debt valuations for pe and bdcs


LATEST ON DEBT VALUATIONS FOR THE PRIVATE EQUITY AND BDC INDUSTRY

November 10, 2016

American Society of Appraisers

©2016 RSM US LLP. All Rights Reserved.

Melissa Brady- Director- RSM US LLP- Financial Advisory Services- Valuation Services- New York, NY- [email protected] 212-372-1296

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mailto:[email protected]


Middle Market Loan Overview

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Definition of middle market

Lower Middle Market: Under $50MM in EBITDA

Upper Middle Market: $50MM - $100MM in EBITDA

Deals are private; relationship driven; club deals

Less liquidity

More robust covenant packages

Simpler capital structures


Key Trends

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• Increase in unitranche loans• Supply demand imbalances

• More competition in middle market investing• Increase in private credit fundraising• Decline in refinancing and M&A

• Traditional bank lending declining• Increase in co-investment positions• Purchase multiples have increased with debt

financing availability


Middle Market New Issue Volume

5Source: S&P Global Market Intelligence. www.lcdcomps.com

$0B

$20B

$40B

$60B

$80B

$100B

$120B

$140B

Middle Market New Issue Loan Volume

$200M or Less $201M - $350M $351M - $500M


Middle Market New Issuance Volume 3Q16

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28.3%

24.6%

18.8%

16.1%

10.3%

1.8%

0.1%

0% 10% 20% 30% 40% 50%

Retail

Healthcare

Computers &Electronics

Printing & Publishing

Aerospace &Defense

Restaurants

Oil & Gas

Issuers with EBITDA of $50MM or less ($1.4B). Source: S&P Capital Market Intelligence


Middle Market: 3Q 2016



Issuers with $50MM EBITDA or Less


Period Debt/EBITDASenior

Debt/EBITDAEBITDA/Cash

InterestEBITDA - Maint

Capex/Cash InterestEBITDA - Capex/

Cash Interest

1997 4.82 3.69 2.37 1.88 1.641998 4.55 3.49 2.75 2.30 1.841999 4.11 3.32 3.03 1.80 1.772000 4.01 3.14 3.10 1.94 1.702001 3.56 2.65 3.22 2.47 2.232002 3.75 2.81 3.64 2.50 2.372003 3.86 3.02 3.67 2.87 2.712004 4.11 3.51 3.92 3.34 3.122005 4.31 3.97 3.34 2.91 2.802006 4.40 4.03 2.82 2.24 2.142007 4.76 4.52 2.79 2.50 2.352008 4.25 3.61 3.17 2.74 2.722009 3.41 2.90 3.37 2.40 2.402010 3.66 3.16 3.92 3.43 3.232011 4.23 3.91 3.43 3.08 2.912012 4.34 3.98 3.43 2.90 2.732013 4.81 4.68 3.53 2.91 2.822014 4.97 4.88 3.67 2.84 2.692015 4.92 4.72 3.72 3.06 2.83

1Q-3Q16 5.11 4.67 2.98 2.42 2.313Q16 5.31 5.31 3.06 NA NA


Methodology Overview

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Credit Analysis

High Probability for Credit Event/ Default

Liquidation Approach:No longer expected to be a

going concern

Net Recovery Approach:

Expected to remain a going concern

Low Probability for Credit Event/ Default

Income Approach


Calibration Analysis – Capital Structure

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Pricing 10/30/2015 xEBITDA 06/30/2016 xEBITDA 09/30/2016 xEBITDARevolver L+175 23.6$ 0.7x 6.6$ 0.2x 9.0$ 0.3xFirst Lien Term Loan L+575 100 3.8x 100 3.3x 100 3.7xTotal Senior Debt 123.6 3.8x 106.6 3.3x 109 3.7xSecond Lien Term Loan L+1000 55 5.5x 55 5.0x 55 5.6xOther Debt 4 5.6x 3.9 5.1x 3.7 5.7xTotal Debt 182.6 5.6x 165.5 5.1x 167.7 5.7xLess: Cash 4.4 4.2 3.2Total Net Debt 178.2$ 5.5x 161.3$ 5.0x 164.5$ 5.6x

EBITDA 32.6$ 32.5$ 29.2$

At Investment Previous Valuation Current Valuation


Calibration Analysis – Credit Ratios

Investment Date vs. Valuation Date

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EBIT interest coverage (x)EBITDA interest coverage (x)Free oper. cash flow/total debt (%)FFO/total debt (%)Return on capital (%)Operating income/sales (%)Total debt/capital (incl. STD) (%)Discretionary cash flow/total debt (%)Total debt/EBITDA (x)


Lower Middle Market Stats By EBITDA

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Debt Pricing

Primary loan issuances

Secondary pricing

Comparable bond pricing

Loan Indices By credit rating By industry By size (EBITDA) By leverage / type Other

Data providers that focus on middle market debt pricing

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3 Month Average New Issue Yields

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MM6.40%

LC

5.14%

4%

5%

6%

7%

8%

Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16

3 Month Average New-Issue Yields($50M of EBITDA or Less)

Source: LCD, an offering of S&P Global Market


Yield Calibration

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Market Indices Change in Yield CalculationsIssuance Date Valuation Date Change in Yields Implied Yield

Credit Quality Related IndicesLCD All Loans Index 5.18% 5.14% -0.03% 10.97%LCD MM Single B Loan Index 6.74% 7.23% 0.49% 11.49%LCD Second Lien Loan Index 10.11% 11.93% 1.82% 12.82%LCD Middle Market Index 7.14% 8.19% 1.04% 12.04%

Interest Rate Related IndicesBloomberg HY Corporate Bond Index 1-5 Year 6.97% 6.62% -0.35% 10.65%Bloomberg HY Corporate Bond Index 5-10 Year 6.26% 6.03% -0.23% 10.77%

Industry Related IndicesLCD Financial Intermediaries Index 4.21% 3.94% -0.26% 10.74%Barclays High Yield Other Finance 7.69% 8.12% 0.42% 11.42%Middle Market Services ($20M to $50M EBITDA) 9.53% 9.90% 0.38% 11.38%

Yield at Investment Date: 11%


Credit Analysis

Leverage - Seniority in the capital structure

Senior Lender – Terms/Type

Collateral coverage Capital expenditure needs

Industry trends – favorable / unfavorable

Sponsor – reputation, relationship with creditors, etc.

Structural subordination (holding company vs. operating company)

Debt semantics

Not all Bs created equally16


Credit Analysis: Other Factors

Adequacy of liquidity Regulatory issues Operational disturbances Diversification (Product/Geographic/etc.) Customer concentration Failures in risk management Misguided management decisions Other issues

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Some Tips if Credit Risk Deteriorates

If you have a deterioration in credit quality:

- Assess the spreads between different credit rating indices

- Assess spreads between first lien and second lien

- Assess new issuances and secondary trades of loans with similar credit profile

- Assess qualitative factors

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Credit Rating Table

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Moody's S&P FitchLong-Term Short-Term Long-Term Short-Term Long-Term Short-Term

Aaa P-1 AAA A-1+ AAA A1+Aa1 AA+ AA+Aa2 AA AAAa3 AA- AA-A1 A+ A-1 A+ A1A2 A AA3 P-2 A- A-2 A- A2

Investment Baa1 BBB+ BBB+Grade Baa2 P-3 BBB A-3 BBB A3

Baa3 BBB- BBB-Ba1 Not Prime BB+ B BB+ B

Non-Investment Ba2 BB BBGrade or Junk Ba3 BB- BB-

B1 B+ B+B2 B BB3 B- B-Caa1 CCC+ C CCC CCaa2 CCC

D DDDDD

Caa3 CCC-

Ca CC


Credit Ratings

Risk comparison between public debt and private debt can be difficult

Accuracy of rating agencies may be questionable

Credit ratings are backward looking

Credit ratio analysis does not capture all credit risk factors. Qualitative factors are just as important.

Market prices and yields could be volatile and affected by liquidity and market volatility

Key credit ratios will differ by industry

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Broker Quotes

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Challenges associated with broker quotes:

• Does a broker quote represent fair value?

• What are the typical nuances of assessing trading activity?

• Does fair value differentiate between retail trades and institutional trades?


Recovery methods for non-performing loans


Recovery Rates for Balance Sheet Assets

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Example:• Cash – 100% recoverable

• Accounts Receivable – 75% to 85% recoverable

• Inventory – 50% to 80% recoverable

• Fixed assets – 50% recoverable

• Intangible assets – 0%

• Prepaid assets – 0%

• Other assets – 0%

The rates above are for illustrative purposes only. Recovery rates vary by industry and by company.


Example 1 – Plant Nursery Business

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Balance Low High Low HighCurrent Assets:

Cash & Cash Equivalents 3,040$ 0% 0% -$ -$ Accounts Receivable 2,973 70% 80% 2,081 2,378 Prepaids 5,225 0% 0% - - Inventory 250,257 15% 25% 37,539 62,564 Other Current Assets - 0% 0% - -

Total Current Assets 261,495$ 39,620$ 64,943$

Net Fixed Assets 18,368 40% 60% 7,347 11,021

Intangible Assets 12,667 0% 0% - - Total Other Assets 12,667$ -$ -$

Total Assets Supporting Debt 292,530$ 46,967$ 75,963$

Less: Revolver 31,035 31,035 31,035

Collateral Supporting First Lien 261,495 15,932 44,928

First Lien Term Loan A 75,000$ 75,000$ 75,000$ First Lien Coverage 21.2% 59.9%


Example 2: Sun Block Retail (Part I of II)

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($ in thousands) Low Range High RangeValuation Valuation

Balance Adjustments Adjustments Low HighCurrent Assets:

Cash 80$ 100% 100% 80$ 80$ Accounts Receivable 6,990 75% 85% 5,243 5,942 Inventories 6,018 90% 90% 5,416 5,416 Other Current Assets 2,065 0% 0% - -

Total Current Assets 15,153$ 10,739$ 11,438$

Net Fixed Assets 1,445$ 45% 55% 650$ 795$

Intangible Assets 16,564 0% 0% - - Brands - N/A N/A 12,496 14,995 Other Assets 964 0% 0% - -

Total Other Assets 17,528$ 12,496$ 14,995$

Total Assets 34,126$ 23,885$ 27,228$


Example 2: Sun Block Retail (Part II of II)

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($ in thousands)Low -- High

Available for Paydown 23,885$ 27,228$ Less: Senior Debt 13,322 13,322 Residual Coverage 10,563$ 13,906$ Less: Subordinated Debt 17,854 17,854 Residual Value to Common -$ -$

Subordinated Debt Coverage 59.2% 77.9%


Considerations

• Factors behind market approach limitations.

- Choosing only distressed firms may be problematic if there is few available.

- Adjust multiple for distress (highly challenging)

• Factors behind income approach limitations.

- Using distressed discount rates of 30% or higher may overestimate value.

• Use multiple methods, if possible.

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Example 3: Market Approach – Service Co.

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Low -- HighAdjusted EBITDA 5,355$ 5,355$ EBITDA Multiple 6.5x 7.0xImplied Enterprise Value 34,808$ 37,485$ Plus: Sponsor Committed Equity Infusion 2,500 5,000 Plus: Cash 248 248 Available for Paydown 37,556$ 42,733$ Less: Senior Debt 25,249 25,249 Residual Value For Subordinated Debt 12,307 17,485 Less: Subordinated Debt 29,045 29,045

Subordinated Debt Coverage 42% 60%

Valuation Range


Exploration and Production / Oil & Gas

• Proved Reserves, 90% Certainty of Commercial Extraction

• Probable Reserves, 50% Certainty of Commercial Extraction

• Possible Reserves, 10% Certainty of Commercial Extraction

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