prof. ian giddy new york university structured finance: leveraged buyouts
TRANSCRIPT
Copyright ©2002 Ian H. Giddy Structured Finance 2
Structured Finance
Asset-backed securitization Corporate financial
restructuring Structured financing
techniques
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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).
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Case Study
The John Case LBO Proposal Devise a recommended financing plan
John Case (owner)
Buyers VC Investors
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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.
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Divestitures
Divestiture: the sale of a segment of a company to a third party
Spin-offs—a pro-rata distribution by a company of all its shares in a subsidiary to all its own shareholders
Equity carve-outs—some of a subsidiary' shares are offered for sale to the general public
Split-offs—some, but not all, parent-company shareholders receive the subsidiary's shares in return for which they must relinquish their shares in the parent company
Split-ups—all of the parent company's subsidiaries are spun off and the parent company ceases to exist.
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Divestitures Add Value
Shareholders of the selling firm seem to gain, depending on the fraction sold:
Total value created by divestititures between 1981 and 1986 = $27.6 billion.
% of firm sold Announcement effect
0-10%10-50%50%+
0+2.5%+8%
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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)
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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.
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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.
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M&A and Leverage
Leveraged buyout?
Company has
unused debt
capacity Leveraged
recapitalization?
Takeover?
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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
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Case Study: John M. Case Company
Bank debt and equity-linked structured financing in the context of leveraged buyout financing, including valuation and exit strategies. Convertibles and bridge financing.
What financial structure enables the acquiring group to retain control?
What is the cost of financing? “How much equity should/must our client give
up in order to get the funding we need?”
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The John M Case Leveraged Buy-Out
1. What are the most important operating and financial characteristics of the Case Company?
2. Is the company worth Mr Case's $20 million asking price?
3. Can the $20 million purchase be financed so that management can retain at least 51% ownership? What sources should management tap? In what amounts? Is the return being sought by the venture capital reasonable?
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4. How compelling a buyout opportunity is this proposition for the four managers?
5. Would you, as a commercial banking lender, provide the loan needed to finance the seasonal buildup in accounts receivable and inventory? On what terms?
6. Would you, as the venture capital firm, provide the balance of the funds needed? If so, on what terms?
The John M Case Leveraged Buy-Out
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Bank Loan Loan from Mr Case Venture Capitalists' Investment
Financing Sources
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POSITIVES :
The company has a stable product The company enjoys good profit
margins There are important barriers to
competitor entry The business is not too asset-intensive The four key managers know the
business well
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NEGATIVES :
Sales growth is probably quite limited This low-tech product has no patent
protection Even if outsiders find it difficult to
penetrate the market, that may not apply to vendors already in the industry, most particularly, the Watts Company
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Simplified Balance Sheetfor a restructured J.M.Case Company
Cash $5762 Current Liab $1266Other current 3236 Bank loan 6000Fixed & other 2184 Case loan 4000
Good will 10084 Plug figure 9500
Managers’ equity
500
Total 21,266 Total 21,266
Assets Liabilities
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WACC
John M. Case LBOHow is the acquisition to be financed?Answer: let's work out what we have to pay the VCs in order to fill the gap
Assets Liabilities Nominal Effective Weight ProductCash 5,762$ Current $1,266 0% 0.00% 5.95% 0.00%Other current 3,236$ Bank loan $6,000 12% 8.40% 28.21% 2.37%Long term 2,184$ Seller note $4,000 4% 8.17% 18.81% 1.54%Goodwill 10,084$ VC plug $9,500 9% 21.40% 44.67% 9.56%
Managers' equity $500 30% 2.35% 0.71%Total 21,266$ $21,266 14.17%
johncaselbo.xls
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Feasibility of the Price
Book Value Basis Stock Market Valuation Basis Comparable Company Value Discounted Cash Flow Basis
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Book Value Basis :
Asking price : twice the value of the company’s equity
Why would anyone pay this ?
If the profitability of the company justifies it
- in this case, it appears to – ROE around 20 % or $ 2 million in 1984
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Stock Market Valuation
If a company is publicly traded, the valuation accorded its outstanding market shares can be a starting point for valuation
In this case, the company is not publicly traded, so no opportunity is available here
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Comparable Company Value
Common practice to compare its value with those accorded to publicly traded companies in a similar business
After comparisons made, it is seen that the Case asking price is in line with the market value of a publicly traded competitor
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John Case Valuation
John Case Analysis 1 2 3 4 5 6Year 1985 1986 1987 1988 1989 1990
Principal Repayment 9500Coupon payments 855 855 855 855 855 855Total Repayments 855 855 855 855 855 10355Return @ 25% 25% 25% 25% 25% 25% 25%NPV 684 547.2 437.76 350.208 280.1664 2714.501NPV @ yr0 5014Equity 4486Total VC 9500
I) FCF#1: Original Core BusinessFCF after financing: 1448 1702 1920 2114 1982 2002NPV of FCF after financing 1268.257 1305.681 1290.083 1244.113 1021.639 903.8505NPV of FCF @ yr 0 7034NPV of VC Equity 4486 39%Total Equity 11520
II) FCF#2: Expansion PlanTurnover 1000 1400 1960 2744 3073.28 3442.074Profit (margin of 6%) 60 84 117.6 164.64 184.3968 206.5244NPV of FCF after financing 52.55209 64.44019 79.01755 96.89255 95.04891 93.24036NPV of FCF @ yr 0 481
III) Total Equity Valuation 12,000,980$
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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?