Corporations commonly incur debt in financing the acquisition of other companies or in fighting takeover attacks by competitors. Two strategies often employed involve deferring interest payments and incorporating interest rate resets. For example, Interco Inc. incurred large amounts of debt in 1989 to make itself unattractive as a takeover target. The debt postponed interest payments until 1991 at which time interest was to be paid at 14%. Interco’s strategy was to sell a portion of its business, Ethan Allen Inc., to redeem the debt.
However, the sale netted $120 million less than expected.
Western Union incurred $500 million in debt that carried with it a reset provision. The provision called for increased interest rates if the bonds were not trading at a specified price. Western Union’s reset provision increased interest rates from 16.5% to 19.25% in 1990. While interest expense rose, revenues dropped 28% from 1988 to 1989 as a result of fax machines making Western Union’s telex service obsolete.
1. What is the significance of debt with respect to company acquisitions?
2. Why would corporations use deferred interest features and interest rate resets?
3. In the case of Interco, how would incurring large amounts of debt be an effective method for fighting a takeover?