Harvard Business School 9-283-065

American Home Products Corporation

I just don’t like to owe money,” said William F. Laporte when asked about his company’s almost debt-free balance sheet and growing cash reserves.1 The exchange took place in 1968, four years after Laporte took over as chief executive of American Home Products (AHP). The subsequent 13 years did not improve his opinion of debt financing. During Laporte’s tenure as chief executive, AHP’s abstinence from debt continued, while the growth in its cash balance outpaced impressive growth in both sales and earnings. At the end of 1980 AHP had almost no debt and a cash balance equal to 40% of its net worth. In 1981, after 17 years as chief executive, Laporte was approaching retirement, and analysts speculated on the possibility of a more aggressive capital structure policy.

The Company

AHP’s 1981 sales of more than $4 billion were produced by over 1,500 heavily marketed brands in four lines of business: prescription drugs, packaged (i.e., proprietary or over-the-counter) drugs, food products, and housewares and household products. Consumer products included a diversity of well-known brand names, such as Anacin, Preparation H, Sani-Flush, Chef Boyardee, Gulden’s Mustard, Woolite, and the Ekco line of housewares. AHP’s largest and most profitable business—prescription drugs—included sizable market shares in antihypertensives, tranquilizers, and oral contraceptives. AHP’s success in these lines of business was built on marketing expertise.

Whether the product was an oral contraceptive or a toilet bowl cleaner, “they sell the hell out of everything they’ve got,” said one competitor.2

AHP’s Corporate Culture

AHP had a distinctive corporate culture that, in the view of many observers, emanated from its chief executive. This culture had several components. One was reticence. A poll of Wall Street analysts ranked AHP last in corporate communicability among 21 drug companies. A second element of AHP’s managerial philosophy was frugality and tight financial control. Reportedly, all expenditures greater than $500 had to be personally approved by William Laporte, even if authorized in the corporate budget.

Other important components of AHP’s culture were conservatism and risk-aversion. AHP consistently avoided much of the risk of new-product development and introduction in the volatile drug industry. Most of its new products either were acquired or licensed after their development by other firms or they were copies of new products introduced by competitors. A substantial number of AHP’s new products were clever extensions of existing products. AHP thus avoided risky gambles on R&D and new-product introductions and used its marketing prowess to promote acquired products and product extensions. When truly innovative products were introduced by competitors, AHP responded with “me-too” products and relied on its marketing clout to erode competitors’ head start.

Finally, an integral part of AHP’s corporate philosophy was the firm’s long-standing policy of centralizing complete authority in the chief executive. The current incumbent was described by a former colleague as a “brilliant marketer and tightfisted spender.”3 Laporte’s management style was characterized as management from the top, unparalleled in any firm of comparable size. Though reticent in discussing operations, Laporte was emphatic in stating the objective underlying his use of this authority: “We run the business for the shareholders.”4 The author of a Business Week article on the firm commented, “One of the most common business platitudes is that a corporation’s primary

mission is to make money for its stockholders and to maximize profits by minimizing costs. At American Home, these ideas are a dogmatic way of life.

AHP’s Performance

The managerial philosophy described above produced impressive results. AHP’s financial performance was characterized by stable, consistent growth and profitability. The firm had increased sales, earnings, and dividends for 29 consecutive years through 1981. This growth had been consistent and steady, ranging in recent years between 10% and 15% annually (see Exhibit 1 for 10 years’ review of AHP’s performance). Under Laporte’s stewardship, AHP’s return on equity had risen from about 25% in the 1960s to 30% in the 1980s. Because of its passion for parsimony, AHP had been able to finance this growth internally while paying out almost 60% of its annual earnings as dividends. During Laporte’s reign as chief executive, AHP’s price/earnings ratio had fallen by about 60%, reflecting the marketwide collapse of P/E ratios of growth companies. Nonetheless, AHP’s more than sixfold growth in earnings per share had pushed up the value of its stock by a factor of three during his tenure. AHP’s stock was widely held by major institutional investors. Its popularity among investors reflected analysts’ assessment of AHP’s management. In the opinion of one analyst, “When you think of American Home Products, you think of the best-managed company in the whole pharmaceutical field.”6 Nevertheless, AHP’s excess liquidity and low degree of leverage were criticized by many analysts. Others wondered whether it would be a good idea to tinker with success.

What I need for this case:

1.  Calculate optimal capital structure

2.  Calculate new share price

3. Fill the attached excel template

4. Full report about the case , analyzing the whole case and adding some charts, illustrative graphs