Prof. Ian Giddy New York University Corporate Financial Restructuring More to come.

Prof. Ian GiddyNew York University

Corporate FinancialRestructuring

More to come

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 2

Corporate Financial Restructuring

Why Restructure?

Proactive

Example:

Sealed Air

Distress

Example:

Loewen 1999

Defensive

Example:

Loewen 1996

Management acts to preserve or enhance shareholder value

Management acts to protect company, stakeholders and management from change in control

Lenders and shareholders lose, but try to work out best way to minimize loss



Corporate restructuring – business and financial

Structured financing techniques Proactive restructuring Distress-induced restructuring Mergers, divestitures and LBOs


A Simple Framework

A company is a “nexus of contracts” with shareholders, creditors, managers, employees, suppliers, etc

Restructuring is the process by which these contracts are changed – to increase the value of all claims.

Applications: restructuring creditor claims (Conseco);restructuring shareholder claims (AT&T);restructuring employee claims (UAL)


“Nexus of Contracts”

Shareholders

Senior lenders

Subordinated lenders

Franchisors

Salespeople

Management


Examples

SAP – upgrading shareholder control rights

Sealed Air – exploiting free cash flow Marvel – post-bankruptcy negotiations Westpac – structured finance Novartis – merged and divested Alphatec – rescuing residual value


Novartis: Financial Restructuring

Fixed

Assets

Debt

Equity

Assets LiabilitiesFixed the cash

and working capital

Fixed the capital

structureCash

Divested

Non-core

business


Restructuring Checklist

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


Valuation is a Key to Unlock Value

Value with and without restructuring Consider means and obstacles Who gets what? Minimum is liquidation value

Valuation

Going Concern LiquidationAfter Restructuring


Getting the Financing RightStep 1: The Proportion of Equity & Debt

Debt

Equity

Achieve lowest weighted average cost of capital

May also affect the business side


Getting the Financing RightStep 2: The Kind of Equity & Debt

Debt

Equity

Short term? Long term? Baht? Dollar? Yen?

Short term? Long term? Baht? Dollar? Yen?

Bonds? Asset-backed? Convertibles? Hybrids?

Bonds? Asset-backed? Convertibles? Hybrids?

Debt/Equity Swaps? Private? Public? Strategic partner? Domestic? ADRs?

Debt/Equity Swaps? Private? Public? Strategic partner? Domestic? ADRs?

Ownership & control? Ownership & control?


Capital Structure: Optimal Range?

VALUE OFTHE

FIRM

DEBT

RATIO

Optimal debt ratio?

Nestle Loewen


Cost of Capital and Leverage: Method

Estimated Beta

With current leverage

From regression

Unlevered Beta

With no leverage

Bu=Bl/(1+D/E(1-T))

Levered Beta

With different leverage

Bl=Bu(1+D/E(1-T))

Cost of equity


E(R)=Rf+Bl(Rm-Rf)

Equity

Leverage, EBITDA

And interest cost

Interest Coverage

EBITDA/Interest

Rating

(other factors too!)

Cost of debt


Rate=Rf+Spread+?

Debt


Ratings and Spreads

Corporate bond spreads: basis points over Treasury curveRating 1 year 2 year 5 year 10 year 30 year Typical Int Coverage RatiosAaa/AAA 40 45 60 85 96 >8.50Aa1/AA+ 45 55 70 95 106 6.50-8.50Aa2/AA 55 60 75 105 116 6.50-8.50Aa3/AA- 60 65 85 117 136 6.50-8.50A1/A+ 70 80 105 142 159 5.50-6.50A2/A 80 90 120 157 179 4.25-5.50A3/A- 90 100 130 176 196 3.00-4.25Baa1/BBB+ 105 115 145 186 208 2.50-3.00Baa2/BBB 120 130 160 201 221 2.50-3.00Baa3/BBB- 140 145 172 210 232 2.50-3.00Ba1/BB+ 225 250 300 350 440 2.00-2.50Ba2/BB 250 275 325 385 540 2.00-2.50Ba3/BB- 300 350 425 460 665 2.00-2.50B1/B+ 375 400 500 610 765 1.75-2.00B2/B 450 500 625 710 890 1.50-1.75B3/B- 500 550 750 975 1075 1.25-1.50Caa/CCC 600 650 900 1150 1300 0.80-1.25

Corporate bond spreads: basis points over Treasury curveRating 1 year 2 year 5 year 10 year 30 year Typical Int Coverage RatiosAaa/AAA 40 45 60 85 96 >8.50Aa1/AA+ 45 55 70 95 106 6.50-8.50Aa2/AA 55 60 75 105 116 6.50-8.50Aa3/AA- 60 65 85 117 136 6.50-8.50A1/A+ 70 80 105 142 159 5.50-6.50A2/A 80 90 120 157 179 4.25-5.50A3/A- 90 100 130 176 196 3.00-4.25Baa1/BBB+ 105 115 145 186 208 2.50-3.00Baa2/BBB 120 130 160 201 221 2.50-3.00Baa3/BBB- 140 145 172 210 232 2.50-3.00Ba1/BB+ 225 250 300 350 440 2.00-2.50Ba2/BB 250 275 325 385 540 2.00-2.50Ba3/BB- 300 350 425 460 665 2.00-2.50B1/B+ 375 400 500 610 765 1.75-2.00B2/B 450 500 625 710 890 1.50-1.75B3/B- 500 550 750 975 1075 1.25-1.50Caa/CCC 600 650 900 1150 1300 0.80-1.25


Interest Coverage Ratios, Spreads and Ratings: Small Firms

If interest coverage ratio isgreater than ≤ to Rating is Spread is

-100000 0.499999 D 14.00%0.5 0.799999 C 12.70%0.8 1.249999 CC 11.50%1.25 1.499999 CCC 10.00%1.5 1.999999 B- 8.00%2 2.499999 B 6.50%

2.5 2.999999 B+ 4.75%3 3.499999 BB 3.50%

3.5 4.499999 BBB 2.25%4.5 5.999999 A- 2.00%6 7.499999 A 1.80%

7.5 9.499999 A+ 1.50%9.5 12.499999 AA 1.00%12.5 100000 AAA 0.75%

Example:EBIT 10000Interest expense 2500LT Govt bond rate 6.00%

Interest coverage ratio = 4Estimated Bond Rating = BBBEstimated Default Spread = 2.25%Estimated Cost of Debt = 8.25%

Example:EBIT 10000Interest expense 2500LT Govt bond rate 6.00%

Interest coverage ratio = 4Estimated Bond Rating = BBBEstimated Default Spread = 2.25%Estimated Cost of Debt = 8.25%


Optimal Debt Ratio for a Private Company: Example

Debt RatioBetaCost of EquityBond RatingInterest RateAT Cost of DebtCost of CapitalFirm Value0% 1.03 12.65% AA 7.50% 4.35% 12.65% $26,78110% 1.09 13.01% AA 7.50% 4.35% 12.15% $29,11220% 1.18 13.47% BBB 8.50% 4.93% 11.76% $31,18230% 1.28 14.05% B+ 9.50% 5.51% 11.49% $32,80340% 1.42 14.83% B- 11.25% 6.53% 11.51% $32,67950% 1.62 15.93% CC 13.00% 7.54% 11.73% $31,34160% 1.97 17.84% CC 13.00% 7.96% 11.91% $30,33370% 2.71 21.91% C 14.50% 10.18% 13.70% $22,89180% 4.07 29.36% C 14.50% 10.72% 14.45% $20,70390% 8.13 51.72% C 14.50% 11.14% 15.20% $18,872

Debt RatioBetaCost of EquityBond RatingInterest RateAT Cost of DebtCost of CapitalFirm Value0% 1.03 12.65% AA 7.50% 4.35% 12.65% $26,78110% 1.09 13.01% AA 7.50% 4.35% 12.15% $29,11220% 1.18 13.47% BBB 8.50% 4.93% 11.76% $31,18230% 1.28 14.05% B+ 9.50% 5.51% 11.49% $32,80340% 1.42 14.83% B- 11.25% 6.53% 11.51% $32,67950% 1.62 15.93% CC 13.00% 7.54% 11.73% $31,34160% 1.97 17.84% CC 13.00% 7.96% 11.91% $30,33370% 2.71 21.91% C 14.50% 10.18% 13.70% $22,89180% 4.07 29.36% C 14.50% 10.72% 14.45% $20,70390% 8.13 51.72% C 14.50% 11.14% 15.20% $18,872

Damodaran’s spreadsheets:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm


TDI Financial History

TDI

0

20

40

60

80

100

120

140

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

$ m

illi

on

s

Debt

EBITDA


Restructuring Debt and Equity at TDI (A & B)

Evaluate the financial restructuring taking place at TDI:

Effect of the LBO on capital structure? How did LBO lenders protect their interests? Alternative restructuring plans? Post Dec 89 operational, portfolio and

financial restructuring proposals? 1992-93 restructuring, before-and-after

comparison


Restructuring Debt and Equity at TDI (C)

Consider the choices facing TDI in 1994: Evaluate the alternatives available to take

best advantage of TDI’s free cash flow:Leveraged buyoutLeveraged ESOPLeveraged recapitalization

Or: Invest cash or debt in growth opportunities

Or: Do nothing to retain flexibility


Restructuring Debt and Equity at TDI (D)

Evaluate the possible means for cashing out shareholder value in a private company such as TDI in 1996:Leveraged recapIPOSale to financial buyerSale to strategic buyer

Which when?


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.


Leveraged Recapitalizations

Motivations:DefensiveProactiveOwnership transition/liquidity

Which produces what value?


Exchange Offers

Give one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm.

Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock,

Or vice-versa Motivations?


Exchange Offers-- Effect Depends On:

Leverage increasing or decreasing Implied increases or decreases in future

operating cash flows Implied undervaluation or overvaluation of

common stock Increase or decrease in management share

ownership Increase or decrease in management control

over cash usage Positive or negative signalling effects.


Asset-Backed Securities:Ford Credit Owner Trust 1999-A


Finance Co. Ltd(Seller)

FCL 1997-A(Special Purpose Co.)

Investors

Financial GuaranteeProvider

(if required)

Servicing Agreement

Proceeds

Sale of Assets

Proceeds

Asset-BackedSecurities

GuaranteeAgreement

Rating Agency

Top Rating

TrusteeTrust

Agreement

Finance Co.’sCustomers

Hire-PurchaseAgreement

Credit Enhancement: Guarantee Method


Finance Co. Ltd(Seller)

FCL 1997-A(Special Purpose Co.)

Senior

Proceeds

Sale of Assets

Rating Agency

Top Rating

Credit Enhancement:An Alternative Approach

Subordinated

More Subordinated

Lower Rating

No Rating

Financial GuaranteeProvider

(if required)GuaranteeAgreement


The Alternative: Synthetic ABS

DB (Originator)

SPECIALPURPOSEVEHICLE

REFERENCE

POOL OF LOANS

(Stay on

balance sheet)

ISSUESASSET-BACKEDCERTIFICATES

CREDIT SWAPAGREEMENT

TOP QUALITYINVESTMENTS



Why Restructure?

Proactive

Example:

Sealed Air

Distress

Example:

Loewen 1999

Defensive

Example:

Loewen 1996

Management acts to preserve or enhance shareholder value

Management acts to protect company, stakeholders and management from change in control

Lenders and shareholders lose, but try to work out best way to minimize loss


Match the Solution to the Problem

Trouble!

The financing

is bad

The company

is bad

Business

mix is bad

Raise equity, or

Do debt/equity swap

Or change debt mix

Change control

or management

through M&A

Sell some businesses

or assets

to pay down debt

Reason

Remedy


Reorganization Processes Out-of-court negotiated settlement

Firm continues Exchange: equity for debt Extension: pay later Composition: creditors agree to take less

Firm ceases to exist: assignee liquidates assets and distibutes proceeds on a pro-rate basis

Merger into another firm (which assumes or pays off debt) Continues as subsidiary Absorbed into other operations

Formal legal proceedings Firm continues: Ch 11, court supervises composition or modification of

claims Firm ceases to exist

Statutory assignment: assignee liquidates assets under formal legal procedures Ch 7 liquidation: bankruptcy court supervises liquidation


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?


Zombie Inc Valuation

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 1,000,000 1,000,000WACC 17.43% 10.68%Growth 2% 2%

Debt 10,100,000 5,600,000 (8.72)$ 7.23$

Debt at 65% 0.11$ Option value?

Bank lenders Before AfterDebt (at market) 5,850,000 3,600,000 Equity (NPV value) 0 3,254,631Total 5,850,000 6,854,631


Contact Info

Ian H. Giddy

NYU Stern School of Business

Tel 212-998-0426; Fax 212-995-4233

[email protected]

http://giddy.org

Prof. Ian Giddy New York University Corporate Financial Restructuring More to come.

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