Prof. Ian Giddy New York University Corporate Financial Restructuring 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 n Management acts to preserve or enhance shareholder value n Management acts to protect company, stakeholders and management from change in control n Lenders and shareholders lose, but try to work out best way to minimize loss
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 3 Corporate Financial Restructuring l Corporate restructuring – business and financial l Structured financing techniques l Proactive restructuring l Distress-induced restructuring l Mergers, divestitures and LBOs
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 4 A Simple Framework l A company is a “nexus of contracts” with shareholders, creditors, managers, employees, suppliers, etc l Restructuring is the process by which these contracts are changed – to increase the value of all claims. l Applications: restructuring creditor claims (Conseco); restructuring shareholder claims (AT&T); restructuring employee claims (UAL)
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 5 “Nexus of Contracts” Shareholders Senior lenders Subordinated lenders Franchisors Salespeople Management
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 6 Examples l SAP – upgrading shareholder control rights l Sealed Air – exploiting free cash flow l Marvel – post-bankruptcy negotiations l Westpac – structured finance l Novartis – merged and divested l Alphatec – rescuing residual value
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 7 Novartis: Financial Restructuring Fixed Assets Debt Equity AssetsLiabilities Fixed the cash and working capital Fixed the capital structure Cash Divested Non-core business
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 8 Restructuring Checklist Figure out what the business is worth now Use valuation model – present value of free cash flows Fix the business mix – divestituresValue 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 equityWhat 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 controlValue the changes new control would produce
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 9 Valuation is a Key to Unlock Value l Value with and without restructuring l Consider means and obstacles l Who gets what? l Minimum is liquidation value Valuation Going ConcernLiquidationAfter Restructuring
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 10 Getting the Financing Right Step 1: The Proportion of Equity & Debt Debt Equity n Achieve lowest weighted average cost of capital n May also affect the business side
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 11 Getting the Financing Right Step 2: The Kind of Equity & Debt Debt Equity n Short term? Long term? n Baht? Dollar? Yen? n Short term? Long term? n Baht? Dollar? Yen? n Bonds? Asset-backed? n Convertibles? Hybrids? n Bonds? Asset-backed? n Convertibles? Hybrids? n Debt/Equity Swaps? n Private? Public? n Strategic partner? n Domestic? ADRs? n Debt/Equity Swaps? n Private? Public? n Strategic partner? n Domestic? ADRs? n Ownership & control?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 12 Capital Structure: Optimal Range? VALUE OFTHE FIRM DEBT RATIO Optimal debt ratio? NestleLoewen
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 13 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 With different leverage E(R)=Rf+Bl(Rm-Rf) Equity Leverage, EBITDA And interest cost Interest Coverage EBITDA/Interest Rating (other factors too!) Cost of debt With different leverage Rate=Rf+Spread+? Debt
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 14 Ratings and Spreads
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 15 Interest Coverage Ratios, Spreads and Ratings: Small Firms
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 16 Optimal Debt Ratio for a Private Company: Example Damodaran’s spreadsheets:
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 17 TDI Financial History
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 18 Restructuring Debt and Equity at TDI (A & B) Evaluate the financial restructuring taking place at TDI: l Effect of the LBO on capital structure? l How did LBO lenders protect their interests? l Alternative restructuring plans? l Post Dec 89 operational, portfolio and financial restructuring proposals? l restructuring, before-and-after comparison
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 19 Restructuring Debt and Equity at TDI (C) Consider the choices facing TDI in 1994: l Evaluate the alternatives available to take best advantage of TDI’s free cash flow: Leveraged buyout Leveraged ESOP Leveraged recapitalization l Or: Invest cash or debt in growth opportunities l Or: Do nothing to retain flexibility
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 20 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 recap IPO Sale to financial buyer Sale to strategic buyer l Which when?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 21 Leveraged Recapitalization l Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares) l Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity l After the large dividend has been paid, the market value of the shares will drop.
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 22 Leveraged Recapitalizations l Motivations: Defensive Proactive Ownership transition/liquidity l Which produces what value?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 23 Exchange Offers l Give one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm. l Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock, l Or vice-versa l Motivations?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 24 Exchange Offers-- Effect Depends On: l Leverage increasing or decreasing l Implied increases or decreases in future operating cash flows l Implied undervaluation or overvaluation of common stock l Increase or decrease in management share ownership l Increase or decrease in management control over cash usage l Positive or negative signalling effects.
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 25 Asset-Backed Securities: Ford Credit Owner Trust 1999-A
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 26 Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Financial Guarantee Provider (if required) Servicing Agreement Proceeds Sale of Assets Proceeds Asset-Backed Securities Guarantee Agreement Rating Agency Top Rating Trustee Trust Agreement Finance Co.’s Customers Hire-Purchase Agreement Credit Enhancement: Guarantee Method
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 27 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 Guarantee Provider (if required) Guarantee Agreement
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 28 The Alternative: Synthetic ABS DB (Originator) SPECIAL PURPOSE VEHICLE REFERENCE POOL OF LOANS (Stay on balance sheet) ISSUES ASSET-BACKED CERTIFICATES CREDIT SWAP AGREEMENT TOP QUALITY INVESTMENTS
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 29 Corporate Financial Restructuring Why Restructure? Proactive Example: Sealed Air Distress Example: Loewen 1999 Defensive Example: Loewen 1996 n Management acts to preserve or enhance shareholder value n Management acts to protect company, stakeholders and management from change in control n Lenders and shareholders lose, but try to work out best way to minimize loss
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 30 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
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 31 Reorganization Processes l Out-of-court negotiated settlement Firm continues q Exchange: equity for debt q Extension: pay later q Composition: creditors agree to take less Firm ceases to exist: assignee liquidates assets and distibutes proceeds on a pro-rate basis l Merger into another firm (which assumes or pays off debt) Continues as subsidiary Absorbed into other operations l Formal legal proceedings Firm continues: Ch 11, court supervises composition or modification of claims Firm ceases to exist q Statutory assignment: assignee liquidates assets under formal legal procedures q Ch 7 liquidation: bankruptcy court supervises liquidation
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 32 When Default Threatens, Value the Company
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 33 Zombie Inc Valuation
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 37 Contact Info Ian H. Giddy NYU Stern School of Business Tel ; Fax