Prof. Ian Giddy New York University Structuring LBO Financing.
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Transcript of Prof. Ian Giddy New York University Structuring LBO Financing.
Prof. Ian GiddyNew York University
StructuringLBO Financing
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 2
Leveraged Buy-Outs
LBO is a transaction in which an investor group acquires a company by taking on an extraordinary amount of debt, with plans to repay the debt with funds generated from the company or with revenue earned by selling off the newly acquired company's assets
Leveraged buy-out seeks to force realization of the firm’ potential value by taking control (also done by proxy fights)
Leveraging-up the purchase of the company is a "temporary" structure pending realization of the value
Leveraging method of financing the purchase permits "democracy" in purchase of ownership and control--you don't have to be a billionaire to do it; management can buy their company.
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 3
Leveraged Financing
Leveraged Finance is the provision of bank loans and the issue of high yield bonds to fund acquisitions of companies or parts of companies by
an existing internal management team (a management buy-out),
an external management team (a management buy-in), or
a third party (a leveraged acquisition).
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 4
M&A and Leverage
Leveraged buyout?
Company has
unused debt
capacity Leveraged
recapitalization?
Takeover?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 5
Corporate Restructuring
Divestiture—a reverse acquisition—is evidence that "bigger is not necessarily better"
Going private—the reverse of an IPO (initial public offering)—contradicts the view that publicly held corporations are the most efficient vehicles to organize investment.
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 6
Going Private
A public corporation is transformed into a privately held firm
The entire equity in the corporation is purchased by management, or managment plus a small group of investors
These account for about 20% of public takeover activity in recent years in the United States.
Can be done in several ways: "Squeeze-out"—controlling shareholders of the firm buy up
the stockholding of the minority public shareholders Management Buy-Out—management buys out a division or
subsidiary, or even the entire company, from the public shareholders
Leveraged Buy-Out (LBO)
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 7
LBOs, Agency Costs and Free Cash Flow "Free cash flow" is cash-cow type
earnings in excess of amounts required to fund all positive-NPV projects
Payout of free cash flow, to stockholders, reduces the amount of resources under managment's discretion. Forces management to go out into the markets and justify raising funds
Thus debt has a disciplining role. “Safe” managers choose less debt.
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 8
Seagate
1. Show, with a diagram, the restructuring that resulted in the Seagate LBO
2. How would the buyers create value?
3. How would they realize that value?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 9
Seagate
1998
SEAGATE
VERITAS
40% for $1.8b
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 10
Seagate
2000
SEAGATE
VERITAS
40% worth $22b
100% worth $16b
Seagate
shareholders
Distribution taxable at
39.2%?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 11
Seagate
Nov 2000
VERITAS
Seagate
shareholders
SEAGATE Disk drive
business
109m Veritas shares
(worth $18.7b)
NEWCO128m Veritas
shares
(worth $22b)
$2b cash
Management,
Chase,
Goldman
Silver Lake
Partners
Cost $1.65b
after tax
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 12
Seagate
NEWCO
Disk
drive
businessEquity $1b
Debt $1b
Management,
Chase,
Goldman
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 13
Typical LBO Sequence
Company gets bloated or slack and stock price falls
LBO offer made
LBO completed
Restructuring Efficiencies Divestitures Financial
? years 3-9 months 5-7 years
IPO or sale of company
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 14
Can the Financing Work?
1 2 3 4 5 6Debt ($m) 5.5 5 4.5 4 3.5 3Equity ($m) 1 1.09 1.273 1.55845 1.957218 2.4818
EBITDA 1080000 1401000 1761150 2166323 2623271 2835434Interest 550000 500000 450000 400000 350000 300000Coverage Ratio 1.96 2.80 3.91 5.42 7.50 9.45
LBO Leverage Analysis
0
2
4
6
8
10
1 2 3 4 5 6
Debt ($m) Equity ($m) Coverage Ratio
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 15
Can the Financing Work?
Free Cash Flow Analysis of LBO
-800000
-600000
-400000
-200000
0
200000
400000
600000
1 2 3 4 5 6
FCFF Interest*(1-T) Principal repayment FCFE
1 2 3 4 5 6FCFF 220000 253000 290950 334592.5 384781.4 404020.4
- Interest*(1-T) 330000 300000 270000 240000 210000 180000- Principal repayment 500000 500000 500000 500000 500000 0
= FCFE -610000 -547000 -479050 -405408 -325219 224020.4
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 16
LBO Financing
NEWCO
Disk
drive
businessEquity $0.25b
Senior
debt $1b What securities?
What returns?
What investors?Mezzanine
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 17
The Financing SpectrumE
xpec
ted
Ret
urn
Risk
Senior secured debtSenior secured debt
EquityEquity
Senior unsecured debtSenior unsecured debt
Subordinated debtSubordinated debt
Preferred equityPreferred equity
Convertible debtConvertible debt
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 18
What Are The Alternatives?
Asset-backed or cash flow-backed debt Senior debt Subordinated debt Subordinated debt with upside
participation Subordinated debt with equity option Preferred equity Restricted shares Common stock
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 19
Subordinated High Yield Debt
“Junk bonds” – like equity, but allow increased financial leverage
Tax advantage over equity Big market in USA (institutional investors) and
increasing in Europe Leveraged loans favored by certain
commercial banks Often used in connection with M&A and LBOs Behave like equity – and often have equity
participation
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 20
Sub Debt -- Motivations
Optimization of financial leverage Regulatory-driven capital requirements Rated asset securitizations (senior-sub
structure in asset-backed securities) Insider or supplier-credit subordination
(eg in project finance) Work-outs and restructurings (existing
borrowers agree to seniority of new loans, to buy time)
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 21
Sub Debt’s Big Problem: High Interest!
Solutions Deep discount subordinated debt Subordinated debt with equity warrants Convertible subordinated debt Participating subordinated debt Puttable subordinated debt
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 22
Convertibles
ConversionValue
StraightBond Value
Market ValueMarket Premium
Value
of
Convertible
Bond
($) 0
Price Per Share of Common Stock
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 23
Warrants
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 24
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
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 25
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
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 26
Preferred Stock: Pros and Cons
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
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 27
Motivations for Issuing Hybrid Bonds
Company has a view There are constraints on what the
company can issue The company can arbitrage to save
money Always ask: given my goal, is there an
alternative way of achieving the same effect (e.g., using derivatives?)
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 28
Why Use a Hybrid?
Motivations for Hybrids
Linked to business risk
Linked to
market risk
Cannot hedge
with derivatives
Driven by investor needs
Company hedges
Company does not
hedge
Debt or
equity are
Not good enough
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 29
Case Study: Le Meridien
What kind of financing package would enable Royal Bank to beat other commercial and investment banks in the Meridien deal? Who are potential rivals, and what strengths might give them a competitive edge?
If RBS offers sale-and-leaseback financing, what should be the structure and terms of the deal, terms that make sense for the client as well as for the bank?
If RBS offers equity participation, what form should this take? Common stock or mezzanine finance? Or should the bank avoid the risks of an equity investment?
Would asset-backed securities be suitable as a financing source for this acquisition?
Copyright ©2002 Ian H. Giddy Corporate Financial Restructuring 30
Case Study
The John Case LBO Proposal Devise a recommended financing plan
John Case (owner)
Buyers VC Investors