Reflection- sources of finance ITC 2024

Question 1

Utilizing cash balances

Answer 1

Considerations
-sufficient to finance the full value
-consider the cash utilised by the existing operations so as not to expose XS Gaming Limited to undue liquidity risk
-

Question 2

If an unusual event causes super profits

Answer 2

It is important to consider
the impact that the boom in the gaming industry due to the COVID-19 pandemic; with
the world returning to some form of “normality”, the era of “super-profits” has passed,
and it would be advisable for to retain its free cash flow.

Question 3

Is there any benefit of a country with fluctuating interest rates?

Answer 3

As South Africa has likely reached the peak of the interest rate cycle, interest rates
are likely to drop in the interest rate market in the near term; the Origin Bank loan
having a variable interest rate would impact positively on the finance charges incurred
on said loan

Question 4

bullet payment repayment

Answer 4

pro- Repayment of the loan by means of one bullet repayment at end of four-year term is
beneficial from a cash flow perspective; no cash outflows until the end of the loan
term, resulting in a positive cash saving annually

con-The flip-side is that it also creates a risk of not being able to afford the single bullet
repayment – should it not match cash inflows with outflows

Question 5

Covenants

Answer 5

interest cover and debt equity may become a constraint in future

Question 6

Rights issue

Answer 6

rights issue, it will not necessarily dilute the existing shareholders’ stakes
in unless they are unable to take up the rights

Question 7

Timing of rights issue

Answer 7

The XS Gaming Limited shares are viewed as being undervalued at present; the
timing of the issue is not favourable and as such issuing equity at present would not
be advisable until the share price picks up, resulting in the higher proceeds from an
equity issue in future (or fewer shares having to be issued in future to raise the same
amount of funding).

Question 8

Considerations needs to be?

Answer 8

Sufficient if not use pecking order theory

Question 9

Conclusion structure Jan ITC

Answer 9

Recommendation is to use up some of the cash resources, as these would not be
yielding sufficient return equalling at least the WACC of XS.

Fund the remainder with debt, which is cheaper (the after-tax cost of the Origin Bank
loan of 9.75% p.a. is less than the cost of equity of 22%) and creates a more efficient
capital structure as XS’ gearing levels are currently low, and it would avoid a dilution
resulting from the issuing of shares while the share price is low.

The Origin Bank loan would be favoured as it is cheaper and more flexible, and the
covenants and encumbrances are not necessarily qualitatively material based on the
profitability and financial status of XS Gaming Limited at present.

Question 10

Bank loan

Answer 10

If interest rates rise (which they are expected to, due to the recent temporary
drastic decreases in the interest rate due to the COVID-19 pandemic), the market
value of the bank loan (which has a fixed rate) will decrease. If the debt ratio is
measured on market values (as it ought to be), the decreasing
market value would assist Breeze in potentially reaching its targets.

Question 11

The bank loan requires upfront security whereas the issue of shares and
corporate bonds do not. The latter two options enable more flexibility for providing
security for future borrowings

Answer 11

Are there sufficient accounts receivable and inventory available to pledge (i.e.,
not already pledged)?

Question 12

Green bonds

Answer 12

The green bond has the lowest cost, followed by the bank loan. The
equity is different in nature and therefore significantly more
expensive

Question 13

Despite having the lowest cost, the green bond has the most detrimental impact
on the debt ratio because the loan is only repaid after seven
years.

Answer 13

The green bond is a growing market and Breeze is likely to attract
investors who want to invest in ESG initiatives.

Question 14

Green bond might have additional terms and conditions attached to it, which
might limit the way in which the bond is used, the reporting requirements,
etc.
OR Consider whether the green bond could be used for refinancing purposes as it
could be expected that it is used to rather fund green /
environmentally friendly projects.

Answer 14

The green bonds mature at the same time as the R750 million of existing debt,
exposing Breeze to a risk of not being able to raise sufficient
funding to repay all debt (refinancing risk)

Question 15

The green bond exposes Breeze to the risk of interest rate increases
(floating vs fixed rate bank loan).

Answer 15

The repayment of the green bond’s capital, which is only repayable in seven years’
time, provides more cash flow flexibility than the bank loan

Question 16

hat the share issue is a rights issue, it will have a dilutive effect on
existing shareholdings for shareholders that do not take up their rights

Answer 16

Legal and governance considerations which could be more complicated
for a rights issue than for loans.

Question 16

Rights issue

Answer 16

The rights issue is the only source that results in the target debt ratio being
achieved; and consequently, the debt covenants not being
breached.

Question 17

Breeze has a high financial risk and did breach loan covenants which may cause
current shareholders to have significant skepticism on future growth plans of the
company. Therefore, they might not be willing to take
up the rights issue.

Answer 17

he rights issue provides the most flexibility from a cash flow perspective as
dividends do not have to be paid and the ZAR500 million is not repayable

Question 18

Breeze will however need to consider shareholders’ expectations of future
returns (shareholders may pressure the company for the payment of dividends)
and the signalling effect of the rights issue.

Answer 18

Other issues

he cost of issuing the various instruments need to be considered, e.g.,
marketing costs for the rights issues, advisory fees, legal agreements for the loans,
initial costs, meeting reporting requirements for the security,
etc

The crux of the matter is that Breeze is currently too highly geared. Not choosing
the rights issue will mean that the target debt ratio will not be met,
and the existing loan covenant will be breached complicating matters with existing
creditors.

Although the financial risk may not increase because of the new loans (the total
debt balance remains unaffected), the new forms of loans, the covenants and the
costs, may affect the market’s perception of the
company’sriskiness.

Question 19

Although the financial risk may not increase because of the new loans (the total
debt balance remains unaffected), the new forms of loans, the covenants and the
costs, may affect the market’s perception of the
company’sriskiness.

Answer 19

The company’s expansion into the rest of Africa needs to be considered
in terms of the existing financing options (e.g. impact on loan if taken out,
covenants, etc.)