Capital Structure
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Transcript of Capital Structure
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Joseph V. RizziAmsterdam Institute of FinanceNovember, 2009
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• Cash Flow
Impacts default risk
• Balance Sheet
Determines Loss in Event of Default (LIED)
Liquidity
Valuation
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• Business Risk: EBITDA Volatility◦ Industry Characteristics◦ Firm Characteristics
• Financial Risk: EBITDA Relative to Debt• Structural Risk
◦ Issues Priority of claim on assets and income Control
◦ Focus Covenants, Seniority, Security
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Company Fundamentals◦ Size◦ Relative Market Share◦ Product Type◦ Diversity of Product◦ Customer Concentrations◦ Supply Risks◦ Management Expertise◦ Contingencies
Labor Environmental Litigation Pension
Industry Fundamentals
◦ Industry Growth Prospects◦ Competition◦ Cyclicality◦ Technology Risk◦ Barriers to Entry◦ Regulatory Environment◦ Foreign Exchange Risk
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Projected Debt Service Coverage◦ EBITDA / Interest Expense
Credibility of Projections Downside Coverage/Cushion Capitalization Purchase Price Multiple versus Comparables Interest Rate Projections Secondary Repayment Sources Collateral Coverage
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• Borrowing Entity Clearly Identified• Structural Subordination• Term Loan Amortization• Financial Covenants• Excess Cash Recapture• Subordinated Debt Provisions• Fraudulent Conveyance/Other Legal Issues• Pricing• Due Diligence• Documentation
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• Quantitative◦ Capitalization
Cash Equity >25% Total Debt <6.0x Senior Debt (1) <4.5x First Lien <4.0x Second Lien <0.5x
◦ Cash Flow LTM EBITDA / PFI >2:1 7 x LTM FFOCF / TLA(2) >1:1
◦ Liquidity Cash + MS + RCA / P+I (3) > 1.5 : 1
1:- TLA usually >20% of senior debt and amortizes at least 30% by year 5
2:- FFOCF = LTM EBITDA - (WCI + CAPEX + Taxes + PF Interest)
3:- Liquidity tested day 1. MS (Marketable Securities). RCA (Revolving Credit Availability). Revolver usually set at 1 x EBITDA
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• Debt capacity is derived from firm’s assets◦ Operating Cash Flows◦ Asset Sales / Asset Quality◦ Leveragability
• Market Conditions
• Target financing structure
Credit curve shifts over
time depending on the economy
Rating
Rate
s
2H07Crisis
Overheated 1H07
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There are two different approaches to designing the capital structure:
20%
30%
50%
Cash FlowCash FlowModelModel
Balance SheetBalance SheetModelModel
Senior Debt
Sub Debt
Equity
3 - 4xEBITDA
4 - 6xEBITDA
Equity
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• Ratio Approach
• Cash Flow
• Advance Rate
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Market◦ Maximum senior debt and total debt ratios◦ Vary over cycle
Peers◦ Identify◦ Rating Classification◦ Key Ratios
Rating Agencies◦ Credit Statistics
Statistical Models (KMV)
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Peer XYZ XYZABC DEF GHI JKL MNO PQR STU Average Actual Pro-Forma
12 Months Ended 02/10/20xx 30/09/20xx 01/01/20xx 30/09/20xx 31/10/20xx 30/11/20xx 31/12/20xx 31/12/20xx 31/12/20xxSales 3073.8 8294.9 6165.2 852.4 2345.8 1682.1 2133.4 3506.8 3025.4 3205.3Gross Margin 25.6% 14.4% 16.3% 19.8% 22.0% 16.6% 17.1% 18.8% 17.8% 17.4%EBITDA 153.7 430.1 272.3 35.9 130.8 77.3 100.3 171.5 122.6 134.5 Margin 5.0% 5.2% 4.4% 4.2% 5.6% 4.6% 4.7% 4.8% 4.1% 4.2%Interest Expense 34.4 78.6 49.6 13.2 19.5 15.3 25.0 33.7 55.2 55.8Capex 32.1 40.7 37.1 9.8 25.8 11.3 27.8 26.4 10.7 10.7 % of Sales 1.0% 0.5% 0.6% 1.1% 1.1% 0.7% 1.3% 0.9% 0.4% 0.3%Total Assets 1482.0 3835.4 2790.1 360.5 1099.5 829.3 961.5 1622.6 950.5 952.3
Secured Bank Debt 455.4 0.0 0.0 117.8 0.0 0.0 0.0 211.9 83.2Unsecured Bank Debt 0.0 504.6 175.9 0.0 208.0 210.0 37.6 0.0 0.0Other Senior Debt 111.7 391.4 708.2 6.3 179.2 0.0 75.0 42.6 8.3 Total Senior Debt 567.1 896.0 884.1 124.1 387.2 210.0 112.6 254.5 91.5Subordinated Debt 0.0 197.6 0.0 0.0 0.0 0.0 143.7 289.2 289.2 Total Debt 567.1 1093.6 884.1 124.1 387.2 210.0 256.3 543.7 380.7Equity 419.9 1461.1 1293.3 150.2 473.8 414.4 262.5 (69.0) 96.4 Total Capitalization 987.0 2554.7 2177.4 274.3 861.0 624.4 518.8 474.7 477.1
Total Debt/EBITDA 3.7 2.5 3.2 3.5 3.0 2.7 2.6 3.0 4.4 2.8Senior Debt/EBITDA 3.7 2.1 3.2 3.5 3.0 2.7 1.1 2.8 2.1 0.7Total Debt/Capital 57.5% 42.8% 40.6% 45.2% 45.0% 33.6% 49.4% 44.9% 114.5% 79.8%EBITDA/Interest (incl. A/S) 4.5 5.5 5.5 2.7 6.7 5.1 4.0 4.8 2.2 2.4
Credit Ratings S&P BBB- A- A NR NR NR BB BB- Moody's NR A3 A2 NR NR NR Baa3 Ba2
Market Capitalization 468.2 1482.0 1295.8 104.4 510.9 249.2 177.9 612.6Enterprise Value 1035.3 2575.6 2179.9 228.5 898.1 459.2 434.2 1115.8Ent Value/EBITDA 6.74 5.99 8.01 6.36 6.87 5.94 4.33 6.32Ent Value/Sales 0.34 0.31 0.35 0.27 0.38 0.27 0.20 0.30Ent Value/Book Value 2.47 1.76 1.69 1.52 1.90 1.11 1.65 1.73Earnings per Share 1.78$ 1.73$ 2.83$ (0.06)$ 2.37$ 1.69$ 1.09$ 1.63$
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Important: Loan Market Evolution from a bank to an institutional market(back to a bank market?)
Impact: Majority of syndicated loans are rated
Pricing: Affected by rating
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October 2009
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Maximum debt capacity formula:-MDC = f(operations, amortization, rate, asset sales)MDC = [EBIT / (i+ 1/n)] + AS + RF
EBIT - Earnings Before Interest and Taxesi - Interest Raten - Straight line loan amortizationAS - Proceeds from Asset Sales
RF - Refinancing
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Issues◦ Adjustments (beware of solving for cash flows to justify price)◦ Normalization
Cyclicality Bad Management
Value Test◦ Projections implied price
Reverse Engineer - Management implied forecast◦ Firms◦ Peers
Tie Into◦ Compensation◦ Covenants
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Asset Based Lending◦ Receivables (80%)◦ Inventory (50%)◦ Net PP&E (40%)
Business Value Lending◦ Estimate business value◦ Take stock as collateral◦ Advance up to a certain percentage of business
value
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Debt Capacity Approaches
Cash Flow Approach Example:Based on projected cashflow's ability to service Earnings Before Interest & Taxes (EBIT) 40
debt. Multiple is a function of cash flow volatility. Add Back Non Cash Charges 10Suitable for larger, more stable borrowers. Operating Cash Flow (EBITDA) 50
Maximum Senior Debt (4.0x EBITDA) 200Subordinated Debt 100Maximum Debt Capacity (6.0x EBITDA) 300
Asset Based Approach Example:Based on probable liquidation value of collateral. Receivables 100 80% 80Advance rate is a function of the certainty of Inventory 100 50% 50liquidation value and market to book. Suitable Fixed Assets 175 40% 70for smaller, higher risk borrowers. Maximum Senior Debt 200
Subordinated Debt 100 Maximum Debt Capacity 300
Ratings Approach Example: 50Using S&P's financial risk tolerance levels by S&P BBB Debt/Cap Ratio 45.6%rating category a capital structure can be designed Company Debt/Cap 50.0%to match the issuers ratings preference. Heavily Debt Capacity 0dependent on the businesses risk profile.
S&P B Debt/Cap Ratio 74.2%Company Debt/Cap 50.0%Debt Capacity 60.8
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Macro/Market Level◦ Determine rating target◦ Use target rating level financial characteristics
Funded Debt/EBITDA EBITDA/Interest Expense Funded Debt/Total Cap
Example:(A) Target Rating BB(B) EBITDA/Int for Target Rating c3.0x(C) Firm EBITDA $300mln(D) Interest Rate for Target Rating 10%(E) Maximum Debt Capacity = (C/B)/D
= (300/3)/10%= $1,000
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10/22/09
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Source S&P
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US 220
UK 160
Germany 110
France 125
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Tend to default at same rate as similarly rated non sponsored firms
Larger deals tend to have worse performance PE underwriting performance varies
Firm Defaulted and Distressed Deals (D&D) (%)Cerberus 4(67%)Apollo 13 (65%)TH Lee 6 (55%)Carlyle 16(52%)Bain 10(45%)Goldman 8(38%)Warburg 5(36%)Providence 4(33%)TPG 6(32%)Welsh 4(31%)JPM 2(29%)Blackstone 6(27%)Madison 3(25%0KKR 3(15%)
29Source: Moody’sAmsterdam Institute of Finance
November 2009
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Initiation of Bankruptcy
- Who has the right to file for bankruptcy?- What kinds of enterprises should be eligible to file for bankruptcy?- Can the decision to file be challenged?- When should inappropriate cases be terminated?
Preserving Firm Value / Minimizing Business Losses in Bankruptcy
- Should the business be reorganized or liquidated?- How should creditors be prevented from dismembering the
business?- Should the debtor be required to honor pre-bankruptcy contracts
with suppliers and lenders?- Should debtor-in possession (DIP) financing be made available?
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Corporate Governance in Bankruptcy
- Should the debtor’s decision making authority be limited?- How should debtor management be monitored?
Choosing the Plan of Reorganization
- Should the process be consensual or formulaic?- Who has the right to propose a plan?- How should the plan be voted upon?- How should dissenting claimholders be treated?- Should there be a time limit?- How should the debtor’s new capital structure be determined?
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LIABILITIES+EQUITY
LIABILITIES+EQUITY
ASSETS
ASSETS
Equilibrium
Restructure
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How Big is the pie?- Valuation of LHS
How much does each claimholder receive?- RHS waterfall analysis- Legal System
How should this consideration be paid?- Cash- Instruments
How much debt can the company support after a reorganization?- Debt capacity
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Objective: Improve position
- Pricing- Collateral- Seniority- Cash Payments- Maturity- Covenants- Control- Force Sale
Starting Position
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• Determining debt capacity using credit analysis
• Expanding debt capacity• What to expect when you exceed debt
capacity
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Banks Lose $3.7B in loans - $20.9BGoldman - $850
ABN Amros/RBS - £1B write-off on $3.4B claim UBS - $500Out of Season – 2H07/1H07
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Purchase Price
20% Premium to 7/16/07 closing price
Commodity
Basell/Blavatnik and Lyondell – Russian Rule
DIP – Debt converted into post petition financing
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This information has been prepared solely for informational purposes and is not
intended to provide or should not be relied upon for accounting, legal, tax, or
investment advice. The factual statements herein have been taken from
sources believed to be reliable, but such statements are made without any
representation as to accuracy or completeness. Opinions expressed are current
opinions as of the date appearing in this material only. These materials are
subject to change, completion, or amendment from time to time without notice
and CapGen Financial is not under any obligation to keep you advise of such
changes. All views expressed in this presentation are those of the presenter,
and not necessarily those of CapGen Financial.
Amsterdam Institute of Finance November 2009