Restructuring in Emerging Markets Prof. Ian Giddy New York University

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

High growth disguised speculative financing structures 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

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 Source: McKinsey Quarterly, 2002 Number 4

Official Restructuring: A Spotty Record Source: McKinsey Quarterly, 2002 Number 4

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 debt composition

How can corporate and financial restructuring create value? It’s All About Value How can corporate and financial restructuring create value? Assets Liabilities Operating Cash Flows Debt Fix the business Or fix the financing Equity

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 Intel TPI VALUE OFTHE FIRM Optimal debt ratio? DEBT RATIO

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 Business mix is bad The company is bad Reason Raise equity or Change debt mix Sell some businesses or assets to pay down debt Change control or management through M&A 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: Iridium Give creditors equity in place of debt Example: Sammi Steel Both Example: Alphatec

What Do Debt-Equity Swaps Do? Overleverage creates financial distress Actual or potential default Lenders take equity in lieu of repayment Lenders hold equity passively Lenders replace management Lenders sell equity Existing management buys time Change of control means restructuring Financial engineering Bottom line “rationalization” Divestitures & outsourcing

What Are The Alternatives? Key: Make the new securities attractive to: Existing lenders New lenders New bond investors New equity investors

The Financing Spectrum Equity Residual returns after contractual claims Control through voting rights Expected Return Senior Debt Returns independent of the value of the business Control through covenants Risk

The Financing Spectrum Equity Preferred equity Convertible debt Expected Return Subordinated debt Senior unsecured debt Senior secured debt Risk

The Financing Spectrum Equity Preferred equity Convertible debt Expected Return Subordinated debt Senior unsecured debt Asian bank NPLs Senior secured debt Risk

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."

What Globally Mobile Investors Look At Macro Factors Currency overvaluation Capital restrictions Acctg & disclosure requirements IAS compliance Bankruptcy regime Creditor rights Govt-corporate nexus Trading infrastructure Structural Factors Firm-level Factors Price-Value ratio, Sharpe ratio, EVA D/E ratio Currency & maturity mismatch IAS conformity Insider control Objective research coverage Trading liquidity

Can the Form of Foreign Participation Make a Difference? (ADRs) Debt Equity Domestic Market Issue in Foreign Market (Depositary Receipts) Unsponsored Private placement Exchange traded Global issue or GDR Private placement IPO Exchange traded IPO

Key: Make the new equity attractive to: Portfolio investors The New Equity Option Key: Make the new equity attractive to: Portfolio investors Domestic International Reduce agency costs or we’ll “Just say no!” Strategic/direct investors Cede 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? What returns should they expect? Portfolio investors Financial investors Corporate 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 creditors New equity investors A possible management buyout

Contact Info Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org