1. Acquisition Finance Capital Structure Structuring The Deal
Joseph V. Rizzi
Amsterdam Institute of Finance
10-12 October, 2016
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2. Capital Structure Joseph V. Rizzi Amsterdam Institute of Finance
October, 2016

3. Approaches To Credit Analysis
Cash Flow
Impacts default risk
Balance Sheet
Determines Loss in Event of Default (LIED)
Liquidity
Valuation
Amsterdam Institute of Finance
October, 2016 3

4. Credit Analysis Business Risk: EBITDA Volatility
Industry Characteristics
Firm Characteristics
Financial Risk: EBITDA Relative to Debt
Structural Risk
Issues
Priority of claim on assets and income
Control
Focus
Covenants, Seniority, Security
Amsterdam Institute of Finance
October, 2016

5. Credit Screening – Subject to market availability
Quantitative
Capitalization ROT Pre Crisis Crisis
Cash Equity >25% <25% %+
Total Debt <6.0x >6% <5%
Senior Debt (1) <4.5x >5% <4%
First Lien <4.0x >4% <4%
Second Lien <0.5x >1% __
Cash Flow
LTM EBITDA / PFI >2:1
7 x LTM FFOCF / TLA(2) >1:1
Liquidity
Cash + MS + RCA / P+I (3) > 1.5 : 1
1:- TLA usually >20% of senior debt and amortizes at least 30% by year 5
2:- FFOCF = LTM EBITDA - (WCI + CAPEX + Taxes + PF Interest) :- Liquidity tested day 1. MS (Marketable Securities). RCA (Revolving Credit Availability). Revolver usually set at 1 x EBITDA
Amsterdam Institute of Finance
October, 2016

6. Debt Capacity Considerations
Debt capacity is derived from firm’s assets
Operating Cash Flows
Asset Sales / Asset Quality
Leveragability
Market Conditions
Target financing structure
2H07Crisis
Normal
Credit curve shifts over time
dependent on the economy
Rates
Overheated 1H07
Rating
Amsterdam Institute of Finance
October, 2016

7. Capitalization Alternatives
There are two different approaches to designing the capital structure:
Cash Flow
Model
Balance Sheet
Model
3 - 5x
EBITDA
50%
5 - 6x
EBITDA
30%
Senior Debt
Sub Debt
Equity
Equity
20%
Amsterdam Institute of Finance
October, 2016

8. Approaches to Determining Debt Capacity
Ratio Approach
Cash Flow
Advance Rate
Amsterdam Institute of Finance
October, 2016

9. Ratio Approach Market Maximum senior debt and total debt ratios
Vary over cycle
Peers
Identify
Rating Classification
Key Ratios
Rating Agencies
Credit Statistics
Amsterdam Institute of Finance
October, 2016

10. Rating Agencies - Ratings as keys opening market doors Syndication CLO
Important: Loan Market Evolution from a bank to an institutional market
(back to a bank market?)
Impact: Majority of syndicated loans are rated
Pricing: Affected by rating
Market Access Amount: Impacted by rating
Amsterdam Institute of Finance
October, 2016

11. S&P Rating Comparison (Sample/Industrial)
Presentation for AIF - October 2006
S&P Rating Comparison (Sample/Industrial)
750
Amsterdam Institute of Finance
October, 2016

12. Cash Flow Maximum debt capacity formula:-
MDC = f(operations, amortization, rate, asset sales)
MDC = [EBIT / (i+ 1/n)]
EBIT - Earnings Before Interest and Taxes
i - Interest Rate
n - Straight line loan amortization
Amsterdam Institute of Finance
October, 2016

13. Financial Analysis Opening Balance Sheet
Adjustments – from sources and uses (see next page) – including purchase price assumptions
Proforma balance Sheet
Income Statement
Cash Flow Statement
Capitalization table/transaction structure
Debt Schedule
Term sheet(s)
Valuation/maximum purchase price
Returns Analysis – IRR and MOC
Amsterdam Institute of Finance
October, 2016

14. Sources and Uses Sources Uses Excess Cash Debt assumed by the buyer
Minority interest assumed
Revolver
Term Loan A
Term Loan B
Senior notes
Mezzanine preferred stock
Subordinated (high-yield) notes
Mezzanine debt
Seller notes
Preferred stock
Common equity (sponsor’s investment)
Management equity roll-over
Investor roll-over
Equity Purchase
Fund target’s cash balance
Assumed (roll over) debt
Refinance short-term debt
Refinance long-term debt
Assume (roll over) minority interest
Purchase (buy out) minority interest
Transaction fees and expenses
Financing fees
Amsterdam Institute of Finance October, 2016

15. Credibility of Cash Flow Projections
Issues
Adjustments (beware of solving for cash flows to justify price)
Normalization
Cyclicality
Bad Management
Value Test
Projections implied price
Reverse Engineer - Management implied forecast
Firms
Peers
Tie Into
Compensation
Covenants
Amsterdam Institute of Finance
October, 2016

16. Capital Structure Tradeoffs Mispricing Issue Operationalize
Amount
Cost
Flexibility
Control
Dilution
Mispricing Issue
Operationalize
Ratings Target
Comparative Credit Analysis
Cash Flow Testing
Market Conditions
Amsterdam Institute of Finance October, 2016

17. In Practice (A) Target Rating BB
Macro/Market Level
Determine rating target
Use target rating level financial characteristics
Funded Debt/EBITDA
EBITDA/Interest Expense
Funded Debt/Total Cap
Example:
(A) Target Rating BB
(B) EBITDA/Int for Target Rating c3.0x
(C) Firm EBITDA $300mln
(D) Interest Rate for Target Rating 10%
(E) Maximum Debt Capacity = (C/B)/D
= (300/3)/10%
= $1,000
Amsterdam Institute of Finance
October, 2016

18. Euro Defaults and Restructuring (Number)
Year 1H
Amsterdam Institute of Finance October, 2016

19. New Issue Spreads and Credit Statistics: Europe & U.S. – 1H16
BB/BB- Europe U.S. Pro Rata Spread E L Weighted Avg Institutional Spread E L Deal Size (€MM) 1, , Pro Rata Term (in Years) Institutional Term (in Years) Revenues (€MM) 1, EBITDA (€MM) 395 1,257 Pro Forma Debt/EBITDA Pro Forma Senior Debt/EBITDA Pro Forma Cash Interest Coverage Observations 5 26 B+/B Pro Rata Spread E L Weighted Avg Institutional Spread E L Deal Size (€MM) , Pro Rata Term (in Years) Institutional Term (in Years) Revenues (€MM) 961 1,434 EBITDA (€MM) Pro Forma Debt/EBITDA Pro Forma Senior Debt/EBITDA Pro Forma Cash Interest Coverage Observations Source: S&P Global
Amsterdam Institute of Finance
October, 2016

20. Impact of Debt Capacity on Purchase Price Multiples
Amsterdam Institute of Finance
October, 2016

21. Sponsors Borrow Cheap and Buy High
Leverage and Pricing in Buyouts dependent on credit market conditions
Opportunistic
Pro Cyclical
Overpay when credit access is easy leading to lower buyout returns dependent on fund vintage
Amount
Pricing
Investor risk appetite determines credit market conditions
Capital structure decisions differ for corporates and sponsors
Link between organizational form and financial policies
Agency problems between PE general partners and limited partner investors may be an issue
Amsterdam Institute of Finance October, 2016

22. Purchase Price Multiples
Strategic Buyers Pricing Primarily a function of synergies
Financial Buyers Pricing Primarily a function of Debt Capacity
(FD/EBITDA)*EBITDA + Equity + Asset Sales
Developing the Funded Debt Multiple: Market Driven
Maximum Debt Capacity = [EBITDA/(I +1/n)] + Asset Sales
Multiple = 1/(i + 1/n) as rates go up debt capacity declines
Increasing Debt Capacity:
i = by decreasing interest expense (rates + spread)
1/n = by lengthening duration maturities through changes to
the structure (bridges, hybrids, etc.)
Developing the Funded Debt Multiple: Market Driven
Maximum Debt Capacity = [EBITDA/(i+1/n)]
Multiple = 1/(i + 1/n) as rates go up debt capacity declines
Increasing Debt Capacity:
i = by decreasing interest expense (rates + spread)
1/n = by lengthening duration maturities through changes to
the structure (bridges, hybrids, etc.)
Amsterdam Institute of Finance
October, 2016

23. Purchase Price Matrix 10% 15% 20% 25% 30% 35% 40% 3.0x 333 353 375 400
Assuming an acquisition where the Target’s EBITDA is $100 min, the maximum Purchase price that could be paid given the sponsor’s desired level of equity injection and the amount of leverage that the market will bear. Equity Contribution
10%
15%
20%
25%
30%
35%
40%
3.0x
333
353
375
400
429
462
500
3.5x
389
412
438
467
538
583
4.0x
444
471
533
571
615
667
4.5x
529
563
600
643
692
750
5.0x
556
588
625
714
769
833
5.5x
611
647
688
733
786
846
917
6.0x
706
800
857
923
1,000
6.5x
722
765
813
867
929
1,083
7.0x
778
824
875
933
1,077
1,167
7.5x
882
938
1,071
1,154
1,250
Leverage Multiple
Amsterdam Institute of Finance
October, 2016

24. Purchase Price Matrix 10% 15% 20% 25% 30% 35% 40% 3.0x 333 353 375 400
As can be seen below, when the leverage multiple decreases, the required equity contribution can increase significantly. Depending the buyers internal rate of return requirements, this may or may not cause them to abort the transaction. Equity Contribution
10%
15%
20%
25%
30%
35%
40%
3.0x
333
353
375
400
429
462
500
3.5x
389
412
438
467
538
583
4.0x
444
471
533
571
615
667
4.5x
529
563
600
643
692
750
5.0x
556
588
625
714
769
833
5.5x
611
647
688
733
786
846
917
6.0x
706
800
857
923
1,000
6.5x
722
765
813
867
929
1,083
7.0x
778
824
875
933
1,077
1,167
7.5x
882
938
1,071
1,154
1,250
Leverage Multiple
750
750
Amsterdam Institute of Finance
October, 2016

25. Purchase Price Multiple
Financing Gap
The shaded area of the chart below reflects the financing gap that develops when leverage multiples do not keep up with increasing purchase price multiples. As we will see later, some innovative securities have been developed in order to close the financing gap. Debt Multiple D
2.00
2.50
3.00
3.50
4.00
4.50
5.00
160
110 60 10
(40)
(90)
(140)
200
150
100 50 -
(50)
(100)
5.50
240
190
140 90 40
(10)
(60)
6.00
280
230
180
130 80 30
(20)
6.50
320
270
220
170
120 70 20
7.00
360
310
260
210
7.50
400
350
300
250
8.00
440
390
340
290
8.50
480
430
380
330
9.00
520
470
420
370
Purchase Price Multiple
Amsterdam Institute of Finance
October, 2016