falling market. For full details see Article 26.

Exotic products This is a term to cover new innovative financial markets products. The of the term 'exotic' denotes that these are different from the normal version of this product will see it used in several contexts such as exotic bonds, exotic swaps, exotic options.

Book runner This is the lead manager who is in charge of the whole process in a new b issue. They will be jointly responsible with the issuer for inviting other banks to work on the issue in activities such as syndication and underwriting.

Arbitrage This is a very common practice among financial market traders. They will simultaneously sell (or buy) a financial instrument (for example a share or a bond) and at the same time take an equal and opposite position in a similar instrument. This transaction will give them a financial profit. This is possible where there is a clear price anomaly that has been identified between the markets involved. In theory such arbitrage trading is considered risk free. This makes it particularly attractive.

Snorting its shares This is used to refer to traders who sell a financial market security' they do not yet own. In other words, they have not yet made an offsetting purchase. This is a very risky activity as if the price of the financial market security rises the trader will have to pay an ever higher price to secure the stock.

The reverse process is when a trader goes long. This means that they have bought some financial market securities which they have not yet sold.

Liquid yield option notes (lyons) These are zero-coupon bonds that are issued below their par value. This guarantees the holder a return despite the zero coupon.

Zero-coupon bond This is a bond that does not have any interest payable but will instead be offered at a significant discount to the par value. This results in a large capital gain at redemption.

Coupon This is the interest rate that is set for a bond when it is first issued. In practice, the coupon is normally paid in two equal instalments.

Plain vanilla This denotes the simplest version of any type of financial market instrument. It alludes to ice cream varieties. A plain vanilla ice cream is the simplest type you can buy. It has no chocolate flake or any sauces!

What do you think?

  1. What are the advantages for companies in issuing convertible bonds?

  2. What factors determine the correct level of the premium between the conversion share price and the current market share price?

  3. What financial market conditions are necessary to ensure that a new convertible bond issue will be converted in good time?

  4. Explain what is meant when a trader is described as engaging in 'short selling'.

  5. What is meant by a plain vanilla financial market security?


Arnold, G. (2008) Corporate Financial Management, 4th edn, Harlow, UK: FT Prentice Hall. You should especially look at Chapter 11 where there is a superb section on convertible bonds.

Pike, R. and Neale, B. (2006) Corporate Finance and Investment, 5th edn, Harlow, UK: FT Prentice Hall. You should look at Chapter 16.

Watson, D. and Head, A. (2007) Corporate Finance: Principles and Practice, 4th edn, Harlow, UK: FT Prentice Hall. You should look at Chapter 6.

Go to www.pearsoned.co.uk/boakes or iTunes to download Podcast 9, which pro-PODCAST vjdes further analysis of key Issues for you to listen lo at your leisure. The podcastS are easily downloadable to your PC or iPod/MP3 player.

Bulldog, Yankee and samurai bonds

When you start reading the Financial Times you might come across a term that will both intrigue and confuse you. In this article there is a classic example with the discussion of 'samurai bonds'. It might make you wonder what possible link can there be between medieval Japanese warriors and the modern world of international finance. The answer is simple. A samurai bond is the term given to identify a Japanese foreign bond, Other foreign bonds have been given equally unusual names. So we also have bulldogs ( foreign bonds), Yankees (dollar foreign bonds) and matildas (Australian-dollar bonds). Once you know what they are, the rest of this article is much easier to understand.

Article 12

Financial Times, 6 September 2005

Record samurai deal by Citigroup

Mariko Sanchanta

Citigroup, the world's largest financial institution, yesterday sold ¥230 bn in samurai bonds, marking the largest such issuance ever.

The figure surpasses the record-high ¥220 bn in samurais issued in 2000 by DaimlerChrysler. Samurai bonds are yen-denominated bonds issued in Japan by foreign governments and companies.

Citigroup sold six tranches of samurais with maturities ranging from five to 30 years. The issuance of 30-year samurai bonds is also the first in the market, indi­cating demand is growing for longer-dated maturities. Citigroup Japan said it had not yet decided how to use the proceeds from the samurai issuance.

'We've seen a pick-up from financial institutions offering samurais', said Jason Rogers, banks analyst at Barclays Capital in Tokyo. 'It highlights the strong demand for samurais, which is due to low interest rates and tight credit spreads.'

Japan's benchmark 10-year government bond yielded an average of 1.3'7 percent in the past year, sending institutions and individuals searching for investments with better returns. In comparison. coupon on Citigroup's 10-year san bond is 1.58 per cent.

Nikko Citigroup, a joint venture of Nikko Cordial and Citigroup, managed the sale.

Citigroup Japan said the Japanese market remained 'very important' t< US financial services giant, and it w continue to expand its presence in market.

Citigroup last year was ordered Japan's financial regulator to shut private banking operations in Japan breaking banking laws. Its Japanese private banking business will close b; end of this month.

The analysis

The US banking giant Citigroup has just sold the largest ever issue of samurai bonds. These Japanese foreign bonds are yen-denominated bonds issued by non-Japanese companies but sold primarily to Japanese investors. The dual incentive for Citigroup to make such an issue comes in part from the low level of Japanese interest rates right across all maturities but the article also points to the presence of 'tight credit spreads'. This means that the cost of issuing higher-risk bonds has fallen to very low levels. As a result, Citigroup was able to sell a huge amount of bonds at a low cost of finance.

At the same time, demand would have been strong from a wide range of Japanese investors, including banks, insurance companies and pension funds. These firms were awash with spare investment cash and a samurai bond enables them to obtain some diver­sification in their bond portfolio with this international exposure. However, at the same time they have none of the currency risk that would apply if they simply purchased bonds issued in other countries.

The article explains that this new issue will be split into six tranches with some issues, for the first time, having a very long-term maturity of up to 30 years. This issue confirmed that Citigroup would be likely to expand its activities in the Japanese financial services market.

The Financial Times reports that Citigroup has so far had mixed fortunes in the Japanese finance sector. Back in 2004 the Japanese financial services authorities forced it to shut all its private banking operations 'for breaking banking laws'. It is expected that its Japanese private banking business would be closed by the end of September.

Key terms

Bonds A bond is a security issued by a government or a corporation which represents a debt that must be repaid, normally at a set date in the future. Most bonds pay a set interest rate each year.

Foreign bonds are bonds issued by a foreign borrower in another country's domestic market. For example, we might have yen-denominated bonds issued by a foreign borrower in the domestic Japanese market. They are called samurai bonds.

Foreign bonds are often given strange names:

Nome Country

Samurai Japan

Yankee United States

Bulldog United Kingdom

Matildas Australia

Tight credit spreads This is a measure of the relative cost of issuing more risky bonds. It is best seen with an example.

Let us assume that the United States government has close to zero risk of default. As a result, a 10-year US Treasury bond might have a yield of 4.5 per cent.

In contrast, a 10-year issue from Ford Motor Company which has significantly more risk of default might have a yield of 6.5 per cent.

This gives us a credit yield spread of 6.5% minus 4.5% = 200 basis points differ­ence.

If investors now start to buy lots of the higher yielding (more risky) bonds this could result in 'tighter credit spreads' as the relative cost of these bonds falls.

In this case the yield on the 10-year issue from Ford might fall back to 5.5 per cent. This would reduce the yield spread to just 100 basis points. This would be a 'tighter credit spread'.

In this article this term is used to explain why there had been a spate of new samurai bonds. The relative cost of issuing more risky bonds in yen-denominated markets had fallen sharply, this case Japan's benchmark 10-year government bond yield had fallen to an average 1.37 per cent in the past year. This had forced Japanese investors to look elsewhere for better returns. For example, the coupon on the new Citigroup issue was 1.58 per cent which was me attractive to investors but also shows the impact of 'tight credit spreads' in terms of reducing the cost of the bond finance for Citigroup.

Tranches This term is derived from the French word 'tranche', which means a slice. In this context a tranche simply refers to the individual parts of a new bond issue. You might also s the term 'tap' or 'mini-taplet' used.

Private banking This refers to banks that manage the financial affairs for 'high net worth’ individuals.

Bank's analyst This is the person employed at an investment bank (in this case Barclays Capital) whose job it is to advise the bank's clients on the major financial institutions operating within the financial services industry. They will be required to value these businesses and of comparisons between their own and the market's valuations as reflected in the current share prices.

■ What do you think?

■ Explain what is meant by the term samurai bond.

<■ Why might a Japanese investor prefer to buy a samurai bond rather than a simple domestic bond issue?

■ Why might a foreign company prefer to issue a samurai bond rather than a simple domestic bond issue?

■ Investigate FT data

You will a copy of the Companies and Markets section of the Financial Times

Go to the Market Data section.

Hint: this is normally one page before the London share price service.

Locate the Global Investment Grade section. Look at this table and select any five major corporate bond issues.

1. You should calculate the spread on these bond issues compared with the benchmark government bond.

2. Comment on the reasons for this additional yield. Hint: focus on the credit rating of the bond issuer.

■ Research

Arnold, C. (2008) Corporate Financial Management, 4th edn, Harlow, UK: FT Prentice Hall. You should especially look at Chapter 11.

Pilbeam, K. (2005) International Finance, 3rd edn, Basingstoke, UK: Palgrave Macmillan. There is a good introduction to foreign bonds.

Valdez, S. (2007) An Introduction to Global Financial Markets, 5th edn, Basingstoke, UK: Palgrave Macmillan. You should look at Chapter 6.


Go to www.pearsoned.co.uk/boakes or iTunes to download Podcast 8, which pro­vides further analysis of key issues for you to listen to at your leisure. The podcasts are easily downloadable to your PC or iPod/MP3 player.

Capital structure

Capital structure refers to the long-term finance that a business needs in order to trade. This includes long-term debt finance, ordinary shares, preference shares and retained earnings. It is a key topic in corporate finance as companies must decide on the appropriate balance between equity and debt finance. The first article looks at how different types of capital are treated when a company gets into financial difficulties.

The following two articles are analysed in this section:

Article 13

MyTravel shareholders offered 4% in £800 m debt-to-equity restructuring

Financial Times, 14 October 2004

Article 14

Blacks Leisure falls into the red

Financial Times, A May 2007

These articles address the following issues:

  • Secured and unsecured bonds

  • Convertible bonds

  • Preference shares

  • Business risk

  • Gearing

MyTravel on the brink

In corporate finance it is essential to understand the important role that a company's capital structure plays in all its business activities. When a company looks to raise new finance the choice is between the extremes of equity finance and debt finance. From the point of view of the company the issue of more share finance is much less risky as the company makes no financial commitments to the shareholders. In contrast, the issue of new bond finance means that the company is now obliged pay interest each year and it also has to repay the loan at a fixed date in the future. Financial risk is the name given to the type of risk associated with this commitment to the debt holder.

In recent years we have seen the development of a number of new financing products which are debt-equity hybrids. This means that they are somewhere between the two extremes of equity and debt finance. This includes the use of convertible bonds. In this article we will see how the various providers of capital are treated very differently when a company faces the prospect of severe financial distress.

Article 13

MyTravel shareholders offered 4% in &800 m debt-to-equity restructuring

Matthew Garrahan

MyTravel shareholders have been offered just 4 per cent of the embattled travel group under an ambitious proposal that would see £800 m of the company's unse­cured debt converted into equity.

Following sharp declines in MyTravel shares, the price of the stock had already factored in dilution so yesterday's announcement will not come as a great surprise to investors.

Under the hoard's proposal, creditors have been offered 88 per cent of the enlarged share capital, with convertible bondholders in line for 8 per cent should they wish to accept it.

The rest of the shares would be retained by existing equity investors.

James Ainley, leisure analyst with Dresdner Kleinwort Wasserstein, said the restructuring would imply the issue of about 13 bn new shares. 'At the current 5 p price, this equates to £650 m additional equity or about 80 per cent of the face value of the debt', he said.

However, the move could come unstuck if convertible bondholders object to the terms.

Bank creditors will, in effect, receive the face value of their loans in new MyTravel shares. But convertible bond­holders will only receive shares equivalent to 30 p for every 100 p invested.

Analysts said it was unlikely the bond­holders would not accept the proposal.

One said: 'If they say no, they could derail the deal and the business may go into liquidation'.

MyTravel has proposed a timetable for the restructuring that would see it completed by the end of 2004.

On completion, the company's debt will Non-voting preference shares will be

be approximately £140 m of aircraft awarded to creditors and bondholders

finance leases. from outside this area.

In order to satisfy European Union Provided the bondholders and creditors

rules as to airline ownership, MyTravel accept the proposal, the company will

has also proposed issuing ordinary shares have a new, five-year overdraft facility

to creditors and bondholders from coun- worth £167 m. tries in the EU and European economic area.

■ The analysis

The company MyTravel plc has run into serious difficulties. As a result, there is now a pro­posal for a major restructuring of the financing of the business. So who are the winners and who are the losers in this situation?

The debt holders in any failing business are always in the strongest bargaining position. They are higher up the creditor hierarchy than the preference shareholders or the ordinary shareholders. As a result, the plans from the company's board of directors would offer 88 per cent of the new enlarged share capital to the various debt holders. In effect, they will see 100 per cent of the face value of their debt converted into shares in MyTravel plc. So the monetary value of their investment has been protected, although they now have seen the money that they were owed by MyTravel converted into equity finance.

The middle of the creditor hierarchy is represented by the convertible bond holders who are being offered a further 8 per cent of the share capital. This means that they would get back 30 per cent of their existing investment in the form of shares.

And at the bottom of the hierarchy are the ordinary shareholders who are being offered just 4 per cent of the expanded share capital. In order to go ahead with this course of action the company's board of directors will need a positive vote in favour from the various bond holders. One analyst quoted in the Financial Times article speculates that a rejection 'could derail the deal and the business may go into liquidation'. This would leave the various parties fighting over any assets that the company still owns.

This article perfectly shows the risks that are faced by ordinary shareholders. If a company is doing well, they reap the rewards in terms of capital gains through a sharp rise in the share price plus higher income in the form of rising dividend payments. However, if the company hits problems, they act as the shock absorber for the other providers of capital. In other words, in times of trouble companies will see a sharp fall in the capital value of their shares while the bond holders will normally be insulated against the most severe consequences of corporate failure. As a counter to this lower risk, the bond holders accept much lower potential returns.

In summary, this article shows the stark choice that investors face. If they purchase good quality corporate bonds, they are normally getting a low risk but also a low-return investment. In contrast, if they buy shares from the same company, they are getting a high-risk asset which carries with it the potential for very substantial returns. This investment

decision is often driven by the attitude of the individual investor to risk and return. The final choice is yours!

■ Key terms

Capital structure This refers to the long-term finance that a business needs in order to trade. This is made up of debt and equity finance. The debt finance will normally be in the form of a bond that carries fixed interest payments and a set date when it will be redeemed. In con­trast, there are no guarantees of any financial returns to the providers of equity (the shareholders). If a company does well and is highly profitable it is likely that there will be sig­nificant dividends paid to the shareholders. However, if the company runs into financial difficulties, the dividends will be cut back and they might disappear altogether. It should be clear that in terms of capital structure the shareholders take a greater risk than the debt holders. As a result, it is reasonable for the shareholders to expect a higher level of financial returns to compensate for this higher risk.

See Articles 2 and 3 to see these issues discussed in more detail. It shows how activist share­holders are increasingly seeking management changes in companies that do not perform in line with their expectations.

Convertible bonds On the face of it, these are just like conventional bonds as they are interest bearing and have set redemption dates. However, they give the holder the right to convert their bonds into the shares of the issuing company.

Hint: For a more detailed discussion of convertible bonds you should look at Article 11, which looks at the |apanese convertible bond market. There is a more detailed definition of a convert­ible bond in the key terms section following the article.

Secured and unsecured debt Companies will normally have a range of different types of debt capital. The lowest risk form of debt capital will be secured debt. This means that the debt is secured on various assets owned by the business including property or plant and machinery. If the business goes into liquidation, the secured bond holders will have a claim on these assets so that their investment will be protected. In contrast, the unsecured debt holders do not enjoy this form of protection. They accept a higher degree of risk which must be compensated for by a higher level of return.

Non-voting preference shares In many ways, preference shares can be seen to be very similar to bond finance. They normally pay dividends at a set percentage very much like the coupon on a bond issue. And, in addition, they will normally have a set redemption date. However, unlike bonds, the dividends on a preference share are paid at the discretion of the board of directors of a company. Most preference shares are non-voting which means that the holders will not have the right to vote on corporate policy at the annual general meeting.

What do you think?

  1. With reference to this article, comment on the relative risk and reward profile of ordinary shareholders, preference shareholders, convertible bond holders and secured bond holders.

2. Explain why the ordinary shareholders receive only 4 per cent of the new expanded share capital.

3 it is often said that shareholders act as 'shock absorbers' for the company. In the context of this article, explain what this means.

  1. What is meant by the term convertible bonds? What are the advantages for investors who buy convertible bonds rather than ordinary bonds?

  2. What is meant by the term non-voting preference shares?

  3. Why are preference shares referred to as hybrid securities?

  4. What are the likely outcomes if the bond holders reject the restructuring proposal:

Investigate FT data

You will need the Companies and Market section of the Financial Times. Go to the London Share Price Service. This is normally the two pages inside the back page of the Companies and Markets section.

Answer these questions:

  1. What is the current share price for MyTravel plc?

  2. What is the high/low for this share price in the last 12 months?

  3. What is the current P/E ratio for MyTravel?

  4. How does this P/E ratio compare with that of other transport companies?


Arnold, G. (2007) Essentials of Corporate Financial Management, Harlow, UK: FT Prentice I Gives a very clear introduction to different types of bond issues.

Arnold, G. (2008) Corporate Financial Management, 4th edn, Harlow, UK: FT Prentice Hall. should especially look at Chapter 11 to get more information about convertible bonds. It out very clearly the advantages of convertible to both the issuers (companies) and the investors.

Pike, R. and Neale, B. (2006) Corporate Finance and Investment, 5th edn, Harlow, UK Prentice Hall. You should look at Chapter 16.

Watson, D. and Head, A. (2007) Corporate Finance: Principles and Practice, 4th edn, Harlow, F"T Prentice Hall. You should look at Chapters 5 and 6.


Go to www.pearsoned.co.uk/boakes or iTunes to download Podcast 11, which pr vides further analysis of key issues for you to listen to at your leisure. The podcasts are easily downloadable to your PC or iPod/MP3 player.

Blacks Leisure hit by global warming

Business risk is an important concept in corporate finance. This is the general risk that applies to all companies that operate in any business environment. For example, a company might see a sharp drop in sales because a rival business brings out a better product or another company might be hit by a change in tax laws that have a negative impact on the profitability of a business. No matter what a company does, it is impossible to remove all business risk. It is a fact of life for companies. Instead they must do their best to protect themselves against the most severe damage that might be caused to their businesses.

In this example we focus on Blacks Leisure which has seen a sharp downturn in its financial performance as a result of a change in weather patterns. The company blames this business risk on the impact of global warming.

Article 14

Blacks Leisure falls into the red

Tom Braithwaite and Maggie Urry Background

Retailers are fond of blaming the weather when things go wrong. Blacks has gone a step further by blaming climate change.

'Blacks and Millets have historically benefited from the traditional British climate of somewhat wet summers and cold winters,' it said yesterday as it reported a loss for the year that was 'the warmest and driest on record'.

Moreover, the new year had seen unseasonably warm spring weather'.

Blacks Leisure has slashed its dividend as it tries to stabilise the troubled business, heaping more misery on both its shareholders and those of Sports Direct.

Results for the year to March 3 showed the outdoor wear group just managed to break even, with underlying profit of £100 000 on sales little changed at £298 m, in line with expectations after its most recent profit warning.

However, Blacks went into the red fol­lowing an exceptional charge of £13.9 m, the cost of closing about 45 loss-making stores, which mainly trade under its worst performing Millets fascia.

Investors in Sports Direct, the sports­wear group that floated in February, are exposed to the fortunes of Blacks via a 29.4 per cent stake. Mike Ashley, the con­troversial founder and majority shareholder of Sports Direct, bought the stake in his own name last year but rolled it into the company upon flotation.

Both companies have suffered a signifi­cant sell off this year: shares in Blacks are down 37 per cent, while those in Sports Direct have fallen 25 per cent since it joined the market in February.

Shares in Blacks fell 2p to 259 p yes­terday, while those in Sports Direct closed down 3^p at 226 p.

Russell Hardy, chief executive of Blacks,

said there had been 'some pleasing signs of good growth from the camping business' but that the company had endured a 'tough April'. In the first eight weeks of the new financial year, to April 28, sales were up 2.7 per cent and like-for-like sales had increased 0.8 per cent.

Blacks has traditionally performed well in wet summers and cold winters and claims that 'global warming' has brought about much of its weaker performance.

'In terms of weather proofing the busi­ness, we've done a lot of work for this season but my sense is it's going to take another couple of seasons to put the busi­ness in a position where it can cope with consistently drier weather', said Mr Hardy.

Blacks is cutting its final dividend by 6p to 2 p, leaving the total for the ] 5.3p, down from 11.3p last time.

The board said it regarded 'the reduction in the final dividend as a measure reflective of the poor trading performance'.

During the year, like-for-like sales fell 2.7 per cent and high operational gearing meant margins fell sharply.

After taking the £13.9 m charge, reported a pre-tax loss of £13.8 m (£21.4 m profit). Losses per share were 29.7 p (earnings of 34.6 p).

■ The analysis

Anyone who has been on an outdoor activity holiday will know the name Blacks. I it is the shop of choice for walking and climbing gear. The last time I was in a Blacks store getting some new trekking boots I remember being most impressed by its indoor walking ramp which is used to try them out. It is probably a slight simplification but, as a Blacks Leisure can be split into two main parts. The core activity is the outdoor leis product market including clothing and boots. Perhaps less widely known, it also sells boardwear gear as it is the UK's distributor and retailer of O'Neill products.

This Financial Times article focuses on its latest very poor set of financial results which were for the year to 3 March 2007. In this period the company broke even or £298 m. This was very much in line with the market's expectations following a very recent profit warning. However, an exceptional charge of some £13.9 m took the company into the red. This charge resulted from the closure of a significant number of loss-making Millets stores. Shareholders in the group have suffered a sharp fall of 37 per cent Blacks share price in the last year.

The Chief Executive, Russell Hardy, saw some encouraging signs despite these bad figures. He claimed that the company had suffered in the face of the impact o change. A company like Blacks performs best with wet summers and cold winters. So the onset of drier summers and milder winters hits sales badly. The company was attempting to insulate itself from the impact of global warming. This is most easily achieved product diversification.

This is a classic example of a business risk damaging a company's performance.As usual, it is the shareholders who take the biggest hit. In this case they have seen the final dividend slashed by 6 p to 2 p. So the total dividend for the year fell from 11.3 p to just 5.3 p. This dividend reduction combined with the sharp fall in the share price

means that business risk has resulted in a disastrous year for Blacks' shareholders. As the advertisers of certain financial products are forced to say, 'always remember the price of shares can go down as well as up'. What they do not say is that the cause is normally business risk.

Key terms

Business risk This refers to the general risk that can impact on a company's cash flow or profitability. It could be caused by general economic conditions (consumer spending, level of interest rates, etc.) as well as more specific company factors (changes in key staff, strike action by employees, etc.).

Hint: if you look at Topic 11, you will see more discussion of the risks facing companies. Article 25 shows how companies can manage some forms of currency risk.

Break-even A company achieves break-even when its sales revenue equals total costs. These costs will include some fixed costs as well as the variable costs that will be dependent on the level of sales.

Gearing This refers to the proportion of debt in the company's capital structure. A company is termed highly geared if it has a large amount of debt finance and only a small amount of equity finance. In contrast, a low geared company will be largely financed by equity finance.

What do you think?

  1. What is meant by the term business risk? Select any five FTSE-1OO companies and identify an example of business risk that might impact on them in the next year.

  1. Explain what is causing the business risk associated with Blacks Leisure.

  2. What steps could Blacks Leisure take to try to minimise this type of business risk?

  1. Just about a year ago you advised a friend (perhaps, now a former friend!) to purchase 1000 shares in Blacks Leisure. Write a short report (300 words max.) explaining the negative performance of these shares in the past year. Give a view on their likely per­ formance in the year ahead.

Hint: get hold of the company's latest report and accounts and visit its website.

Investigate FT data

You will need the Companies and Market section of the Financial Times. Read through the first few pages of this section in today's edition of the Financial Times.

Attempt this short activity:

1. Identify any two examples of a company's share price being impacted by a form of business risk.

Hint: if you cannot see an example in the various company reports look instead at the Markets Report at the back of the Companies and Markets section.This shows the main share prices movements in London and gives a reason for the change in most cases.


Arnold, G. (2008) Corporate Financial Management, 4th edn, Harlow, UK: FT Prentice Hall. You' should especially look at Chapter 13 to get more information about business risk.

Pike R- ar|d Neale, B. (2006) Corporate Finance and Investment, 5th edn, Harlow, UK: FT Prentice Hall. You should look at Chapter 8 for a good explanation of the main types of risk,

Watson, D. and Head, A. (2007) Corporate Finance: Principles and Practice, 4th edn, Harlow, UK:FT Prentice Hall. You should look at Chapter 9.

Go to www.pearsoned.co.uk/boakes or iTunes to download Podcast 12, which pro- vides further analysis of key issues for you to listen to at your leisure. The podcasts are easily downloadable to your PC or iPod/MP3 player.

Equity finance

Shareholders are the main providers of long-term finance to companies. They are the owners of the companies and as such have a number of rights. These three articles examine the process of launching an initial public offer for a company and in addition consider the issue of how the shares of a particular company should be valued.

The following three articles are analysed in this section:

Article 15

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