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Copyright ©2003 Ian H. Giddy Financial Restructuring 1
Cap des Biches
Friday: Financial Restructuring
Ashanti-Bogoso
Feng-Shui
Copyright ©2003 Ian H. Giddy Financial Restructuring 2
Mt CameroonEcotours
Copyright ©2003 Ian H. Giddy Financial Restructuring 3
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 5
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 6
LBO Financing
NEWCO
Cost of
purchasing
the
business Equity $25
Senior
debt $457 What securities?
What returns?
What investors?Mezzanine
Copyright ©2003 Ian H. Giddy Financial Restructuring 7
Case Study: Cap des Biches (B)
The LBO Proposal Devise a recommended financing plan
GTI (owner)
Buyers Other Investors
Copyright ©2003 Ian H. Giddy Financial Restructuring 8
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 10
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 11
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 12
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 13
Corporate Finance
CORPORATE FINANCE
DECISONS
CORPORATE FINANCE
DECISONS
INVESTMENTINVESTMENT RISK MGTRISK MGTFINANCINGFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
Copyright ©2003 Ian H. Giddy Financial Restructuring 14
Capital Structure: East vs West
VALUE OFTHE
FIRM
DEBT
RATIO
Optimal debt ratio?
Intel TPI
Copyright ©2003 Ian H. Giddy Financial Restructuring 15
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 17
The Three Excesses
Labor Capacity Debt
Copyright ©2003 Ian H. Giddy Financial Restructuring 18
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 19
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 20
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 21
What Are The Alternatives?
Key: Make the new securities attractive to:Existing lendersNew lendersNew bond investorsNew equity investors
Copyright ©2003 Ian H. Giddy Financial Restructuring 22
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 23
The Financing SpectrumE
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 24
The Financing SpectrumE
xpec
ted
Ret
urn
Risk
Senior secured debt
Equity
Senior unsecured debt
Subordinated debt
Preferred equity
Convertible debt
Asian bank NPLsAsian bank NPLs
Copyright ©2003 Ian H. Giddy Financial Restructuring 25
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 26
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 27
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)
Copyright ©2003 Ian H. Giddy Financial Restructuring 28
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 29
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 30
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 31
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 32
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 33
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 34
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 35
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."
Copyright ©2003 Ian H. Giddy Financial Restructuring 36
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 38
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 39
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)
Copyright ©2003 Ian H. Giddy Financial Restructuring 40
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?
Copyright ©2003 Ian H. Giddy Financial Restructuring 41
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?
Copyright ©2003 Ian H. Giddy Financial Restructuring 42
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 43
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 44
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 45
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 46
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 48
Leveraged Finance
Share buyback?
Company has
unused debt
capacity Leveraged
recapitalization?
Takeover?
Copyright ©2003 Ian H. Giddy Financial Restructuring 49
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.
Copyright ©2003 Ian H. Giddy Financial Restructuring 50
Leveraged Recapitalizations
Motivations:DefensiveProactiveOwnership transition/liquidity
Which produces what value?
Copyright ©2003 Ian H. Giddy Financial Restructuring 51
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
Copyright ©2003 Ian H. Giddy Financial Restructuring 52
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 53