copyright ©2003 ian h. giddy financial restructuring 1 cap des biches friday: financial...

Copyright ©2003 Ian H. Giddy Financial Restructuring 1

Cap des Biches

Friday: Financial Restructuring

Ashanti-Bogoso

Feng-Shui


Mt CameroonEcotours


Mt Cameroon

Mount Cameroon EcotoursLast Year Year 1 Year 2 Year 3 Year 4 Year 5 Terminal

Tourists 700 850 935 2,550 2,805 3,086 3,240 Revenue/Tourist 0.65 0.65 0.65 1.30 1.30 1.30 1.30 Revenues 455.00 552.50 607.75 3,315.00 3,646.50 4,011.15 4,211.71 Expenses (305.00) (442.50) (463.75) (867.50) (931.25) (1,001.38) (1,039.94) Profit 150.00 110.00 144.00 2,447.50 2,715.25 3,009.78 3,171.76 Capex (2,100.00) 1,100.00 Working Cap (500.00) (50.00) (55.00) (55.50) (55.55) (27.78) Free cash flows: (2,490.00) 1,194.00 2,392.50 2,659.75 2,954.23 3,143.99

Expected Return 25% 25% 25% 25% 25% 15%Terminal Value 31,439.86 PV (Cashflows) (1,992.00) 764.16 1,224.96 1,089.43 968.04 10,302.21 NPV 12,357 Cash 1,300 = 5,000 - 2,200 - 1,000 -500Firm Value 13,657

Equity to Raise 5,000 37% Percentage of equity to investorsEquity to Firm 8,657 63% Percentage of equity to owners

Leveraged Finance


Cost of the Deal

Estimating cost of deal

Shares 10Price 45$ Premium 15%Equity cost 518$ Debt cost 55$ Fees 5% 29$ Capex & restructuring 10% 57$ Total cost of deal 658$

lbocapacity.xls


LBO Financing

NEWCO

Cost of

purchasing

the

business Equity $25

Senior

debt $457 What securities?

What returns?

What investors?Mezzanine


Case Study: Cap des Biches (B)

The LBO Proposal Devise a recommended financing plan

GTI (owner)

Buyers Other Investors


Cap des Biches (B)

Cap des Biches (B)Evaluating a Leveraged Buy-Out (LBO)GivenShare price 24 Acquisition dataNumber of shares 9 million Flexics P/E 10.64 GTI ownership 35% Free cash flows next year $2.57 per sharePublic ownership 65% Free cash flows last year $2.48 per share

Raise growth to 5.50%NOI 30.00 Upfront costs 18 $2.00 per shareInterest 1.00 Coverage 30.00 Tax 30% 8.70 Earnings 20.30 Per share 2.26 Growth rate 3.60%

LBO dataManagement equity 20Bank coverage ratio needed 2Bank rate 12%Seller's debt amount 30Seller's debt rate 15%Premium for shares 5% assumptionSale NOI multiple 12

www.stern.nyu.edu/~igiddy/dakarwww.stern.nyu.edu/~igiddy/dakar

CorporateFinancial Restructuring

Prof. Ian GIDDYStern School of Business

New York University


What is Corporate Restructuring?

Any substantial change in a company’s financial structure, or ownership or control, or business portfolio.

Designed to increase the value of the firm Restructuring

Improve

capitalization

Change ownership

and control

Improve

debt composition


It’s All About Value

How can corporate and financial restructuring create value?

Operating

Cash

Flows

Debt

Equity

Assets Liabilities

Fix the business

Or fix the financing


Restructuring

Figure out what the business is worth now

Use valuation model – present value of free cash flows

Fix the business mix – divestitures Value assets to be sold

Fix the business – strategic partner or merger

Value the merged firm with synergies

Fix the financing – improve D/E structure

Revalue firm under different leverage assumptions – lowest WACC

Fix the kind of equity What can be done to make the equity more valuable to investors?

Fix the kind of debt or hybrid financing

What mix of debt is best suited to this business?

Fix management or control Value the changes new control would produce


Corporate Finance

CORPORATE FINANCE

DECISONS

CORPORATE FINANCE

DECISONS

INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING

CAPITAL

PORTFOLIO

M&ADEBT EQUITY

TOOLS

MEASUREMENT


Capital Structure: East vs West

VALUE OFTHE

FIRM

DEBT

RATIO

Optimal debt ratio?

Intel TPI


Fixing the Capital Structure

Too little debt Managers like to control

shareholders’ funds Underestimate the cost

of equity

Produces Less discipline Excessive cost of

capital Takeover risk

Too much debt Close control of equity Easy money Underestimate business

or financial risks

Produces Risk of financial distress Excessive cost of

capital Destroy operating value Takeover risk

Fixing the Capital Structure:Distress Restructuring


The Three Excesses

Labor Capacity Debt


TPI’s Refinancing

Asia’s biggest debtor Almost $4 billion in foreign currency

debt financing domestic revenues Protracted rescheduling results in $360

million debt/equity swap No change in management or effective

control Still needs $1.2 billion new equity


Debt-Equity Swaps

Cosmetic or real? Choices for company under siege

Raise new equity to pay off creditors

Example: IridiumGive creditors equity in place of debt

Example: Sammi


What Do Debt-Equity Swaps Do?

Overleverage creates financial distressOverleverage creates financial distress

Actual or potential defaultActual or potential default

Lenders take equity in lieu of repaymentLenders take equity in lieu of repayment

Lenders hold equity passivelyLenders hold equity passively Lenders replace managementLenders replace management Lenders sell equityLenders sell equity

Existing management buys timeExisting management buys time Change of control

means restructuring

Change of control

means restructuring

Financial engineering Bottom line “rationalization” Divestitures & outsourcing

Financial engineering Bottom line “rationalization” Divestitures & outsourcing


What Are The Alternatives?

Key: Make the new securities attractive to:Existing lendersNew lendersNew bond investorsNew equity investors


The Financing SpectrumE

xpec

ted

Ret

urn

Risk

Senior Debt Returns independent

of the value of the business

Control through covenants

Senior Debt Returns independent

of the value of the business

Control through covenants

Equity Residual returns

after contractual claims

Control through voting rights

Equity Residual returns

after contractual claims

Control through voting rights



xpec

ted

Ret

urn

Risk

Senior secured debtSenior secured debt

EquityEquity

Senior unsecured debtSenior unsecured debt

Subordinated debtSubordinated debt

Preferred equityPreferred equity

Convertible debtConvertible debt



xpec

ted

Ret

urn

Risk

Senior secured debt

Equity

Senior unsecured debt

Subordinated debt

Preferred equity

Convertible debt

Asian bank NPLsAsian bank NPLs


What Are The Alternatives?

Asset-backed or cash flow-backed debt Senior debt Subordinated debt Subordinated debt with upside

participation Subordinated debt with equity option Preferred equity Restricted shares Common stock


Subordinated High Yield Debt

“Junk bonds” – like equity, but allow increased financial leverage

Tax advantage over equity Big market in USA (institutional investors) and

increasing in Europe Leveraged loans favored by certain

commercial banks Often used in connection with M&A and LBOs Behave like equity – and often have equity

participation


Sub Debt -- Motivations

Optimization of financial leverage Regulatory-driven capital requirements Rated asset securitizations (senior-sub

structure in asset-backed securities) Insider or supplier-credit subordination

(eg in project finance) Work-outs and restructurings (existing

borrowers agree to seniority of new loans, to buy time)


Sub Debt’s Big Problem: High Interest!

Solutions Deep discount subordinated debt Subordinated debt with equity warrants Convertible subordinated debt Participating subordinated debt Puttable subordinated debt


Preferred Equity

Legally a form of equity Claim senior to ordinary equity May have fixed dividend, or may be

“participating” But cannot trigger liquidation if payment

missed Par value determines liquidation claim


Convertible Preferred

Used by venture capital firms Permit investors to participate in growth But give preference in liquidation if the

venture fails And disguise share value (tax!) A variant – PERCS* give issuer right to

convert into common stock

*Preferred equity redemption cumulative stock


Preferred Stock: Pros and Cons

Advantages No dilution of control Dividends

conditional on availability of earnings

Omission cannot force liquidation

Disadvantages Higher after-tax cost

than debt Lower return on

equity Limited investor

interest


Restricted Stock: Pros and Cons

Advantages Overcome foreign

control restrictions Insiders retain

control If company well run,

value of control may be low

Disadvantages Nonvoting stock

trades at a discount Dual-class recaps

hurt stock price May allow

management to avoid needed reforms


The New Equity Option

Key: Make the new equity attractive to: Portfolio investors

DomesticInternationalReduce agency costs or we’ll “Just say

no!” Strategic/direct investors

DomesticInternationalCede control or we’ll go elsewhere


The Difference

“The Ministry of Finance received a preferred share while investors received a preferred share and a warrant allowing them to purchase the ministry's share at a 13.3% premium (equivalent to the cost of carry) during a three-year period. The preferred shares carry a 5.25% dividend and full voting rights”

"When institutions started buying the story, they bought the convertible bonds, the sub debt - you name it, they bought it."

Alternatives: Thai Farmers Bank: SLIPS, Bankok Bank: CAPs


Transparency and Disclosure

A 275-page prospectus, which provided a breadth and depth of information previously unseen in an Asian issue.

"We went and looked back at US bank holding company offers - those that were US SEC Grade 3 compliant. We also went back and looked at a lot of the prospectuses for the recaps of US banks, like Mellon and Citibank. We looked at the level of disclosure they achieved and committed ourselves to exceeding that -- which SCB did."


MacroFactors

• Currency overvaluation• Capital restrictions

StructuralFactors

• Acctg & disclosure requirements• IAS compliance• Bankruptcy regime• Creditor rights• Govt-corporate nexus• Trading infrastructure

• Price-Value ratio, Sharpe ratio, EVA• D/E ratio• Currency & maturity mismatch• IAS conformity• Insider control• Objective research coverage• Trading liquidity

Firm-levelFactors

What Globally Mobile Investors Look At

Fixing the Capital Structure:Distress Restructuring


Cap des Biches (C)The Creditors are Prowling

Trouble!

The financing

is bad

The company

is bad

Business

mix is bad

Raise equity

or

Change debt mix

Change control

or management

through M&A

Sell some businesses

or assets

to pay down debt

Reason

Remedy


Financially Distressed Firms

Lose customers Get less favorable terms from suppliers Are forced to discount products Reduce new investment to below the

optimal levelExample: Hynix (Korea)

Source: Altman (1984), Opler and Titman (1994)


When Default Threatens, Value the Company

S a le to S tra te g ic B u yer A u c tion

M e rg ed V a lue

E x is tin g M an a g em e nt N e w M a n a ge m e nt

V o lu n ta ry R eo rg a n iza tion C h 1 1 R e org a n iza tion

G o in g C o nce rn V a lue

V o lu n ta ry L iq u id a tion C h 7

L iq u id a tio n V a lue

H ig h e s t V a lu a tion o f C om p a n y?


Zombie, Inc

Does it make sense to dissolve the company?

Is it better to sell the company? How much debt can the company afford

to have? Assume you have been brought in as

the new CEO-CFO team. What terms of restructuring can you propose to the banks?


Debt Restructuring in Distress

Can a debt restructuring create value?

Operating

Cash

Flows

Debt

Equity

Assets Liabilities Banks give up some creditor rights in

exchange for equity


Example

Earnings at Zombie Inc., have suffered in recent years. The private company now faces a financial crisis, as a result of its possible inability to repay a principal repayment on its debt coming due in the next quarter.

The company's summary balance sheet is as follows:

Assets LiabilitiesCash 100000 Accounts payable 1000000Accounts receivable 900000 Short term secured debt 100000Other short term assets 5100000 Long term bank debt 9000000Property, plant and equipment 8000000 Shareholders equity 4000000Total 14100000 Total 14100000


Example

The company faces a takeover, but management has made a restructuring proposal to its unsecured bank lenders, namely that they convert one half of Zombie's bank debt into equity at the current book value per share.

Should the banks take the offer?

Assets LiabilitiesCash 100000 Accounts payable 1000000Accounts receivable 900000 Short term secured debt 100000Other short term assets 5100000 Long term bank debt 4500000Property, plant and equipment 8000000 Shareholders equity 8500000Total 14100000 Total 14100000


Example of Valuation:Before-and-After

Zombie, Inc

Share ValuationBefore After

Shares 400,000 850,000Book Value 10.00$ 10.00$ Acquisition Value 8.00$ Management Est. 20.00$ 9.41$ NPV, based on

EBITDA 1,100,000 1,100,000WACC 17.48% 11.22%Growth 2.5% 2.5%

Debt 10,100,000 5,600,000 Going Concern Value (6.43)$ 8.62$

Option value?

Bank lenders Before AfterDebt (at market) 7,182,749 4,500,000 Equity (NPV value) 0 3,876,905Total 7,182,749 8,376,905

Zombie, Inc

Share ValuationBefore After

Shares 400,000 850,000Book Value 10.00$ 10.00$ Acquisition Value 8.00$ Management Est. 20.00$ 9.41$ NPV, based on

EBITDA 1,100,000 1,100,000WACC 17.48% 11.22%Growth 2.5% 2.5%

Debt 10,100,000 5,600,000 Going Concern Value (6.43)$ 8.62$

Option value?

Bank lenders Before AfterDebt (at market) 7,182,749 4,500,000 Equity (NPV value) 0 3,876,905Total 7,182,749 8,376,905


Cap des Biches (C)

CDB, two years after the successful LBO, is having difficulty meeting its debt service obligations. The banks are putting pressure on management to make a restructuring proposal.Can Cap des Biches afford to pay its required

interest and principal this year? Next year?What is the debt capacity of Cap des Biches

Power Company?Please suggest a way in which the debt could be

restructured to keep the banks satisfied and keep the company alive.

Fixing the Capital Structure:Making Use of Cash Flows


Leveraged Finance

Share buyback?

Company has

unused debt

capacity Leveraged

recapitalization?

Takeover?


Leveraged Recapitalization

Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares)

Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity

After the large dividend has been paid, the market value of the shares will drop.


Leveraged Recapitalizations

Motivations:DefensiveProactiveOwnership transition/liquidity

Which produces what value?


Cap des Biches (D)

CDB, after its debt restructuring, has achieved a turnaround. Net cash flows are now positive and steady, and the shareholders are looking for ways in which they can realize the benefits of their investments.

Should they pay a dividend, buy back shares, or sell the company?

Group report due by Wednesday 11th June Group report due by Wednesday 11th June


What is Corporate Restructuring?

Any substantial change in a company’s financial structure, or ownership or control, or business portfolio.

Designed to increase the value of the firm Restructuring

Improve

capitalization

Change ownership

and control

Improve

debt composition

copyright ©2003 ian h. giddy financial restructuring 1 cap des biches friday: financial...

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