Copyright ©2003 Ian H. Giddy Financial Restructuring 1 Cap des Biches Friday: Financial Restructuring Ashanti- Bogoso Feng-Shui
Copyright ©2003 Ian H. Giddy Financial Restructuring 2 Mt Cameroon Ecotours
Copyright ©2003 Ian H. Giddy Financial Restructuring 3 Mt Cameroon
Leveraged Finance
Copyright ©2003 Ian H. Giddy Financial Restructuring 5 Cost of the Deal lbocapacity.xls
Copyright ©2003 Ian H. Giddy Financial Restructuring 6 LBO Financing NEWCO Cost of purchasing the business Equity $25 Senior debt $457 What securities? What returns? What investors? Mezzanine
Copyright ©2003 Ian H. Giddy Financial Restructuring 7 Case Study: Cap des Biches (B) l The LBO Proposal l Devise a recommended financing plan GTI (owner) BuyersOther Investors
Copyright ©2003 Ian H. Giddy Financial Restructuring 8 Cap des Biches (B)
Corporate Financial Restructuring Prof. Ian GIDDY Stern School of Business New York University
Copyright ©2003 Ian H. Giddy Financial Restructuring 10 What is Corporate Restructuring? l Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. l Designed to increase the value of the firm Restructuring Improve capitalization Change ownership and control Improve debt composition
Copyright ©2003 Ian H. Giddy Financial Restructuring 11 It’s All About Value l How can corporate and financial restructuring create value? Operating Cash Flows Debt Equity AssetsLiabilities Fix the business Or fix the financing
Copyright ©2003 Ian H. Giddy Financial Restructuring 12 Restructuring 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 ©2003 Ian H. Giddy Financial Restructuring 13 Corporate Finance CORPORATE FINANCE DECISONS CORPORATE FINANCE DECISONS INVESTMENT RISK MGT FINANCING CAPITAL PORTFOLIO M&A DEBTEQUITY TOOLS MEASUREMENT
Copyright ©2003 Ian H. Giddy Financial Restructuring 14 Capital Structure: East vs West VALUE OFTHE FIRM DEBT RATIO Optimal debt ratio? IntelTPI
Copyright ©2003 Ian H. Giddy Financial Restructuring 15 Fixing the Capital Structure Too little debt l Managers like to control shareholders’ funds l Underestimate the cost of equity Produces l Less discipline l Excessive cost of capital l Takeover risk Too much debt l Close control of equity l Easy money l Underestimate business or financial risks Produces l Risk of financial distress l Excessive cost of capital l Destroy operating value l Takeover risk
Fixing the Capital Structure: Distress Restructuring
Copyright ©2003 Ian H. Giddy Financial Restructuring 17 The Three Excesses l Labor l Capacity l Debt
Copyright ©2003 Ian H. Giddy Financial Restructuring 18 TPI’s Refinancing l Asia’s biggest debtor l Almost $4 billion in foreign currency debt financing domestic revenues l Protracted rescheduling results in $360 million debt/equity swap l No change in management or effective control l Still needs $1.2 billion new equity
Copyright ©2003 Ian H. Giddy Financial Restructuring 19 Debt-Equity Swaps l Cosmetic or real? l Choices for company under siege Raise new equity to pay off creditors Example: Iridium Give creditors equity in place of debt Example: Sammi
Copyright ©2003 Ian H. Giddy Financial Restructuring 20 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 Change of control means restructuring n Financial engineering n Bottom line “rationalization” n Divestitures & outsourcing n Financial engineering n Bottom line “rationalization” n Divestitures & outsourcing
Copyright ©2003 Ian H. Giddy Financial Restructuring 21 What Are The Alternatives? l Key: Make the new securities attractive to: Existing lenders New lenders New bond investors New equity investors
Copyright ©2003 Ian H. Giddy Financial Restructuring 22 The Financing Spectrum Expected Return Risk Senior Debt n Returns independent of the value of the business n Control through covenants Senior Debt n Returns independent of the value of the business n Control through covenants Equity n Residual returns after contractual claims n Control through voting rights Equity n Residual returns after contractual claims n Control through voting rights
Copyright ©2003 Ian H. Giddy Financial Restructuring 23 The Financing Spectrum Expected Return Risk Senior secured debt Equity Senior unsecured debt Subordinated debt Preferred equity Convertible debt
Copyright ©2003 Ian H. Giddy Financial Restructuring 24 The Financing Spectrum Expected Return Risk Senior secured debt Equity Senior unsecured debt Subordinated debt Preferred equity Convertible debt Asian bank NPLs
Copyright ©2003 Ian H. Giddy Financial Restructuring 25 What Are The Alternatives? l Asset-backed or cash flow-backed debt l Senior debt l Subordinated debt l Subordinated debt with upside participation l Subordinated debt with equity option l Preferred equity l Restricted shares l Common stock
Copyright ©2003 Ian H. Giddy Financial Restructuring 26 Subordinated High Yield Debt l “Junk bonds” – like equity, but allow increased financial leverage l Tax advantage over equity l Big market in USA (institutional investors) and increasing in Europe l Leveraged loans favored by certain commercial banks l Often used in connection with M&A and LBOs l Behave like equity – and often have equity participation
Copyright ©2003 Ian H. Giddy Financial Restructuring 27 Sub Debt -- Motivations l Optimization of financial leverage l Regulatory-driven capital requirements l Rated asset securitizations (senior-sub structure in asset-backed securities) l Insider or supplier-credit subordination (eg in project finance) l Work-outs and restructurings (existing borrowers agree to seniority of new loans, to buy time)
Copyright ©2003 Ian H. Giddy Financial Restructuring 28 Sub Debt’s Big Problem: High Interest! Solutions l Deep discount subordinated debt l Subordinated debt with equity warrants l Convertible subordinated debt l Participating subordinated debt l Puttable subordinated debt
Copyright ©2003 Ian H. Giddy Financial Restructuring 29 Preferred Equity l Legally a form of equity l Claim senior to ordinary equity l May have fixed dividend, or may be “participating” l But cannot trigger liquidation if payment missed l Par value determines liquidation claim
Copyright ©2003 Ian H. Giddy Financial Restructuring 30 Convertible Preferred l Used by venture capital firms l Permit investors to participate in growth l But give preference in liquidation if the venture fails l And disguise share value (tax!) l A variant – PERCS* give issuer right to convert into common stock *Preferred equity redemption cumulative stock
Copyright ©2003 Ian H. Giddy Financial Restructuring 31 Preferred Stock: Pros and Cons Advantages l No dilution of control l Dividends conditional on availability of earnings l Omission cannot force liquidation Disadvantages l Higher after-tax cost than debt l Lower return on equity l Limited investor interest
Copyright ©2003 Ian H. Giddy Financial Restructuring 32 Restricted Stock: Pros and Cons Advantages l Overcome foreign control restrictions l Insiders retain control l If company well run, value of control may be low Disadvantages l Nonvoting stock trades at a discount l Dual-class recaps hurt stock price l May allow management to avoid needed reforms
Copyright ©2003 Ian H. Giddy Financial Restructuring 33 The New Equity Option l Key: Make the new equity attractive to: l Portfolio investors Domestic International Reduce agency costs or we’ll “Just say no!” l Strategic/direct investors Domestic International Cede control or we’ll go elsewhere
Copyright ©2003 Ian H. Giddy Financial Restructuring 34 The Difference l “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” l "When institutions started buying the story, they bought the convertible bonds, the sub debt - you name it, they bought it." l Alternatives: Thai Farmers Bank: SLIPS, Bankok Bank: CAPs
Copyright ©2003 Ian H. Giddy Financial Restructuring 35 Transparency and Disclosure l A 275-page prospectus, which provided a breadth and depth of information previously unseen in an Asian issue. l "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."
Copyright ©2003 Ian H. Giddy Financial Restructuring 36 Macro Factors Currency overvaluation Capital restrictions Structural Factors 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-level Factors What Globally Mobile Investors Look At
Fixing the Capital Structure: Distress Restructuring
Copyright ©2003 Ian H. Giddy Financial Restructuring 38 Cap des Biches (C) 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
Copyright ©2003 Ian H. Giddy Financial Restructuring 39 Financially Distressed Firms l Lose customers l Get less favorable terms from suppliers l Are forced to discount products l Reduce new investment to below the optimal level Example: Hynix (Korea) Source: Altman (1984), Opler and Titman (1994)
Copyright ©2003 Ian H. Giddy Financial Restructuring 40 When Default Threatens, Value the Company
Copyright ©2003 Ian H. Giddy Financial Restructuring 41 Zombie, Inc l Does it make sense to dissolve the company? l Is it better to sell the company? l How much debt can the company afford to have? l Assume you have been brought in as the new CEO-CFO team. What terms of restructuring can you propose to the banks?
Copyright ©2003 Ian H. Giddy Financial Restructuring 42 Debt Restructuring in Distress Can a debt restructuring create value? Operating Cash Flows Debt Equity AssetsLiabilities Banks give up some creditor rights in exchange for equity
Copyright ©2003 Ian H. Giddy Financial Restructuring 43 Example Earnings at Zombie Inc., have suffered in recent years. The private company now faces a financial crisis, as a result of its possible inability to repay a principal repayment on its debt coming due in the next quarter.
Copyright ©2003 Ian H. Giddy Financial Restructuring 44 Example The company faces a takeover, but management has made a restructuring proposal to its unsecured bank lenders, namely that they convert one half of Zombie's bank debt into equity at the current book value per share. Should the banks take the offer?
Copyright ©2003 Ian H. Giddy Financial Restructuring 45 Example of Valuation: Before-and-After
Copyright ©2003 Ian H. Giddy Financial Restructuring 46 Cap des Biches (C) l CDB, two years after the successful LBO, is having difficulty meeting its debt service obligations. The banks are putting pressure on management to make a restructuring proposal. Can Cap des Biches afford to pay its required interest and principal this year? Next year? What is the debt capacity of Cap des Biches Power Company? Please suggest a way in which the debt could be restructured to keep the banks satisfied and keep the company alive.
Fixing the Capital Structure: Making Use of Cash Flows
Copyright ©2003 Ian H. Giddy Financial Restructuring 48 Leveraged Finance n Share buyback? Company has unused debt capacity n Leveraged recapitalization? n Takeover?
Copyright ©2003 Ian H. Giddy Financial Restructuring 49 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 ©2003 Ian H. Giddy Financial Restructuring 50 Leveraged Recapitalizations l Motivations: Defensive Proactive Ownership transition/liquidity l Which produces what value?
Copyright ©2003 Ian H. Giddy Financial Restructuring 51 Cap des Biches (D) l CDB, after its debt restructuring, has achieved a turnaround. Net cash flows are now positive and steady, and the shareholders are looking for ways in which they can realize the benefits of their investments. l Should they pay a dividend, buy back shares, or sell the company? Group report due by Wednesday 11th June
Copyright ©2003 Ian H. Giddy Financial Restructuring 52 What is Corporate Restructuring? l Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. l Designed to increase the value of the firm Restructuring Improve capitalization Change ownership and control Improve debt composition
Copyright ©2003 Ian H. Giddy Financial Restructuring 53
Copyright ©2003 Ian H. Giddy Financial Restructuring 54 Contact Info Ian H. Giddy NYU Stern School of Business Tel ; Fax