Cap des Biches

1. Friday: Financial Restructuring Cap des Biches Ashanti-Bogoso Feng-Shui

2. Mt CameroonEcotours

3. Mt Cameroon

4. Leveraged Finance

5. Cost of the Deal lbocapacity.xls

6. LBO Financing NEWCO Cost of purchasing the business Senior debt $457 What securities? What returns? What investors? Mezzanine Equity $25

7. Case Study: Cap des Biches (B) • The LBO Proposal • Devise a recommended financing plan GTI (owner) Buyers Other Investors

8. Cap des Biches (B) www.stern.nyu.edu/~igiddy/dakar

9. CorporateFinancial Restructuring Prof. Ian GIDDY Stern School of Business New York University

10. Restructuring Improve capitalization Improve debt composition Change ownership and control What is Corporate Restructuring? • Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. • Designed to increase the value of the firm

11. It’s All About Value • How can corporate and financial restructuring create value? Assets Liabilities Operating Cash Flows Debt Or fix the financing Fix the business Equity

12. Restructuring

13. Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING RISK MGT PORTFOLIO MEASUREMENT CAPITAL DEBT EQUITY TOOLS M&A

14. Capital Structure: East vs West Intel TPI Optimal debt ratio? VALUE OFTHE FIRM DEBT RATIO

15. Too little debt Managers like to control shareholders’ funds Underestimate the cost of equity Produces Less discipline Excessive cost of capital Takeover risk Too much debt Close control of equity Easy money Underestimate business or financial risks Produces Risk of financial distress Excessive cost of capital Destroy operating value Takeover risk Fixing the Capital Structure

16. Fixing the Capital Structure:Distress Restructuring

17. The Three Excesses • Labor • Capacity • Debt

18. TPI’s Refinancing • Asia’s biggest debtor • Almost $4 billion in foreign currency debt financing domestic revenues • Protracted rescheduling results in $360 million debt/equity swap • No change in management or effective control • Still needs $1.2 billion new equity

19. Debt-Equity Swaps • Cosmetic or real? • Choices for company under siege • Raise new equity to pay off creditors Example: Iridium • Give creditors equity in place of debt Example: Sammi

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 • Financial engineering • Bottom line “rationalization” • Divestitures & outsourcing

21. What Are The Alternatives? • Key: Make the new securities attractive to: • Existing lenders • New lenders • New bond investors • New equity investors

22. The Financing Spectrum • Equity • Residual returns after contractual claims • Control through voting rights Expected Return • Senior Debt • Returns independent of the value of the business • Control through covenants Risk

23. The Financing Spectrum Equity Preferred equity Convertible debt Expected Return Subordinated debt Senior unsecured debt Senior secured debt Risk

24. The Financing Spectrum Equity Preferred equity Convertible debt Expected Return Subordinated debt Senior unsecured debt Asian bank NPLs Senior secured debt Risk

25. What Are The Alternatives? • Asset-backed or cash flow-backed debt • Senior debt • Subordinated debt • Subordinated debt with upside participation • Subordinated debt with equity option • Preferred equity • Restricted shares • Common stock

26. Subordinated High Yield Debt • “Junk bonds” – like equity, but allow increased financial leverage • Tax advantage over equity • Big market in USA (institutional investors) and increasing in Europe • Leveraged loans favored by certain commercial banks • Often used in connection with M&A and LBOs • Behave like equity – and often have equity participation

27. Sub Debt -- Motivations • Optimization of financial leverage • Regulatory-driven capital requirements • Rated asset securitizations (senior-sub structure in asset-backed securities) • Insider or supplier-credit subordination (eg in project finance) • Work-outs and restructurings (existing borrowers agree to seniority of new loans, to buy time)

28. Sub Debt’s Big Problem: High Interest! Solutions • Deep discount subordinated debt • Subordinated debt with equity warrants • Convertible subordinated debt • Participating subordinated debt • Puttable subordinated debt

29. Preferred Equity • Legally a form of equity • Claim senior to ordinary equity • May have fixed dividend, or may be “participating” • But cannot trigger liquidation if payment missed • Par value determines liquidation claim

30. Convertible Preferred • Used by venture capital firms • Permit investors to participate in growth • But give preference in liquidation if the venture fails • And disguise share value (tax!) • A variant – PERCS* give issuer right to convert into common stock *Preferred equity redemption cumulative stock

31. Advantages No dilution of control Dividends conditional on availability of earnings Omission cannot force liquidation Disadvantages Higher after-tax cost than debt Lower return on equity Limited investor interest Preferred Stock: Pros and Cons

32. Advantages Overcome foreign control restrictions Insiders retain control If company well run, value of control may be low Disadvantages Nonvoting stock trades at a discount Dual-class recaps hurt stock price May allow management to avoid needed reforms Restricted Stock: Pros and Cons

33. The New Equity Option • Key: Make the new equity attractive to: • Portfolio investors • Domestic • International • Reduce agency costs or we’ll “Just say no!” • Strategic/direct investors • Domestic • International • Cede control or we’ll go elsewhere

34. The Difference • “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” • "When institutions started buying the story, they bought the convertible bonds, the sub debt - you name it, they bought it." • Alternatives: Thai Farmers Bank: SLIPS, Bankok Bank: CAPs

35. Transparency and Disclosure • A 275-page prospectus, which provided a breadth and depth of information previously unseen in an Asian issue. • "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."

36. What Globally Mobile Investors Look At Macro Factors • Currency overvaluation • Capital restrictions • Acctg & disclosure requirements • IAS compliance • Bankruptcy regime • Creditor rights • Govt-corporate nexus • Trading infrastructure Structural Factors • Price-Value ratio, Sharpe ratio, EVA • D/E ratio • Currency & maturity mismatch • IAS conformity • Insider control • Objective research coverage • Trading liquidity Firm-level Factors

37. Fixing the Capital Structure:Distress Restructuring

38. Cap des Biches (C)The Creditors are Prowling Trouble! The financing is bad Business mix is bad The company is bad Reason Raise equity or Change debt mix Sell some businesses or assets to pay down debt Change control or management through M&A Remedy

39. Financially Distressed Firms • Lose customers • Get less favorable terms from suppliers • Are forced to discount products • Reduce new investment to below the optimal level Example: Hynix (Korea) Source: Altman (1984), Opler and Titman (1994)

40. When Default Threatens, Value the Company

41. Zombie, Inc • Does it make sense to dissolve the company? • Is it better to sell the company? • How much debt can the company afford to have? • Assume you have been brought in as the new CEO-CFO team. What terms of restructuring can you propose to the banks?

42. Debt Restructuring in Distress Can a debt restructuring create value? Banks give up some creditor rights in exchange for equity Assets Liabilities Operating Cash Flows Debt Equity

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.

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?

45. Example of Valuation:Before-and-After

46. Cap des Biches (C) • 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.

47. Fixing the Capital Structure:Making Use of Cash Flows

48. Leveraged Finance • Takeover? Company has unused debt capacity • Share buyback? • Leveraged recapitalization?

49. 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.

50. Leveraged Recapitalizations • Motivations: • Defensive • Proactive • Ownership transition/liquidity • Which produces what value?