Leveraged Recapitalization

The company's equity was flat. Its earnings were flat, but predictable. Each year, The Little Cable System That Could produced $20 million. It had 100 million shares outstanding and traded for just $2 a share. It had $40 million in cash and no more capital upgrades it needed to spend cash upon for the foreseeable future. So it decided to do a leveraged recap, wherein it would take out $100 million in debt, and just buy back its own stock, hoping to "force" the equity price upwards from $2 a share to $5, or maybe higher.

How do they do this magic? Well, on that $100 million of leverage, they hopefully buy back something close to 50 million shares, and their earnings just continue apace at $20 million a year. The new balance sheet shows $20 million in cash and $100 million of debt, or $80 million in net debt, which presumably the company will pay off in 4-5 years.

But now, with only 50 million shares outstanding and $20 million in earnings, the company earns 40 cents a share instead of 20 cents a share (and yes, we're ignoring interest costs on the debt here for now). But the company will have performed a leveraged recapitalization, taking their "under-risked" balance sheet and deploying it as a weapon on behalf of the equity holders to...grow, under the mantra, "I think I can grow; I think I can grow."

Ironically, the same phrase was the original marketing slogan for Viagra.