Joseph V. Rizzi Amsterdam Institute of Finance October, 2014.

Joseph V. Rizzi Amsterdam Institute of Finance October, 2014

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• Cash Flow

Impacts default risk

• Balance Sheet

Determines Loss in Event of Default (LIED)

Liquidity

Valuation

Amsterdam Institute of Finance October, 2014

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• 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


4

• Quantitative◦ Capitalization ROT Pre Crisis Crisis

Cash Equity >25% <25% 40%+ 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)

3:- Liquidity tested day 1. MS (Marketable Securities). RCA (Revolving Credit Availability). Revolver usually set at 1 x EBITDA


5

• Debt capacity is derived from firm’s assets◦ Operating Cash Flows◦ Asset Sales / Asset Quality◦ Leveragability

• Market Conditions

• Target financing structure

Credit curve shifts over timedependent on the economy, e.g.,

CCC Spreads2007 5002009 3,300

Current 750

Rating

Rate

s

2H07Crisis

Overheated 1H07


6

There are two different approaches to designing the capital structure:

20%

30%

50%

Cash FlowCash Flow ModelModel

Balance SheetBalance Sheet ModelModel

Senior Debt

Sub Debt

Equity

3 - 5xEBITDA

5 - 6xEBITDA

Equity


7

• Ratio Approach

• Cash Flow

• Advance Rate


8

Market◦ Maximum senior debt and total debt ratios◦ Vary over cycle

Peers◦ Identify◦ Rating Classification◦ Key Ratios

Rating Agencies◦ Credit Statistics


9

Peer XYZ XYZABC DEF GHI JKL MNO PQR STU Average Actual Pro-Forma

12 Months Ended 02/10/20xx 30/09/20xx 01/01/20xx 30/09/20xx 31/10/20xx 30/11/20xx 31/12/20xx 31/12/20xx 31/12/20xxSales 3073.8 8294.9 6165.2 852.4 2345.8 1682.1 2133.4 3506.8 3025.4 3205.3Gross Margin 25.6% 14.4% 16.3% 19.8% 22.0% 16.6% 17.1% 18.8% 17.8% 17.4%EBITDA 153.7 430.1 272.3 35.9 130.8 77.3 100.3 171.5 122.6 134.5 Margin 5.0% 5.2% 4.4% 4.2% 5.6% 4.6% 4.7% 4.8% 4.1% 4.2%Interest Expense 34.4 78.6 49.6 13.2 19.5 15.3 25.0 33.7 55.2 55.8Capex 32.1 40.7 37.1 9.8 25.8 11.3 27.8 26.4 10.7 10.7 % of Sales 1.0% 0.5% 0.6% 1.1% 1.1% 0.7% 1.3% 0.9% 0.4% 0.3%Total Assets 1482.0 3835.4 2790.1 360.5 1099.5 829.3 961.5 1622.6 950.5 952.3

Secured Bank Debt 455.4 0.0 0.0 117.8 0.0 0.0 0.0 211.9 83.2Unsecured Bank Debt 0.0 504.6 175.9 0.0 208.0 210.0 37.6 0.0 0.0Other Senior Debt 111.7 391.4 708.2 6.3 179.2 0.0 75.0 42.6 8.3 Total Senior Debt 567.1 896.0 884.1 124.1 387.2 210.0 112.6 254.5 91.5Subordinated Debt 0.0 197.6 0.0 0.0 0.0 0.0 143.7 289.2 289.2 Total Debt 567.1 1093.6 884.1 124.1 387.2 210.0 256.3 543.7 380.7Equity 419.9 1461.1 1293.3 150.2 473.8 414.4 262.5 (69.0) 96.4 Total Capitalization 987.0 2554.7 2177.4 274.3 861.0 624.4 518.8 474.7 477.1

Total Debt/EBITDA 3.7 2.5 3.2 3.5 3.0 2.7 2.6 3.0 4.4 2.8Senior Debt/EBITDA 3.7 2.1 3.2 3.5 3.0 2.7 1.1 2.8 2.1 0.7Total Debt/Capital 57.5% 42.8% 40.6% 45.2% 45.0% 33.6% 49.4% 44.9% 114.5% 79.8%EBITDA/Interest (incl. A/S) 4.5 5.5 5.5 2.7 6.7 5.1 4.0 4.8 2.2 2.4

Credit Ratings S&P BBB- A- A NR NR NR BB BB- Moody's NR A3 A2 NR NR NR Baa3 Ba2

Market Capitalization 468.2 1482.0 1295.8 104.4 510.9 249.2 177.9 612.6Enterprise Value 1035.3 2575.6 2179.9 228.5 898.1 459.2 434.2 1115.8Ent Value/EBITDA 6.74 5.99 8.01 6.36 6.87 5.94 4.33 6.32Ent Value/Sales 0.34 0.31 0.35 0.27 0.38 0.27 0.20 0.30Ent Value/Book Value 2.47 1.76 1.69 1.52 1.90 1.11 1.65 1.73Earnings per Share 1.78$ 1.73$ 2.83$ (0.06)$ 2.37$ 1.69$ 1.09$ 1.63$


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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


AAA AA A BBB BB BCCC

EBITDA/I 20 12 6 4 2 1.5<1

FD/EBITDA NM 1 2 3 4 5+>6

Size Big 20B+ 15B+ 10B+ 5B+1B+ NM

11Amsterdam Institute of Finance October, 2014

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Maximum debt capacity formula:-MDC = f(operations, amortization, rate, asset sales)MDC = [EBIT / (i+ 1/n)] + AS + RF

EBIT - Earnings Before Interest and Taxesi - Interest Raten - Straight line loan amortizationAS - Proceeds from Asset Sales

RF - Refinancing


Opening Balance Sheet Adjustments – from sources and uses – including

purchase price assumptions Proforma balance Sheet

◦ Income Statement◦ Cash Flow StatementCapitalization table/transaction structureDebt ScheduleTerm sheet(s)Valuation/maximum purchase priceReturns Analysis – IRR and MOC


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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


Comparison

Corporate Private Equity Rating – I/G Maximum Debt Capacity –

NIG Capital Market Access Temporary Permanent IRR EPS Control Flexibility – covenants, dividends Upside Pricing Value Transfer/Mispricing

ReasonDiffering motivations


TradeoffsAmountCostFlexibilityControlDilution

Mispricing Issue

OperationalizeRatings Target

Comparative Credit AnalysisCash Flow Testing

Market Conditions


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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


If EBIT > 5mlm – Debt Preferred If EBIT < 5mlm – Equity Preferred

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EPS

EBIT

0 5,000,000 10,000,000

Indifference Point


%1H14 02013 02012 12011 22010 32009 12008 52007 232006 202005 12

Source: S&P Capital IQ


UK France Germany

Bank Debt 46.4 50.1 43.8

2L 1.7 6.8 4.4

HYB --- --- 8.9

Equity 50.1 39.5 40.2

MEZ 1.5 --- ---

Other 0.4 3.6 0.7

Source: S&P Capital

IQ


BB/BB-

Europe U.S.

Pro Rata Spread N/A L+239.0

Weighted Avg Institutional Spread N/A L+297.3

Deal Size (€MM) 397.58 924.06

Pro Rata Term (In Years) 5.00 4.81

Institutional Term (In Years) N/A 6.39

Revenues (€MM) N/A 3,027.86

EBITDA (€MM) N/A 664.82

Pro Forma Debt/EBITDA N/A 3.76X

Pro Forma Senior Debt/EBITDA N/A 3.74X

Pro Forma Cash Interest Coverage N/A 6.89X

Observations 6 111



B+/B

Europe U.S.

Pro Rata Spread E+343.8 L+323.8

Weighted Avg Institutional Spread E+394.4 L+378.2

Deal Size (€MM) 480.67 488.44

Pro Rata Term (In Years) 4.82 4.96

Institutional Term (In Years) 6.03 6.18

Revenues (€MM) 2,974.90 1,578.91

EBITDA (€MM) 356.61 252.57

Pro Forma Debt/EBITDA 5.09X 4.92X

Pro Forma Senior Debt/EBITDA 4.86X 4.88X

Pro Forma Cash Interest Coverage 3.79X 4.50X

Observations 39 381



PPX FD/EBITDA Equity % EUR/U.S. EUR/U.S. EUR/U.S.

1H14 10/9.2 4.9/4.9 42%/38%2013 9.7/8.8 4.7/4.7 42%/38%2012 9.3/8.7 4.5/4.6 48%/38%2011 8.8/8.8 4.4/4.4 45%/38%2010 9.2/8.5 4.2/3.9 47%/45%2009 8.9/7.7 4.1/4.1 45%/45%2008 9.7/9.1 5.1/3.7 42%/40%2007 9.7/9.7 5.9/4.9 30%/30%2006 8.8/8.4 5.4/4.4 30%/30%



Source of Funds

Key Terms Comments

Bank Debt

• Typically 30 – 50% of capital structure

• Based on asset value as well as cash flow

• LIBOR-based (i.e., floating rate) term loan LIBOR floor; pricing grids

• 5-8 year maturity, with annual amortization often in excess of that which is required (average life 4-5 years)

• Up to 5X LTM EBITDA (varies with industry, ratings and economic conditions)

• Usually secured by assets and pledge of stock

• Maintenance and incurrence covenants; cash sweeps

• Bank debt will also include an unfunded revolving credit facility to fund working capital needs

• Can be split into Term A (shorter term, higher amortization) and Term B (longer term, nominal amortization, bullet payment)

• Generally, no minimum size requirement• Amortizes over the life of the loans• Generally, no prepayment penalty• 2L• Cov-Lite

High-YieldSubordinatedDebt

• Typically 20-30% of capital structure• Generally unsecured• Fixed coupon; PIK; PIK-T• May be classified as senior, senior

subordinated or junior subordinated• Longer maturity than bank debt ( 7 -

10 years, with no amortization and a bullet payment)

• Incurrence covenants• Holding company obligor

• Public and 144A high yield offerings are generally $150mm or larger; for offerings below this size, assume mezzanine debt. In some cases, it may be appropriate to include warrants such that the expected IRR is 17-19% to the bondholder

• Senior and senior subordinated offerings are generally cash-pay; junior subordinated offerings (which would generally be issued in combination with senior subordinated offerings) may be zero coupon and issued at a holding company

• Bullet payment (non amortizing)


Source of Funds

Key Terms Comments

Mezzanine Debt

• Can be preferred stock or debt• Convertible into equity• IRRs in the high teens to low

twenties on 3-5 year holding period

• Occasionally used in place of high-yield debt• Generally a combination of cash pay and PIK; can

be both, or change over time• Often includes warrants to enhance IRR to

desired level above coupon rate

Total Debt• Typically 3.0x-7.0x LTM EBITDA• Interest coverage at least 2.0x

LTM EBITDA/first year interest

• Total debt varies by sector, market conditions, and other factors

Common Equity

• Typically 20-35% of capital structure

• 20-30% IRR on about a 5-year holding period

• Exit multiple = entry multiple• Management options of 5-10%

• Required IRR may be lower for larger or less risky transactions

• Exit: IPO, Trade, STS, Recap


Sources Uses

Excess CashDebt assumed by the buyerMinority interest assumedRevolverTerm Loan ATerm Loan BSenior notesMezzanine preferred stockSubordinated (high-yield) notesMezzanine debtSeller notesPreferred stockCommon equity (sponsor’s investment)Management equity roll-over Investor roll-over

Equity PurchaseInvestor roll-overFund target’s cash balanceAssumed (roll over) debtRefinance short-term debtRefinance long-term debtAssume (roll over) minority interestPurchase (buy out) minority interestTransaction fees and expensesFinancing fees


Amsterdam Institute of Finance October, 2014 27

Bull Market Menu

Bear Market Menu

As the credit curve shifts, the menu that is availableto Issuers / Arrangerschanges

• Tranche Term Loans• Covenant Light• High Yield Debt• Holding Company PIK• Bridge Loans• Second Lien • Hybrid Preferred• Cross Lien Facilities• Asset Carve-outs

• OPCO/PROPCO• Recapitalizations

• Stretch Senior• Seller Notes• Senior Notes• Private Placements• Equity • R/C Lite • Mezzanine• Smaller• floors• Sweeps• Prepayment penalties• covenants

Issuer FriendlyInvestor Friendly

Bull Market Menu

Joseph V. Rizzi Amsterdam Institute of Finance October, 2014.

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