A

Case Study

On

Case 4

In Partial Fulfillment

Of the Requirements in the Subject:

Capital Market

Submitted to:

Mrs. Angelita Mando

Capital Market Professor

Lipa City Colleges

Introduction
 The analysis of this case study seeks to retort the following questions regarding

Buffet’s uncommon investing strategies:

(1) Would the inclusion of a call provision had helped Burlington Northern avoid

its long legal struggle to eliminate restrictive covenants?

(2) What would be the stock market’s reaction to Burlington’s proposed stock

buyback or debt reduction plans?

(3) Why was Moody’s rating service concerned about Burlington’s reduced

diversification after it spun off its natural resources plans?

(4) What could have motivated BNI to offer to exchange its low coupon bonds for

new debt?

In the case of answering those questions we will be able to know the case of the

BNI lawsuit settlement and how the call for provisions does had helped Burlington

Northern to eliminate the restrictive covenants on the bonds of the opposing parties.

The perspective of the markets will also discussed regarding the Burlington’s proposed

buyback or the debt reduction plans. Also the rating of Moody and why its concerned

about the diversification of the natural resource plans as well as the motivations factors

that drives BNI to offer to exchange its low coupon bonds to new debt.
 Background

Over thirty years ago, Dr. Ivan Misner, the Founder and Chief Visionary Officer of BNI,

was a business consultant looking for referrals. He approached a few trusted friends for

the favor and suggested that he in turn could help them. The group of professional

colleagues began to meet and share business referrals, augmenting each other’s

marketing efforts by introducing their clients and friends to other trusted professionals.

Dr. Misner’s small group picked up steam. Soon, Ivan was being asked if he could help

others establish their own groups. Initially, he was wary of straying from his career path

as a business consultant. Then, it dawned on him that running referral networks was

itself a powerful kind of business consulting.

Business Network International (BNI) is an American franchised networking

organization with around 233,000 members in 8,399 local chapters worldwide. Members

meet weekly to discuss business and support each other's businesses by sharing

referrals. It claims to be the world's leading 'referral organization'. In 2015, the

organization says its members generated referrals resulting in over $9.3 billion in closed

business worldwide. In 2016, this figure increased to $11.2 billion business passed

between members and their referrals (worldwide) and in 2017, $13.6 billion worth of

business was passed.. In Sept 2018, this figure grew to $15.5 billion worth of done
deals passed between members, with over 242k members worldwide in 8,653 chapters

across 70 countries and 10.4 million referrals passed between them. It is one of the

biggest networking organization of its kind in the world. The company was a success in

its early decades but in the

Late in 1987, a federal court approved a settlement between Burlington Northern

Railroad Company (BNRR) and holders of two series of bonds issued by Northern

Pacific Railroad, one of the companies merged to form BNRR The settlement

agreement provided for payments of $35.5 million to the bondholders, in return for

changes in important covenants in the bond indentures This agreement can be

regarded as the concluding chapter in a story that illustrates vividly one of the agency

costs of bond covenants -- foregone opportunities, or loss of managerial discretion.

Almost three years earlier, BNRR had started what turned out to be a long and

expensive process of modifying indenture provisions on bonds issued in I896 by

Northern Pacific Railroad as it was being reorganized Covenants in the indentures

placed severe restrictions on management's use of valuable assets. Those restrictions

were the result of the deliberate efforts of J.P. Morgan, as he attempted to assure

investors who were being asked to community capital to the reorganization. Attempts by

management to relax the indenture provisions nearly 90 years later were blocked by

bondholders until they received "hold-up" payments that amounted to about 30% of the

face value of the outstanding bonds. Years later the BNI is in new again.
 Evaluation of the Case

Public attention first focused on the Northern Pacific bonds in 1981, when BNRR

announced its plans to form a holding company. The Wall Street Journal (12] claimed

that rumor has it that the bond covenants would prohibit that step. While BNRR insisted

that the bond indentures had no bearing on the company's ability to form the holding

company, bondholders were described as convinced that the company would have to

pay a premium or redeem the bonds at face value in order to proceed. The company

went on to form Burlington Northern, Inc. (BNI) a holding company In early 1982,

Business Weekly referred to speculative interest in the Northern Pacific bonds. That

article described a strong commitment of BNI's new management to build the no

transportation side of the company," and pointed out that the indenture restrictions on

cash flows might force the firm to buy back the bonds at full face value. Given the

coupons, of course the bonds were selling at deep discounts, despite the speculative

interest. The article also noted, however, that the indenture restrictions had not

hampered the company to date, and cited company estimates that it could take ten or

more years before the cash flow from the resource properties would exceed capital

expenditures on the railroad. The treasurer of BNI was reported as saying, "It's a

deferred problem, but it is a problem Even though the prior lien bonds would mature in

1997, the same restrictions in the general lien bonds would continue The first public

step by BNRR to get out from under the indentures came in April 1985. The company

got the agreement of the bond trustees to eliminate the covenant restrictions on cash

flows from the resource properties by placing U.S. Treasury securities in trust to cover
interest and principal payments on the bonds. In essence, BNRR was deceasing the

Northern Pacific bonds. In addition, the company made a tender offer of 53.5 for the 4%

prior lien bonds and 39.0 for the 3% general lien bonds (22). Based on Moody's yield to

maturity on A-rated railroad bonds (the Northern Pacific bonds were A-rated) in March

1985 the 4% bonds would have sold for about 48.6 and the 35 bonds per cut 239. A

class-action suit was filed by bondholders to block the tender offer and the defeasance

transaction, and in June 1985 a federal court issued an order presenting the com penny

from proceeding with the defeasance Public attention first focused on the Northern

Pacific bonds in 1981, when BNRR announced its plans to form a holding company.
 Solution/Conclusion

(1) Would the inclusion of a call provision had helped Burlington Northern avoid its

long legal struggle to eliminate restrictive covenants?

 It is safe to say that the inclusion of a call provision somehow helped the

company to avoid the legal struggle to eliminate the restrictive covenants,

but it is noteworthy that a call provision would not have been cheap solution

to the problem faced by the company in this case, since the bonds are

selling in considerably big discounts. A call for instance in April 1985 would

have cost the company millions for bonds with a market value based on the

yield of maturity A-rated railroad bonds. Thus the absence of the call

provision per se was not critical element in the case. Contemporary

managers facing covenant restrictions on cash flows and outstanding bonds

could likewise find the call option is not the least costly way to relax such

covenants.

(2) What would be the stock market’s reaction to Burlington’s proposed stock

buyback or debt reduction plans?

 From my perspective, the event related to the purposes of assessing stock

market reaction to BNI's attempts stock buyback or debt reduction plans. The

stock market would react positively to both the announcement of the agreement
 and the court approval. This assumes that managers were acting to maximize

shareholder wealth. Since BNI agreed to pay the hold-up premiums as well as

court costs, the agreement would make sense in a net present value context only

if the estimated present value of the additional cash flows from the released

properties exceeded the costs of the settlement. The expected stock market

reaction to the tender offer and the subsequent act of the court to block the offer

is less clear. If the purchase offer and the related defeasance proposal had

worked as planned. BNI would have increased its opportunities for use of the

properties. Thus, the expected market reaction to the offer would be positive and

the reaction to the court action negative. Given the fact that bondholders had

been active in the past to enforce indenture provisions on these bonds, however,

the stock market might have been skeptical that the tender offer and the

defeasance would work.

(3) Why was Moody’s rating service concerned about Burlington’s reduced

diversification after it spun off its natural resources plans?

 It is because Moody’s rating services feared that due to this event the BNI may

weaken its leverage and will be at high level of vulnerability. Thus downgrading

the BNI will somehow respond to the Burlington’s spin-off of the resource unit of

the company. They are also worried that other parts of the BNI may weakened its

protection to the bonds so Moody’s response to this possible threats is to

downgrade the company’s rating.

for new debt?

 The settlement and the higher interest rate may have motivated the BNI to

exchange its low coupon bonds for new debt. The market value of the current

bonds may also influenced this decision of the BNI for the purpose of the

exchange was to enable BNI Railroad to reflect in its financial statement the

current market value of the old debt securities exchanges to lengthen the

average maturity of some of its debt and to eliminate or modify certain restrictive

covenants.
 References:

 https://www.jstor.org/stable/3665666?read-now=1&seq=1#page_scan_tab_contents

 https://en.wikipedia.org/wiki/BNI_(organization)

 https://www.oecd-ilibrary.org/search?

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