Prof. Ian Giddy New York University Restructuring in Emerging Markets.

Prof. Ian GiddyNew York University

Restructuringin Emerging Markets

Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 2

Why Financial Restructuring?

The Asian Bet The Solution, Part I: Recapitalization The Solution, Part II: Financial

Restructuring The Solution, Part III: Corporate

Restructuring


The Asian Bet

High growth disguised speculative financing structures

Governments shielded companies and banks from capital market discipline

Too much debt Too much foreign-currency debt Closely held ownership relying on

reinvested earnings


The Asian Bet

High growth disguised speculative financing structures

Governments shielded companies and banks from capital market discipline

Too much debt Too much foreign-currency debt Closely held ownership relying on

reinvested earnings

The three excesses Too much debt Too much labor Too much capacity

The three excesses Too much debt Too much labor Too much capacity


How the Bet was Lost

Vulnerable economies, newly liberalized, succumbed to currency crises

Vulnerable corporate financial structures Companies were unable to service even

domestic debt, never mind foreign currency debt

Many Asian companies resisted reform even after the crisis, and remain misfinanced


Today

Asia remains awash in bad debt that is putting its banks and economies at risk

Private estimates put the total at $2 trillion and growing

The region's banking culture often makes it difficult to collect.


Bad Debt: It’s Worse Than They Think

Source: McKinsey Quarterly, 2002 Number 4


Bad Old Debt Means Little New Credit



Official Restructuring: A Spotty Record



Tomorrow

Corporations must implement the key principles of corporate finance – estimate realistic cost of capital and discard investments below the WACC

Shareholders must exercise ownership rights Banks must break the link between loan

origination and collection Governments have to leave insolvent

borrowers to their fate Regulators should get tough on loan

classification standards.


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


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


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


Capital Structure: East vs West

VALUE OFTHE

FIRM

DEBT

RATIO

Optimal debt ratio?

Intel TPI


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


When 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


The Three Excesses in Thailand

Labor Capacity Debt


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


Typical Result: Debt-Equity Swaps

Cosmetic or real? Choices for company under siege

Raise new equity or quasi-equity to partially pay off creditors

Example: IridiumGive creditors equity in place of debt

Example: Sammi SteelBoth

Example: Alphatec


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


What Are The Alternatives?

Key: Make the new securities attractive to:Existing lendersNew lendersNew bond investorsNew equity investors


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



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



xpec

ted

Ret

urn

Risk

Senior secured debt

Equity

Senior unsecured debt

Subordinated debt

Preferred equity

Convertible debt

Asian bank NPLsAsian bank NPLs


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


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


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."


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


Debt

Equity

Domestic Market

Issue in Foreign Market(Depositary Receipts)

Unsponsored Private placement

Exchange traded

Exchange traded IPO

Private placement IPO

Global issue or GDR

Can the Form of Foreign Participation Make a Difference? (ADRs)


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


PT Astra International

?


PT Astra International

1997: Almost $2 billion USD debt 1998: Steep losses Mostly IDR revenues 1999: Debt restructuring, return to

profitability Bina Busana Internusa: February 1999 US $1 mio PT Astra International: June 1999 US $1,149 mio. Fuji Technica Indonesia: September 1999 US $16 mio Federal International Finance: December 1999 US $107 mio. Traktor Nusantara: December 1999 US $ 21 mio. Astra Graphia: December 1999 US $82 mio.


New Equity for Astra

What investors?Portfolio investorsFinancial investorsCorporate investors

What returns should they expect?= Risk-free rate+ Corporate risk+ Financial risk (leverage/debt mismatch)+ “Agency cost” premium+ Country risk

What restructuring?


Alphatec

What really caused Alphatec's collapse? What was the January 1999 rehabilitation

proposal? What, specifically, is the "performance-linked

obligation?" Does the January 1999 Rehabilitation Plan

meet investors’ expectations? Look at it from the point of view of:Existing creditorsNew equity investorsA possible management buyout


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 Restructuring in Emerging Markets.

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