Use of QUICS to restructure debt, risk to common stock
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AMR, the parent firm of American Airlines, found its profitability had improved a few years ago. Several years prior, AMR had issued privately about 1.1 billion of convertible preferred stock. As you know, interest is tax deductible whereas dividends are not. AMR decided to offer the preferred stockholders the chance to exchange their shares for a new issue of convertible Quarterly Income Capital Securities (QUICS). AMR offered to exchange 1,000 face amount of 6.125% convertible QUICS for 1,000 face amount of 6% convertible preferred stock. All 1.1 billion of preferred stock could be exchanged at the holder's option. The QUICS would carry a slightly higher yield and would rank senior to the preferred stock. But QUICS include an interest-deferral feature. AMR can defer interest payments from time to time for up to 20 consecutive quarters. It was reported that because of this feature, the rating agencies view QUICS as virtually identical to the preferred.
AMR's main purpose in offering to exchange convertible QUICS for convertible preferred was to improve the firm's after tax cash flow because of the tax deductibility of interest. Below compares the QUICS and the preferred stock.
Just prior to the exchange offer, AMR's capitalization was (dollar amounts in millions):
Long term debt:
Current maturities $189
Long-term debt, less current maturities $7,710
QUICS $0
Total long term debt 7,899
Convertible preferred stock 1,081
Common Stock 3,318
Total Stockholder's Equity 4,399
Total Capitalization $12,298
1) Describe the QUICS. Are they debt, or they equity? How do they differ from the convertible preferred stock?
2) Recalculate AMR's capitalization if holders of (i) 50% and (ii) 100% of the convertible preferred stock exchange them for QUICS
3) Calculate the increase in net income available for common stock that would result from (i) 50% and (ii) 100% of the convertible preferred stock being exchanged for QUICS.
4) Why does this debt-for-equity exchange increase the risk of the common stock? How does the interest deferral feature affect your interpretation of the QUICS? The risk of the common stock?
5) What trade-off did AMR have to evaluate as it considered whether to proceed with the exchange offer?
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Solution Summary
The solution examines the uses of QUICS to restructure debt, risk to common stock.
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Question 1
Quarterly Income Capital Securities of QUICS are variation of the quarterly version of a hybrid security called monthly income debt securities or MIDS which are sub-ordinated debts or debentures with the issuing company or its parents if the issuing entity is a subsidiary guaranteeing the quarterly payments to the debt holders. QUICS, therefore, is more of a debt security.
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