Debt Policy at Ust

Debt Policy at UST Inc.

1. What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.?

Evaluate from the viewpoint of a bondholder. (Your answer should be more qualitative than

quantitative!)

The following factors weave into the risks and attributes of the company from the creditors’

point of view:

A. UST had seven pending health related lawsuits at the end of 1998. The outcomes of

these suits are uncertain. Despite the major Medicaid state settlements, lawmakers

are expected to continue to push for new laws to combat youth tobacco use. Other

litigation against tobacco companies is expected to continue, especially suits filed by

individuals. This uncertain litigation and legislative environment makes the future

cash flows of UST risky

B. UST is a dominant player and market leader and its strategy is to combat entrants by

launching similar products, rather than cutting prices. But the recent market erosion

by small companies has raised concerns. And UST’s “counter attack” has not been

effective in competing against price-value brands. The resignation of his CFO and

President of tobacco unit further raise the uncertainty of the company’s efficiency of

solving the market erosion problem.

C. The previous uncertainty is enhanced by a lawsuit that alleged that UST had violated

antitrust and advertising laws and participated in anti-competitive conduct. Should

UST lost the suite, it will be more vulnerable with competitors.

D. Although the current scientific research that ties tobacco to cancer is not conclusive,

it’s uncertain that future research result will jeopardize the tobacco industry.

E. There is a chance of a cultural shift against tobacco, and UST is unlikely to expand

to international market.

2. Why is UST Inc. considering a leveraged recapitalization after such a long history of conservative

debt policy? (Your answer should be more qualitative than quantitative!)

A. UST wants to increase the firm value by enjoying the huge tax shield provided by

more leverage. Previously, they were too concerned about the default risk thus

adopting a conservative capital structure strategy. Now they want to be more

aggressively levered since the chance of bankruptcy is rather low.

B. Presumably, the company managers are also shareholders. The recapitalization helps

to decrease the total shares outstanding, thus increases the relative percentage owning

of the remaining shareholders. Consequently, the insiders will have more weights on

the voting of the major policies of the company. Since the value players form