So far, we have discussed the possibility of expansion only through the one original cor poration. We have now to consider what may be done through the creation of other sub sidiary corporations; and through mergers, consolidations, and combinations of various kinds. First, we shall take up only the crea tion of new corporations for the extension of the original business and leave for later dis cussion the financing incidental to joining established businesses.
Even when a corporation has a blanket mortgage, it can, by the intervention of a con struction company, finance on essentially a divisional first mortgage. The construction company can build the extension, of what ever kind it may be, and borrow the money on temporary loans with its bonds as collateral. Owning all the stock of the construction com pany, the original corporation stands back of it and lends it credit. When the time comes, which may be whenever the property of the new company has been assembled and the lien of the bonds attached, the original com pany can vote all the stock in the new com pany to sell all the new assets to itself. It will thereupon assume the bonds secured on the new assets. First mortgage bonds of the original company, though issued under a blanket mortgage, never become a first mort gage on the new assets, because the new assets never become the property of the original com pany until after they become subject to the lien of the new bonds. The new bonds are se cured on the new assets, and on their assump tion become a direct general obligation of the original company. Consequently the purchas ers of the new bonds are in just as good a posi tion as if the original company had no blanket mortgage. Of course, the blanket mortgage will cover the new assets as a second mort gage. So the corporation cannot now create a second mortgage on the new property, as it could have done if there had been no blanket mortgage.
The original corporation need not assume the new bonds. It can leave the subsidiary corporation in existence and still sell new bonds having a first right against the new as sets and also having the credit of the original company back of them. Without the general credit of the original company the bonds of the subsidiary would sell at a disadvantage. They need the better-known name, and the assurance of a going concern with an estab lished earning power. Particularly in the case
of the expansion of a railroad by branch lines, the branch-line bonds need the obligation of the main-line company to assure the continu ance of favorable traffic relations. The man agers of the enterprise can give the bonds of the subsidiary the credit of the original com pany in two ways.
The original company can guarantee the bonds of the subsidiary.
In another way the managers of the enter prise can put the credit of the original com pany back of bonds secured on the property of the subsidiary. They can use the bonds of the subsidiary as collateral against which the original company can issue its own bonds. This, of course, makes the new security sold a direct obligation of the original company, not, as in the other case, an indirect obliga tion. This gives them an advantage from a market standpoint just from the fact that they directly carry the name of the older, better-known corporation that has the estab lished earning power. Probably the fact that they are collateral bonds instead of having their lien directly on the property to some ex tent offsets, from the market standpoint, the advantage of being the direct obligation of the parent company. In actual security they have all the effect of a direct first mortgage, but the fact that they have to be described as " virtually a first mortgage," or something to that effect, certainly does not help them market-wise. The public knows that a direct first mortgage is, at any rate, a first mortgage, for whatever it may be worth, but a collateral bond may be almost anything.
For an illustration the St. Louis & San Francisco Railroad Company showed both forms of financing an expansion by branch lines. Ozark & Cherokee Central first mort gage 5s, due October, 1913, $2,880,000, are secured by first mortgage on the road from Fayetteville, Arkansas, to Okmulgee, Okla homa, 143.65 miles. The St. Louis & San Francisco Railroad Company guarantees both principal and interest. St. Louis & San Fran cisco Railroad 41s, due February, 1912 (called for redemption August, 1911), $3,351,000, were secured by the deposit in trust of the entire capital stock and first mortgage bonds, $4,500,000 each, of the Arkansas Valley & Western Railway Company, 175.25 miles, running from Western Junction to Avard, Oklahoma.