Turnaround Financing
description
Transcript of Turnaround Financing
Prof. Ian GiddyNew York University
Turnaround Financing
Copyright ©2000 Ian H. Giddy Financing Turnarounds 2
Corporate Finance
CORPORATE FINANCEDECISONS
INVESTMENT RISK MGTFINANCING
CAPITAL
PORTFOLIO
M&ADEBT EQUITY
TOOLS
MEASUREMENT
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Capital Structure: East vs West
VALUE OFTHE
FIRM
DEBTRATIO
Optimal debt ratio?
Intel TPI
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Fixing the Capital Structure
Too little debt Managers like to control
shareholders’ funds Underestimate the cost
of equityProduces Less discipline Excessive cost of
capital Takeover risk
Too much debt Close control of equity Easy money Underestimate business
or financial risksProduces Risk of financial distress Excessive cost of
capital Destroy operating value Takeover risk
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The Three Excesses
Labor Capacity Debt
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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
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Debt-Equity Swaps
Cosmetic or real? Choices for company under siege
Raise new equity to pay off creditorsExample: IridiumGive creditors equity in place of debtExample: Sammi
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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 controlmeans restructuring
Financial engineering Bottom line “rationalization” Divestitures & outsourcing
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What Are The Alternatives?
Key: Make the new securities attractive to:Existing lendersNew lendersNew bond investorsNew equity investors
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The Financing SpectrumEx
pect
ed R
etur
n
Risk
Senior Debt Returns independent
of the value of the business
Control through covenants
Equity Residual returns
after contractual claims
Control through voting rights
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The Financing SpectrumEx
pect
ed R
etur
n
Risk
Senior secured debt
Equity
Senior unsecured debt
Subordinated debt
Preferred equity
Convertible debt
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The Financing SpectrumEx
pect
ed R
etur
n
Risk
Senior secured debt
Equity
Senior unsecured debt
Subordinated debt
Preferred equity
Convertible debt
Asian bank NPLs
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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
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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
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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)
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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
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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
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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
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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
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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
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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."
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MacroFactors
• Currency overvaluation• Capital restrictions
StructuralFactors
• Acctg & disclosure requirements• IAS compliance• Bankruptcy regime• Creditor rights• Govt-corporate nexus• Trading infrastructure
• Price-Value ratio, Sharpe ratio, EVA• D/E ratio• Currency & maturity mismatch• IAS conformity• Insider control• Objective research coverage• Trading liquidity
Firm-levelFactors
What Globally Mobile Investors Look At
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Debt
Equity
Domestic market
Foreign market(Depositary Receipts)
BNY ADR Index
-7.47%-13.54%-19.28%
MSCI Index
-28.23%-25.64%-36.53%
AsiaLat AmerEmerging Markets
(1996-98)
Can the Form of Foreign Participation Make a Difference?
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Debt
Equity
Domestic market
Foreign market(Depositary Receipts)
Unsponsored Private placement
Exchange traded
Exchange traded IPO
Private placement IPO
Global issue or GDR
Can the Form of Foreign Participation Make a Difference?
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Tracking Stock
Tracking stock, sometimes known as letter stock or alphabet stock, is a class of stock designed to reflect the value and track the performance of a part of the issuer's assets, usually a separate business or group of businesses. Claimed advantages:preservation of the efficiencies of a single
corporationability of the market to more accurately value the
respective businesses of the issuer What does it really add?
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Restricted Stock: Pros and Cons
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
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The New Equity Option
Key: Make the new equity attractive to: Portfolio investors
DomesticInternationalReduce agency costs or we’ll “Just say no!”
Strategic/direct investorsDomesticInternationalCede control or we’ll go elsewhere
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PT Astra International
?
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PT Astra International
1997: Almost $2 billion USD debt 1998: Steep losses Mostly IDR revenues 1999: Debt restructuring, return to
profitability Bina Busana Internusa: February 1999 US $1 mio PT Astra International: June 1999 US $1,149 mio. Fuji Technica Indonesia: September 1999 US $16 mio Federal International Finance: December 1999 US $107 mio. Traktor Nusantara: December 1999 US $ 21 mio. Astra Graphia: December 1999 US $82 mio.
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New Equity for Astra
What investors?Portfolio investorsFinancial investorsCorporate investors
What returns should they expect?= Risk-free rate+ Corporate risk+ Financial risk (leverage/debt mismatch)+ “Agency cost” premium+ Country risk
What restructuring?
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How Risky is Astra?
Mean
The riskier the better!
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Common Stock as a Call Option
The equity in a firm is a residual claim, i.e., equity holders lay claim to all cashflows left over after other financial claim-holders (debt, preferred stock etc.) have been satisfied.
If a firm is liquidated, the same principle applies, with equity investors receiving whatever is left over in the firm after all outstanding debts and other financial claims are paid off.
The principle of limited liability, however, protects equity investors in publicly traded firms if the value of the firm is less than the value of the outstanding debt, and they cannot lose more than their investment in the firm.
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Payoffs to Shareholders on Liquidation
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The Conflict Between Bondholders and Stockholders Stockholders and bondholders have different
objective functions, and this can lead to conflicts between the two. For instance, stockholders have an incentive to take riskier
projects than bondholders do, and to pay more out in dividends than bondholders would like them to.
Since equity is a call option on the value of the firm, an increase in the variance in the firm value, other things remaining equal, will lead to an increase in the value of equity. It is therefore conceivable that stockholders can take risky
projects with negative net present values, which while making them better off, may make the bondholders and the firm less valuable.
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The Creditors are Prowling
Trouble!
The financingis bad
The companyis bad
Businessmix is bad
Raise equityor
Change debt mix
Change controlor management
through M&A
Sell some businessesor assets
to pay down debt
Reason
Remedy
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www.giddy.org
Ian GiddyNYU Stern School of BusinessTel 212-998-0332; 917-930-0291Fax 212-995-4233; [email protected]://www.giddy.org