Florida Power & Light Group Inc.’s Issues

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Table of Contents

Major Issues faced by FPL Group, Inc.
Reasons for Corporate Diversification
Cash Flow Analysis
Advantages and Disadvantages of possible decisions
Market Reaction
Performance Analysis
Recommendations

Major Issues faced by FPL Group, Inc.

FPL Group was one of the largest electric utility corporations in the U.S. and the largest one in Florida. It has been facing a variety of issues and challenges during its operational history in general and in May 1994 in particular. The main groups of issues were regulatory and operational.

Regulatory Issues

The Public Utilities Regulatory Policies Act (PURPA) required the purchase of power output by the utilities from the qualifying facilities in 1978 (Schreiber).
The National Energy Policy Act (NEPA) has allowed the sale of power using transmission systems of various facilities in 1992.
The California Public Utilities Commission has released a proposal (blue book) in 1994, proposing retail wheeling for implementation by the end of 1996. Such legislation would deregulate the third component of the value chain, namely distribution, by allowing the use of the distribution systems of various facilities to compete for customers.

While these changes were presenting opportunities for FPL Group, they were also implying a higher level of competition, naturally leading to the potential risks, associated with the loss of market share. As the result, the share price of the corporation has fallen by 19.6 percent over the year preceding May 1994.

Operational Issues

The company has undergone major quality control reform, contributing to an improvement in the quality of operations, but lowing employee morale. James Broadhead, the new CEO of the company has scaled back the program, focusing on the effectiveness of the core operations.
Effectiveness issues implied broad diversification of the company’s operations after acquisitions of the non-core businesses. The company was going through optimization of the processes with the sale of non-core processes.
Efficiency issues suggested a focus on modernization and construction of the new facilities.

Reasons for Corporate Diversification

The primary reason for the diversification of the corporation’s activities was the need to increase its profitability. The Chairman of FPL Group Marshall McDonald has decided to achieve such results with investments into businesses with higher growth rates.
The secondary reason was the lack of investment opportunities in the power industry. The main acquisitions have taken place in 1985 and 1986, approximately seven years before NEPA, which has made it possible to use the transmission systems of various utilities. Therefore, Marshall McDonald has decided to diversify the company’s operations. However, he has overestimated the capabilities of the company’s management, as well as the employee morale, which was particularly low amid constant quality control checks.

Cash Flow Analysis

Given the data, provided in the cash flow statement, the FPL group has been reporting a continuous increase of the cash from operating activities with $1.27 billion in 1993 being the 4-year high. The company managed to maintain a similar level of cash flows spent for investing, while also receiving moderate cash inflows from the financing activities. The company’s cash balance has been increasing consistently during the period between 1989 and 1993 with the highest level of $152 million at the end of 1993.

Advantages and Disadvantages of possible decisions

FPL Group will face various advantages and disadvantages in case of different decisions regarding dividends.

Table 1. Advantages and Disadvantages of Various Dividend-Related Decisions.

Decision	Advantages	Disadvantages
Increase Dividends	Higher confidence of the shareholders; Share price growth; Lower interest-associated costs.	Potential lack of funding in the future; Lack of funding in case of downward market pressure; Higher interest-associated costs, resulting from a share price decline.
Maintain the Same Amount of Dividends	Avoidance of extreme share price shocks; Availability of funds in case of negative market tendencies; The potentially positive reaction of the stockholders; Moderate interest cost-related risks.	Lack of share price growth; Lack of funds in case of negative market tendencies.
Cut Dividends	Decline of the share price; Potential lawsuit from the shareholders; Higher bond yields, stemming from low share price; Faster dividend increases in the coming years.	Funding available in case of negative market tendencies; Relatively low costs, associated with working capital and capital investments.

Market Reaction

The market reaction will be different for each of the actions described. The market will react negatively in case of the dividend cut, as well as in case of the same level of dividend payouts. The main difference will be the severity and extent of the negative reaction, namely the degree of the share price decline, as well as the increase of the bond yields. However, it is vital to note that the negative market reaction will be short-term, as the company will most likely use share buybacks as a method of increasing share prices, as well as the potential dividend increases in the following years.

Performance Analysis

The shareholders are willing to receive a return on their investment as soon as possible in the majority of cases. However, such a philosophy does not imply the best interest of the shareholders, since it might damage the bottom line of the company in the long term. The case with FPL Group falls in the latter category. The payout ratio of the company had been negative for two out of three most recent years including 1991 and 1993, standing at 161.5 and 107.4 percent respectively (see Table 2). The company has also been reporting a decline in net income while maintaining a moderate net income margin between 4.6 and 9.0 percent (see Table 2).

Table 2. Key Performance Indicators of FPL Group.

Year	Earnings per share (EPS)	Dividends per share (DPS)	Payout Ratio	# of shares, 000	Total Revenues, 000	% change	Net income, 000	% change	Income Margin
1989	$3.12	$2.26	72.40%	131 544	$5 032 544	–	$433 337	–	8.60%
1990	-$2.86	$2.34	–	136 715	$5 086 345	1.10%	-$391 005	-190.20%	-7.70%
1991	$1.48	$2.39	161.50%	162 553	$5 249 436	3.20%	$240 578	-161.50%	4.60%
1992	$2.65	$2.43	91.70%	176 207	$5 193 327	-1.10%	$466 949	94.10%	9.00%
1993	$2.30	$2.47	107.40%	186 413	$5 316 294	2.40%	$428 749	-8.20%	8.10%
1994	$2.75	$2.47	89.80%	191 500	–	–	$527 000	22.90%	–
1995	$2.90	$2.47	85.20%	192 100	–	–	$557 000	5.70%	–
1996	$3.00	$2.47	82.40%	192 100	–	–	$576 000	3.40%	–
1997	$3.10	$2.47	79.60%	192 100	–	–	$596 000	3.50%	–
1998	$3.20	$2.47	77.20%	192 100	–	–	$615 000	3.20%	–

The projections of the company imply growth, but the net income would increase at a low rate of 3.2-3.5 percent between 1996 and 1998. Therefore, the long-term interest of the company suggests lower dividends per share, maintaining a payout ratio below 100 percent.

Recommendations

Tax Implications

If we consider dividend cuts, lower dividends imply higher Earnings Before Taxes (EBT), therefore, potentially higher tax expense of the company. Therefore, it would be essential for the financial management of the company to research the potential increase of the tax expense versus the increase of the interest expense.

Agency Problem

Agency problem represents the conflict of interest between the stockholders of the corporation versus its management. The problem implies the desire of the stockholders to receive a higher return on investment sooner, while the company’s management would prefer a lower share of dividend payouts in favor of using the resource for investing in the development of the firm. A higher level of retained earnings also gives more freedom to the management of the corporation, given the absence of the need to use external funding sources.

Excess Cash from unpaid dividends

The corporation’s management will most likely need to initiate share buybacks as a way to support the share price. These options would reflect the long-term vision and short-term approaches to the corporation’s executive managers. They can also use the excess amount to invest in more profitable projects and acquire more companies to improve the company’s performance.

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