Joseph V. Rizzi Amsterdam Institute of Finance November, 2009.

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

Amsterdam Institute of Finance November 2009

3

• 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


5

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


10

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


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.


Joseph V. Rizzi Amsterdam Institute of Finance November, 2009.

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