1. IBM

3. Prof. Ian Giddy New York University Corporate Financial Restructuring IBM

4. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 4 Restructuring l Restructuring: 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

5. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 5 Restructuring

6. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 6 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)

7. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 7 “Nexus of Contracts” Shareholders Senior lenders Subordinated lenders Franchisors Salespeople Management

8. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 8 A restructuring course on giddy.org

9. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 9 Why and How l Why restructure?  What is the fundamental problem to be solved? l How restructure?  Create or preserve value, and negotiate how the gains are distributed l When restructure?  Pre-emptive, or under duress? l Implementing restructuring

10. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 10 Restructuring at Tower n Portfolio? n Financial? n Organizational? n Or what?

11. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 11 Why Restructure? Some Reasons l Address poor performance l Exploit strategic opportunities l Correct valuation errors

12. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 12 How Restructure? l Fix the business l Fix the financing l Fix the ownership/control l Create or preserve value l Negotiate distribution of the value

13. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 13 How Restructure? Some Obstacles l There are market imperfections or institutional rigidities that make it difficult for the firm to recontract l These include:  Transaction costs  Taxes  Agency costs  Information asymmetries l Example: The restructuring of UAL

14. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 14 TDI in Trouble

15. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 15 When The Creditors are Prowling Time for a Tiger 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

16. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 16 Average Impact of Restructuring on Company Performance Source: Bowman et al, “When Does Restructuring Improve Economic Performance?”

17. Novartis

18. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 18 Operating Restructuring The increase in value that comes from the operating side: l Better operating margins (usually economies of scale ie lower costs) or l Future increased sales/profits from higher growth

19. Novartis

20. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 20 Value-Based Management Sales Operating margin Notional taxes Net Working capital Net Fixed Capital Goodwill NOPAT* Invested Capital Cost of Capital Economic Profit Source: Ciba Specialty Chemicals *Net Operating Profit After Tax

22. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 22 Novartis: Financial Restructuring Fixed Assets Debt Equity AssetsLiabilities Fixed the cash and working capital Fixed the capital structure Cash

23. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 23 Financial Restructuring The increase in value that comes from a purely financial effect: l Lower taxes l Higher debt capacity l Better use of idle cash

24. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 24 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

25. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 25 Dear Michael, February 11, 2004 Mr. Michael D. Eisner The Walt Disney Company 500 South Buena Vista Street Burbank, California 91521 Dear Michael: I am writing following our conversation earlier this week in which I proposed that we enter into discussions to merge Disney and Comcast to create a premier entertainment and communications company. It is unfortunate that you are not willing to do so. Given this, the only way for us to proceed is to make a public proposal directly to you and your Board. We have a wonderful opportunity to create a company that combines distribution and content in a way that is far stronger and more valuable than either Disney or Comcast can be standing alone. To this end, we are proposing a tax-free stock for stock merger in which Comcast would issue 0.78 of a share of its Class A voting common stock for each share of Disney. This represents a premium of over $5 billion for your shareholders, based on yesterday's closing prices. Under our proposal, your shareholders would own approximately 42% of the combined company. The combined company would be uniquely positioned to take advantage of an extraordinary collection of assets. Together, we would unite the country's premier cable provider with Disney's leading filmed entertainment, media networks and theme park properties. ….. Estimates: Forbes, Dec 2002 Estimates: CNN, Jan 2003

26. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 26 Capital Structure: Too Little or Too Much? VALUE OFTHE FIRM DEBT RATIO Optimal debt ratio? NokiaAhold

27. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 27 See Saw Business Uncertainty Financial Risk Operating Leverage Financial Leverage

28. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 28 Debt Restructuring Analysis

29. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 29 Restructuring at TDI

30. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 30 “Nexus of Contracts” Shareholders Senior lenders Subordinated lenders Franchisors Salespeople Management

31. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 31 TDI Financial History

32. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 32 Restructuring Debt and Equity l TDI (sequence of operational and financial restructuring efforts)  Restructuring under threat of financial distress  Restructuring to exploit free cash flows  Exit options

33. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 33 TDI Financial History Leveraged Buyout New Management

34. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 34 Restructuring Debt and Equity at TDI Evaluate the financial restructuring that took place at TDI: l Effect of an LBO on capital structure? l How would LBO lenders protect their interests? l With too much debt, what possible restructuring plans?

35. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 35 Restructuring, Phase 1 Source: debtcapacity.xls

36. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 36 Interest Coverage, Ratings, and Cost

37. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 37 What Possible Restructuring? l Extend debt maturity (principal and/or interest) l Reduce interest l Swap debt into equity l Raise new funding l Sell assets

38. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 38 TDI Financial History Banks are getting really annoyed

39. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 39 Restructuring, Phase 2 Source: debtcapacity.xls

40. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 40 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

41. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 41 TDI Financial History

42. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 42 Restructuring, Phase 3 Source: debtcapacity.xls

43. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 43 Time for an IPO?

44. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 44 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

45. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 45 Applying the Checklist

46. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 46 Prof. Ian Giddy New York University Applied Corporate Finance IBM

47. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 47 Risk and Return  A positive relationship exists between risk and nominal or expected return  The actual return earned on a security will affect the subsequent actions of investors  Investors must be compensated for accepting greater risk with the expectation of greater return Return Risk Risker Investments Have to Offer Higher Returns

48. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 48 Equity versus Bond Risk Uncertain value of future cash flows Uncertain value of future cash flows Contractual int. & principal No upside Senior claims Control via restrictions Contractual int. & principal No upside Senior claims Control via restrictions AssetsLiabilities Debt Residual payments Upside and downside Residual claims Voting control rights Residual payments Upside and downside Residual claims Voting control rights Equity

49. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 49 The Minimum-Variance Frontier of Risky Assets “Efficient frontier” Individual assets Global minimum- variance portfolio E(r)

50. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 50 The Cost of Capital ChoiceCost 1. EquityCost of equity - Retained earnings- depends upon riskiness of the stock - New stock issues- will be affected by level of interest rates - Warrants Cost of equity = riskless rate + beta * risk premium 2. DebtCost of debt - Bank borrowing- depends upon default risk of the firm - Bond issues- will be affected by level of interest rates - provides a tax advantage because interest is tax-deductible Cost of debt = Borrowing rate (1 - tax rate) Debt + equity = Cost of capital = Weighted average of cost of equity and Capitalcost of debt; weights based upon market value. Cost of capital = k d [D/(D+E)] + k e [E/(D+E)]

51. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 51 Pfizer’s WACC l We do not recommend any specific changes to Pfizer's D/E ratio. l We observe that management could safely increase the D/E ratio (slightly decreasing the WACC) if worthy projects were identified. l Should management choose to increase the D/E ratio, the bond rating would not be lowered until the D/E ratio hits approximately 30%. (See Excel spreadsheet for details.)

52. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 52 Investment Decisions: Would You Buy One of These?

53. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 53 Forestry Application Outlay $2321

54. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 54 Forestry Application giddy.org/ibmfinance/forestry.xls

55. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 55

56. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 56 Nokia’s Risk Management Net foreign transaction exposure (non-EUR currencies) : n USD15% n GBP30% n AUD 7% n JPY26% n SEK 5% n Others17% Conclusion : Nokia’s distribution of sales and production/personnel is well balanced throughout the 10 major markets, with the exception of Japan. However, the risk due to the Japanese Yen is reduced by the fact that purchases in Yen exceed sales in Yen. Japanese companies are a major source for parts. In 2003, Nokia used the following financial instruments and notional amounts to hedge the financial risks due to currency exchange rates, interest rates and investment activities (USDm) : Derivative financial instrument notional amount, 2003 n Foreign exchange forward contracts12’623 n Currency options bought3’594 n Currency options sold3’045 n Interest rate swaps1’844 n Cash settled equity options 280

57. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 57 The Gains From an Acquisition Gains from merger SynergiesControl Top lineFinancial restructuring Business Restructuring (M&A) Bottom line

58. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 58 What’s the Company Worth?

59. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 59 The Decisions That Affect Value Restructuring Macro Factors Life Cycle Company Dynamics Enhance Company Value Economy Industry Strategic Choices Financial Choices Business Issues Financial Issues Volatility of Cash Flows Financial Leverage Business M&A Divestitures Restructuring Financial Debt Equity Risk Management Operating Leverage Decision Makers

62. Copyright ©2004 Ian H. Giddy Corporate Financial Restructuring 62 Contact Info Prof. Ian H. Giddy NYU Stern School of Business Tel 212-998-0563; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org