prof. ian giddy new york university corporate financial restructuring more to come
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Prof. Ian GiddyNew York University
Corporate FinancialRestructuring
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
Management acts to preserve or enhance shareholder value
Management acts to protect company, stakeholders and management from change in control
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
Corporate restructuring – business and financial
Structured financing techniques Proactive restructuring Distress-induced restructuring Mergers, divestitures and LBOs
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 4
A Simple Framework
A company is a “nexus of contracts” with shareholders, creditors, managers, employees, suppliers, etc
Restructuring is the process by which these contracts are changed – to increase the value of all claims.
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
SAP – upgrading shareholder control rights
Sealed Air – exploiting free cash flow Marvel – post-bankruptcy negotiations Westpac – structured finance Novartis – merged and divested Alphatec – rescuing residual value
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 7
Novartis: Financial Restructuring
Fixed
Assets
Debt
Equity
Assets LiabilitiesFixed the cash
and working capital
Fixed the capital
structureCash
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 – 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
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 9
Valuation is a Key to Unlock Value
Value with and without restructuring Consider means and obstacles Who gets what? Minimum is liquidation value
Valuation
Going Concern LiquidationAfter Restructuring
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 10
Getting the Financing RightStep 1: The Proportion of Equity & Debt
Debt
Equity
Achieve lowest weighted average cost of capital
May also affect the business side
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 11
Getting the Financing RightStep 2: The Kind of Equity & Debt
Debt
Equity
Short term? Long term? Baht? Dollar? Yen?
Short term? Long term? Baht? Dollar? Yen?
Bonds? Asset-backed? Convertibles? Hybrids?
Bonds? Asset-backed? Convertibles? Hybrids?
Debt/Equity Swaps? Private? Public? Strategic partner? Domestic? ADRs?
Debt/Equity Swaps? Private? Public? Strategic partner? Domestic? ADRs?
Ownership & control? Ownership & control?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 12
Capital Structure: Optimal Range?
VALUE OFTHE
FIRM
DEBT
RATIO
Optimal debt ratio?
Nestle Loewen
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
Corporate bond spreads: basis points over Treasury curveRating 1 year 2 year 5 year 10 year 30 year Typical Int Coverage RatiosAaa/AAA 40 45 60 85 96 >8.50Aa1/AA+ 45 55 70 95 106 6.50-8.50Aa2/AA 55 60 75 105 116 6.50-8.50Aa3/AA- 60 65 85 117 136 6.50-8.50A1/A+ 70 80 105 142 159 5.50-6.50A2/A 80 90 120 157 179 4.25-5.50A3/A- 90 100 130 176 196 3.00-4.25Baa1/BBB+ 105 115 145 186 208 2.50-3.00Baa2/BBB 120 130 160 201 221 2.50-3.00Baa3/BBB- 140 145 172 210 232 2.50-3.00Ba1/BB+ 225 250 300 350 440 2.00-2.50Ba2/BB 250 275 325 385 540 2.00-2.50Ba3/BB- 300 350 425 460 665 2.00-2.50B1/B+ 375 400 500 610 765 1.75-2.00B2/B 450 500 625 710 890 1.50-1.75B3/B- 500 550 750 975 1075 1.25-1.50Caa/CCC 600 650 900 1150 1300 0.80-1.25
Corporate bond spreads: basis points over Treasury curveRating 1 year 2 year 5 year 10 year 30 year Typical Int Coverage RatiosAaa/AAA 40 45 60 85 96 >8.50Aa1/AA+ 45 55 70 95 106 6.50-8.50Aa2/AA 55 60 75 105 116 6.50-8.50Aa3/AA- 60 65 85 117 136 6.50-8.50A1/A+ 70 80 105 142 159 5.50-6.50A2/A 80 90 120 157 179 4.25-5.50A3/A- 90 100 130 176 196 3.00-4.25Baa1/BBB+ 105 115 145 186 208 2.50-3.00Baa2/BBB 120 130 160 201 221 2.50-3.00Baa3/BBB- 140 145 172 210 232 2.50-3.00Ba1/BB+ 225 250 300 350 440 2.00-2.50Ba2/BB 250 275 325 385 540 2.00-2.50Ba3/BB- 300 350 425 460 665 2.00-2.50B1/B+ 375 400 500 610 765 1.75-2.00B2/B 450 500 625 710 890 1.50-1.75B3/B- 500 550 750 975 1075 1.25-1.50Caa/CCC 600 650 900 1150 1300 0.80-1.25
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 15
Interest Coverage Ratios, Spreads and Ratings: Small Firms
If interest coverage ratio isgreater than ≤ to Rating is Spread is
-100000 0.499999 D 14.00%0.5 0.799999 C 12.70%0.8 1.249999 CC 11.50%1.25 1.499999 CCC 10.00%1.5 1.999999 B- 8.00%2 2.499999 B 6.50%
2.5 2.999999 B+ 4.75%3 3.499999 BB 3.50%
3.5 4.499999 BBB 2.25%4.5 5.999999 A- 2.00%6 7.499999 A 1.80%
7.5 9.499999 A+ 1.50%9.5 12.499999 AA 1.00%12.5 100000 AAA 0.75%
Example:EBIT 10000Interest expense 2500LT Govt bond rate 6.00%
Interest coverage ratio = 4Estimated Bond Rating = BBBEstimated Default Spread = 2.25%Estimated Cost of Debt = 8.25%
Example:EBIT 10000Interest expense 2500LT Govt bond rate 6.00%
Interest coverage ratio = 4Estimated Bond Rating = BBBEstimated Default Spread = 2.25%Estimated Cost of Debt = 8.25%
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 16
Optimal Debt Ratio for a Private Company: Example
Debt RatioBetaCost of EquityBond RatingInterest RateAT Cost of DebtCost of CapitalFirm Value0% 1.03 12.65% AA 7.50% 4.35% 12.65% $26,78110% 1.09 13.01% AA 7.50% 4.35% 12.15% $29,11220% 1.18 13.47% BBB 8.50% 4.93% 11.76% $31,18230% 1.28 14.05% B+ 9.50% 5.51% 11.49% $32,80340% 1.42 14.83% B- 11.25% 6.53% 11.51% $32,67950% 1.62 15.93% CC 13.00% 7.54% 11.73% $31,34160% 1.97 17.84% CC 13.00% 7.96% 11.91% $30,33370% 2.71 21.91% C 14.50% 10.18% 13.70% $22,89180% 4.07 29.36% C 14.50% 10.72% 14.45% $20,70390% 8.13 51.72% C 14.50% 11.14% 15.20% $18,872
Debt RatioBetaCost of EquityBond RatingInterest RateAT Cost of DebtCost of CapitalFirm Value0% 1.03 12.65% AA 7.50% 4.35% 12.65% $26,78110% 1.09 13.01% AA 7.50% 4.35% 12.15% $29,11220% 1.18 13.47% BBB 8.50% 4.93% 11.76% $31,18230% 1.28 14.05% B+ 9.50% 5.51% 11.49% $32,80340% 1.42 14.83% B- 11.25% 6.53% 11.51% $32,67950% 1.62 15.93% CC 13.00% 7.54% 11.73% $31,34160% 1.97 17.84% CC 13.00% 7.96% 11.91% $30,33370% 2.71 21.91% C 14.50% 10.18% 13.70% $22,89180% 4.07 29.36% C 14.50% 10.72% 14.45% $20,70390% 8.13 51.72% C 14.50% 11.14% 15.20% $18,872
Damodaran’s spreadsheets:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 17
TDI Financial History
TDI
0
20
40
60
80
100
120
140
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
$ m
illi
on
s
Debt
EBITDA
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:
Effect of the LBO on capital structure? How did LBO lenders protect their interests? Alternative restructuring plans? Post Dec 89 operational, portfolio and
financial restructuring proposals? 1992-93 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: Evaluate the alternatives available to take
best advantage of TDI’s free cash flow:Leveraged buyoutLeveraged ESOPLeveraged recapitalization
Or: Invest cash or debt in growth opportunities
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 recapIPOSale to financial buyerSale to strategic buyer
Which when?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 21
Leveraged Recapitalization
Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares)
Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity
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
Motivations:DefensiveProactiveOwnership transition/liquidity
Which produces what value?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 23
Exchange Offers
Give one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm.
Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock,
Or vice-versa Motivations?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 24
Exchange Offers-- Effect Depends On:
Leverage increasing or decreasing Implied increases or decreases in future
operating cash flows Implied undervaluation or overvaluation of
common stock Increase or decrease in management share
ownership Increase or decrease in management control
over cash usage 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 GuaranteeProvider
(if required)
Servicing Agreement
Proceeds
Sale of Assets
Proceeds
Asset-BackedSecurities
GuaranteeAgreement
Rating Agency
Top Rating
TrusteeTrust
Agreement
Finance Co.’sCustomers
Hire-PurchaseAgreement
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 GuaranteeProvider
(if required)GuaranteeAgreement
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 28
The Alternative: Synthetic ABS
DB (Originator)
SPECIALPURPOSEVEHICLE
REFERENCE
POOL OF LOANS
(Stay on
balance sheet)
ISSUESASSET-BACKEDCERTIFICATES
CREDIT SWAPAGREEMENT
TOP QUALITYINVESTMENTS
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
Management acts to preserve or enhance shareholder value
Management acts to protect company, stakeholders and management from change in control
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 Out-of-court negotiated settlement
Firm continues Exchange: equity for debt Extension: pay later Composition: creditors agree to take less
Firm ceases to exist: assignee liquidates assets and distibutes proceeds on a pro-rate basis
Merger into another firm (which assumes or pays off debt) Continues as subsidiary Absorbed into other operations
Formal legal proceedings Firm continues: Ch 11, court supervises composition or modification of
claims Firm ceases to exist
Statutory assignment: assignee liquidates assets under formal legal procedures Ch 7 liquidation: bankruptcy court supervises liquidation
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 32
When Default Threatens, Value the Company
S a le to S tra te g ic B u yer A u c tion
M e rg ed V a lue
E x is tin g M an a g em e nt N e w M a n a ge m e nt
V o lu n ta ry R eo rg a n iza tion C h 1 1 R e org a n iza tion
G o in g C o nce rn V a lue
V o lu n ta ry L iq u id a tion C h 7
L iq u id a tio n V a lue
H ig h e s t V a lu a tion o f C om p a n y?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 33
Zombie Inc Valuation
Share ValuationBefore After
Shares 400,000 850,000Book Value 10.00$ 10.00$ Acquisition Value 8.00$ Management Est. 20.00$ 9.41$ NPV, based on
EBITDA 1,000,000 1,000,000WACC 17.43% 10.68%Growth 2% 2%
Debt 10,100,000 5,600,000 (8.72)$ 7.23$
Debt at 65% 0.11$ Option value?
Bank lenders Before AfterDebt (at market) 5,850,000 3,600,000 Equity (NPV value) 0 3,254,631Total 5,850,000 6,854,631
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 37
Contact Info
Ian H. Giddy
NYU Stern School of Business
Tel 212-998-0426; Fax 212-995-4233
http://giddy.org