Debt-Equity Choice

The Case of Allied Waste

The Company• Second largest non-hazardous waste

management firm in the U.S. – Sales 5,248.– Waste Management is the largest.

• Sales 11,574.– Republic Services is third.

• Sales 2,518.

• Vertically integrated.– Collect refuse and “to the extent that it is economically

beneficial” dispose of it in their own landfills.

EBITDA and FCF

• EBITDA and FCF each play a role when analyzing a firm’s debt.

• EBITDA– Excludes capital expenditures and taxes.– If a firm is near bankruptcy this is the most it

has available to pay off its bonds.• Firm can, at least temporarily, reduce all capital

expenditures associated with growth.• No taxes since all free cash flow goes to make

interest payments which are tax deductible.

FCF Before Interest and Taxes

• The FCF before interest and taxes equals the funds available to the debt holders in the long run.– This is just EBITDA – Net Capital

Expenditures.• A firm that is “100% debt financed” can

pay interest equal to this amount and continue to makes its ordinary capital investments.

Allied Waste’s Debt Structure

• Cash and bank debt.• Corporate bonds of varying maturities and

seniority.• Asset backed secured debt. Sometimes

used to create off balance sheet debt.

Allied Waste CapitalizationAs of March 31, 2004(Short Term Loans)

Cash and cash equivalents(1) 126 Long-term debt:     Credit facility:       Revolving credit facility(2)(3) 97     2003 term loan B 1,185     2003 term loan C 250     2004 term loan D 150       Total credit facility debt 1,682

Credit Facility DebtFrom the June 2004 10-Q

• Starts with a run down of each loan’s face value and due date.– Bank credit facility is a senior secured credit facility

(the 2003 Credit Facility) that includes: – (i) a $1.5 billion revolver due January 2008 (the 2003

Revolver), – (ii) a $1.2 billion term loan (Term Loan B), – (iii) a $250 million term loan (Term Loan C), – (iv) a $150 million term loan (Term Loan D), and – (v) a $200 million institutional letter of credit facility.

Credit Facility Details About Due Dates and Uses

• Term Loan D was funded in April 2004. The proceeds of Term Loan D were used to fund a portion of the tender offer of the senior subordinated notes due 2009. – Translation: We repurchased some bonds due in 2009 with this

loan.• All of the term loans under the 2003 Credit Facility

mature in 2010. – Due date for items (ii) through (v). Item (i) was previously noted

as due in 2008.• Of the $1.5 billion available under the 2003 Revolver, the

entire amount may be used to support the issuance of letters of credit.– Firm may use the available amount of the loan agreement to

issue another kind of short term debt.

Short Term Debt Outstanding• At June 30, 2004, we had approximately $11.8 million

drawn and $590.0 million in letters of credit outstanding under the 2003 Revolver.

• At June 30, 2004, we had approximately $898.2 million available under the 2003 Revolver. – This is the difference between what they can borrow and have

borrowed under the Revolver.– Allows for quick access to cash, but potentially adds a lot of debt

without getting permission from the current debt holders.• In addition, at June 30, 2004, we had $200.0 million in

letters of credit outstanding under the institutional letter of credit facility.

Short Term Loan Interest Rates

• The 2003 Credit Facility bears interest at (a) an Alternative Base Rate, or (b) Adjusted LIBOR, both terms defined in the 2003 Credit Facility, plus, in either case, an applicable margin based on our leverage ratio. – LIBOR: London InterBank Offering Rate.

Standard among corporations. A lot like short term U.S. Treasury rates.

Short Term Interest RatesLIBOR Treasury

  1-Mo. 3-Mo. 6-Mo. 1-Yr. 6 Mo. Tr. 1 Yr. Tr. 3 Yr. Tr.Sep-03 1.12 1.16 1.18 1.29 1.03 1.24 2.23

Oct-03 1.12 1.17 1.22 1.46 1.02 1.25 2.26

Nov-03 1.12 1.17 1.23 1.49 1.04 1.34 2.45

Dec-03 1.12 1.16 1.22 1.46 1.01 1.31 2.44

Jan-04 1.10 1.13 1.21 1.46 0.99 1.24 2.27

Feb-04 1.10 1.13 1.20 1.36 1.01 1.24 2.25

Mar-04 1.09 1.11 1.16 1.34 1.01 1.19 2.00

Apr-04 1.10 1.18 1.37 1.81 1.11 1.43 2.57

May-04 1.11 1.31 1.58 2.08 1.33 1.78 3.01

Jun-04 1.36 1.60 1.94 2.47 1.64 2.12 3.26

Jul-04 1.49 1.69 1.99 2.46 1.70 2.10 3.05

Aug-04 1.65 1.79 1.99 2.30 1.75 1.99 2.83

Short Term Loan Restrictions or Lack Thereof

• Proceeds from the 2003 Credit Facility may be used for working capital and other general corporate purposes, including acquisitions. – Translation: We can do what we like with the

money.

Where in the Pecking Order are the Short Term Loans

• We are required to make prepayments on the 2003 Credit Facility upon completion of certain transactions as defined in the 2003 Credit Facility, including asset sales and issuances of debt securities.

• Proceeds from these transactions are required to be applied to amounts due under the 2003 Credit Facility pursuant to the credit facility agreement.

• We are also required to make prepayments on the 2003 Credit Facility for 50% of any excess cash flows from operations, as defined.

• Translation: If we generate any substantial free cash flow or attempt to sell any assets we have to pay off the short term loans before anybody else sees a nickel.

Allied Waste Capitalization

As of March 31, 2004(Outstanding Bonds a.k.a. Senior Notes and Debentures)

1998 senior notes, weighted average effective rate of 7.99%(3) 650 2001 senior notes, weighted average effective rate of 8.94% 1,350 November 2002 senior notes, effective rate of 9.39% 377 2003 senior notes, weighted average effective rate of 6.38% 800 February 2011 outstanding notes, effective rate of 5.91% 400 February 2014 outstanding notes, effective rate of 6.33% 425 April 2011 outstanding notes, stated rate of 6.38% 275 April 2014 outstanding notes, stated rate of 7.38% 400 Senior subordinated convertible debentures, stated rate of 4.25% 230 BFI senior notes; net of discount 602

Sample Terms• The February Notes due 2011 will mature on

February 15, 2011.• Interest Payment Date to which interest has been paid or

provided for, payable semiannually on February 15 and August 15 of each year, until the principal thereof is paid or made available for payment, to the Person in whose name the note (or any predecessor note) is registered at the close of business on the preceding February 1 or August 1, as the case may be. – Translation: Checks go out on the 15th of February and August

of each year to whoever owned the bond on the 1st of that month.

Sample Terms Continued• Interest on overdue principal and premium (if any) and, to the extent

permitted by law, overdue interest at the rate per annum shown on the front cover of this prospectus plus 2%. – Translation: If the interest payments are late, the amount owed will

increase at a rate of 5.91% + 2% = 7.91% per annum. That is a 200bps premium over what the company would normally owe.

– Real Life: If you own the bond and are hoping to invoke this clause forget about it. If the interest payments are late the firm is probably bankrupt. Your best hope is that the creditor’s committee can get you back most of the money you were owed absent this penalty clause.

• Interest will be computed on the basis of a 360-day year of twelve 30-day months.– Standard 360 day year used for calculating corporate bond interest.

“Guarantees”• The notes will be fully guaranteed by our parent, Allied Waste Industries,

Inc. In addition, the exchange notes will be guaranteed by substantially all of our subsidiaries so long as they continue to guarantee our senior credit facility.

• Certain of our subsidiaries will not guarantee the exchange notes. – As of and for the three months ended March 31, 2004, the non-guarantor

subsidiaries represented in the aggregate approximately 11% of our consolidated assets and 4% of our consolidated revenues.

• If Allied NA cannot make payments on the exchange notes when they are due, Allied or the guarantor subsidiaries must make them instead.

• For a discussion of the risks relating to the guarantees, see “Risk Factors — Subsidiaries that guarantee the exchange notes may not guarantee the exchange notes in the future under certain circumstances” and “Risk Factors — Federal and state statutes may allow courts to further subordinate or void the guarantees.

– Federal and state statutes allow courts, under specific circumstances, to void or subordinate guarantees and require noteholders to return payments received from guarantors.”

Guarantees Translated

• Allied Waste promises to pay off on the bonds if they can.

• If Allied Waste cannot pay then their subsidiaries will pay. That is unless the subsidiary is exempt from this clause.– About 11% or 4% of the subsidiaries depending on

how you count.• It is possible that some court will tell Allied

Waste not to make a bond payment. If that happens you are out of luck.

Redemptiona.k.a. Call Provisions

• The February Notes due 2011 will be subject to redemption, at the option of Allied NA, in whole or in part, at any time, upon not less than 30 nor more than 60 days’ notice mailed to each Holder of February Notes due 2011 to be redeemed at such Holder’s address appearing in the Security Register, in amounts of $1,000 or an integral multiple of $1,000, at a redemption price equal to the greater of: – (1) 100% of their principal amount or           – (2) the sum of the present values of the remaining scheduled payments

of principal and interest thereon discounted to maturity on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Yield plus 50 basis points, plus in each case accrued but unpaid interest (including Special Interest) to but excluding the Redemption Date (subject to the right of Holders of record on the relevant Regular Record Date to receive interest due on an Interest Payment Date that is on or prior to the Redemption Date).      

Call Provision Translation• AW can call the bonds by giving mailing you a letter

saying they want the bond back within the next 30 to 60 days.

• The will only call say half a bond ($500). If they call a bond it will be the whole bond ($1,000).

• If your bond is called you will get back at least $1,000, clause (1). – However, the second condition makes this clause irrelevant.

• Clause (2) says you will get the PV of the cash flows discounted at treasury plus 50bps. – This is better than then AAA rate and AW is a BB company.– This clause is NOT typical of companies issuing BB grade debt.

Call Provisions Continued• “Equity Claw Back”• At any time, or from time to time, prior to February 15, 2007, up to

33 1/3% in aggregate principal amount of the February Notes due 2011 originally issued under the Indenture will be redeemable, at the option of Allied NA, from the net proceeds of one or more Public Offerings of Capital Stock (other than Redeemable Interests) of Allied, at a redemption price equal to 105.750% of the principal amount thereof, together with accrued but unpaid interest (including Special Interest) to the Redemption Date (subject to the right of Holders of record on the relevant Regular Record Date to receive interest due on an Interest Payment Date that is on or prior to the Redemption Date); provided that the notice of redemption with respect to any such redemption is mailed within 30 days following the closing of the corresponding Public Offering.

Equity Claw Back Translation

• The bonds come due on February 2011.• If the company issues equity prior to

February 2007 the company can call 1/3 of the bonds at 105.75.– The money for the call has to come from the

equity issue.• Typically this provision is in force for the

first three years after the bond is issued.

Why a Claw Back?

• Good for company.– An option to do something never hurts.– Allows the firm to reduce its debt load if the

equity markets make it attractive to do so.• Good for bond holders.

– If the firm buys back bonds by issuing equity the remaining bonds are worth more.

• Notice that only 1/3 of the bonds can be called this way. Bond holders allowed to profit on the other 2/3rds.

Seniority Rights• The notes and the guarantees will rank equal in

right of payment to our current and future senior debt and will rank senior in right of payment to our current and future subordinated debt.

• Translation: AW can in the future issue additional senior debt. This debt will have equal rank the all of the other senior debt.– Seniority is an issue for when a firm goes bankrupt.

In theory, senior securities have to be paid in full before junior securities. More on this when we discuss bankruptcy.

– Note older “senior” debt is not more senior than more recent debt.

Change in Control Provision• Also known as “Event Risk Protection”

– Relatively rare these days.• Within 30 days following the date Allied NA becomes aware of the

consummation of a transaction that results in a Change of Control (as defined below), Allied NA will commence an offer to purchase all outstanding notes, at a purchase price equal to 101% of their aggregate principal amount plus accrued interest, if any, to the date of purchase (subject to the rights of Holders of record on the relevant Regular Record Date to receive interest due on an Interest Payment Date that is on or prior to the date of purchase). Such obligation will not continue after a discharge of Allied NA or defeasance from its obligations with respect to the exchange notes. See “— Defeasance.”

Event Risk Protection –Translation

• Change in control forces the firm to automatically call all of its debt at 101.

• Why?– Leveraged buyouts.

• In a leveraged buyout the bidder takes on a substantial amount of debt to buy the target.

• The new debt causes the current debt to fall in value, sometimes by a substantial amount.

– Note, this happens in part because the new debt has equal seniority to the old debt.

• This clause prevents such buyouts from adversely impacting the current bond holders.

What is a Change in Control?• A “Change of Control” will be deemed to have occurred if• (a) any Person, or any Persons (other than a Permitted

Allied Successor, as defined below), acting together … beneficially own 50% or more of the total voting power of all classes of Voting Stock of Allied, – Translation: If a group manages to get 50% of the firm’s

common stock the bonds get called.• (b) any Person or Group, … succeeds in having a

sufficient number of its nominees who have not been approved by the Continuing Directors elected to the Board of Directors … constitute a majority of the Board of Directors of Allied, or– Translation: If shareholders elect to the board a majority of

people that the old board does not approve of (the one that just lost), the bonds get called.

More Changes in Control• (c) there occurs any transaction or series of related transactions

other than a merger, consolidation or other transaction with a Related Business in which the shareholders of Allied immediately prior to such transaction (or series) receive: – (i) solely Voting Stock of Allied (or its successor or parent, as the case

may be),           – (ii) cash, securities and other property in an amount which could be paid

by Allied NA as a Restricted Payment under the Indenture after giving pro forma effect to such transaction, or          

– (iii) a combination thereof, and the beneficial owners of the Voting Stock of Allied immediately prior to such transaction (or series) do not, immediately after such transaction (or series), beneficially own Voting Stock representing more than 50% of the total voting power of all classes of Voting Stock of Allied … ,

• Translation: Somebody offers to take over Allied Waste. They offer to pay for the stock. They get over half the stock. Then the bonds get called.

Rating Changes – Increases(“Rating Event Date”)

• Following the first date upon which any series of notes are rated the following: (i) Baa3 or better by Moody’s Investors Service, Inc. (“Moody’s”) and BB+ or better by Standard & Poor’s Ratings Group (“S&P”); or (ii) BBB-or better by S&P and Ba1 or better by Moody’s (a “Rating Event”) … the covenants specifically listed under “— Repurchase at the Option of Holders — Asset Dispositions,” “— Certain Covenants — Limitation on Consolidated Debt,” “— Limitation on Restricted Payments,” “— Limitations Concerning Distributions by Subsidiaries, Etc.,” “— Limitation on Transactions with Affiliates and Related Persons” and “— Unrestricted Subsidiaries” in this prospectus will no longer be applicable to such series of notes subject to the Rating Event.

• Translation: If by some miracle the rating agencies increase our rating to investment grade then most of the limitations imposed on Allied Waste by its bond covenants get turned off.

Rating Changes – Decreases after an Investment Grade Rating

• … at no time after a Rating Event Date will the provisions and covenants contained in the Indenture at the time of the issuance of the notes that cease to be applicable after the Rating Event Date be reinstated.

• Translation: If the bonds go from investment grade back to junk the covenants that were turned off on the upswing stay off.

Allied Waste CapitalizationAs of March 31, 2004(Other Types of Debt)

Receivables secured loan 138 Solid waste revenue bond obligations 306 Notes payable and obligations under capital leases 21 1999 senior subordinated notes, effective rate of 10.22% 397 Current portion of long-term debt -105

      Total long-term debt, net of current portion 7,949

Current Prices and Yields

• Bloomberg provides “Bloomberg Fair Value” prices.

• These are “matrix” prices.• Based upon the bond rating, the coupon, the

treasury yield curve, and the current spread above treasury for bonds of similar ratings.

• Not true prices, but better than nothing and often accurate for bonds that have not recently gone up or down in value by substantial amounts.

AW Long Maturity DebtS&P Rating: BB-

5 ¾ 02/15/11 6 1/8 02/15/14

Date Price YTM Price YTM

9/2 97.29 6.267 95.18 6.826

9/1 97.75 6.179 95.83 6.728

8/31 98.01 6.128 96.19 6.674

8/30 97.72 6.183 95.84 6.726

AW Short Maturity DebtS&P Rating: BB-

7 5/8 01/01/06Rating: BB-

8 7/8 04/01/08Rating: BB-

Date Price YTM Price YTM

9/2 105.027 3.665 111.25 5.361

9/1 105.059 3.648 111.56 5.276

8/31 104.805 3.871 111.70 5.243

8/30 104.912 3.798 111.51 5.302

Prices and Yields• Note that the YTM on the bonds varies from bond to

bond.– Implies that the number typically calculated for the company’s rD

depends on the maturity structure of its debt.• This contrasts with the typical story that it depends on the firm’s

bond rating.

• Bonds have book values of 100 but can trade well above or below that.– This is an easy problem to fix. Check on the Bloomberg

terminal.– Other than for the next case you do not need to do this for our

class cases. Just remember we are taking a potentially costly shortcut. Do it right when there is real money at stake!

Allied Waste Capitalization Outstanding Debt – Part I(As of September 1, 2004 via Bloomberg)

Maturity Date Coupon Book Value

Price per Bond

Yield to Worst

Spread Over

Treas.January 2006 7 5/8 599.5 105.30 3.388 +63

January 2006 7 5/8 0.5 104.56 3.963 +54

April 2008 8 7/8 591.695 111.81 5.18 +238April 2008 8 7/8 8.385 109.57 5.844 +240December 2008 8 1/2 750 108.82 6.088 +264December 2008 8 1/2 750 111.26 5.464 +260January 2009 7 7/8 0.3 104.11 2.644 -102

August 2009 10 921 105.95 -2.414 -628November 2010 6 1/2 350 102.68 5.975 +323February 2011 5 3/4 400 98.46 6.043 +258April 2011 6 3/8 275 101.65 6.066 +260

Allied Waste Capitalization Outstanding Debt – Part II

(As of September 1, 2004 via Bloomberg)

Maturity Date Coupon Book Value

Price per Bond

Yield to Worst

Spread Over

Treas.September 2012 9 1/4 375 113.12 5.811 +194

April 2008 7 7/8 450 108.18 6.284 +265

February 2014 6 1/8 425 96.62 6.612 +277

April 2014 7 3/8 400 98.45 7.604 +363

April 2014 4 1/4 230 91.97 4.758 -17

Market Value Weighted Average

105.85 4.537 112.32

Total 6526.38

Negative Spreads?• Look at the call and conversion provisions!• January 2009, 7 7/8 bonds.

– Price: 104.1– Call: 101 5/16 on 1/1/2005

• August 2009, 10 bonds.– Price: 105.95– Call: 103.33 on 8/1/2005

• April 2014, 4 ¼– Convertible into stock. Price reflects the value of the

conversion provision.

AW More or Less Debt?

• If AW added or subtracted debt what would that do to the yield it would have to offer on its bonds?

• To find the answer look at the bond yield of its competitors and their debt to equity ratios.

Waste Management (WMI) Capitalization Outstanding Debt – Part I

(As of September 1, 2004 via Bloomberg)Maturity Date Coupon Book

ValuePrice per

BondYield to Worst

Spread Over

Treas.

Nov-08 6 1/2 400 109.81 3.922 +51

May-09 6 7/8 0.265 110.3 4.407 +101

May-09 6 7/8 499.735 111.652 4.103 +62

Feb-01 7 3/8 600 115.3103 4.389 +95

Mar-11 7 2/3 150 116.1702 4.73 +136

Nov-12 6 3/8 400 109.884 4.891 +74

Nov-12 6 3/8 400 106.0881 5.44 +129

Waste Management (WMI) Capitalization Outstanding Debt – Part II

(As of September 1, 2004 via Bloomberg)Maturity Date Coupon Book

ValuePrice per

BondYield to Worst

Spread Over Treas.

Mar-14 5 350 99.2076 5.073 +85

May-18 8 3/4 250 115.2716 4.165 +5May-29 7 3/8 249.9

25111.9892 6.401 +129

May-29 7 3/8 0.075 108.8738 6.638 +165May-32 7 3/4 500 120.6307 6.183 +125

Market Value Weighted Average

112.03 4.902 88.60

Total 3800

Republic Services (RSG) Capitalization Outstanding Debt

(As of September 1, 2004 via Bloomberg)Maturity Date Coupon Book

ValuePrice per

BondYield to Worst

Spread Over Treas.

May-09 7 1/8 375 113.07 4.022 +61

Aug-11 6 3/4 450 112.66 4.591 +127Market Value Weighted Average

112.85 4.332 96.94

Total 825

Cross Firm ComparisonsUsing Bonds Due 2009 and 2011

Firm Spread 2009

Spread 2011

D/E Interest Coverage‡

Enterprise Value (D+E)

AW +260, +323†

+258 3.11 1.11 10,183.77

WMI +62 +136 1.52 3.68 20,659.98

RSG +61 +127 0.71 5.40 5,499.78

† Bonds due 2008 and 2010. No AW bonds due 2009 unaffected by call provisions.

‡ EBIT/Interest Expense

AW Less Debt?• If AW reduced its debt by about 50% it appear

that it could reduce its spread over treasuries by about 50%.

• Cost: reduced debt tax shield.• How can AW accomplish this if it wants to?

– Bad: Buy back bonds.• Benefits bond holders at the expense of shareholders. Why?

– Better: Do not reissue bonds when they come due or can be called.

• Still benefits bond holders: Less debt = Happier bond holders.

AW More Debt?

• Current Covenants (from the 10-K)– Minimum Interest Coverage: 1.9 rising to 2.75.

• Currently: 1.11, but EBITDA may not be calculated for this purpose as we have in class. Answer in “Exhibit 10.91” which I do not have.

– Maximum Leverage (Total Debt/EBITDA): 5.75 dropping to 4.0.

• Currently: .15

• Not clear that the firm can issue more debt.

AW With Half the Debt

• Assume 150bps drop in interest.• Total debt: 6526.38/2 = 3263.19• Total interest savings: 48.94 per year.• Tax rate of about 40% (official number is

higher): Lost tax savings of 19.57 per year.

• Is it worth it?