Industry Analysis, continued EXERCISE Read the extracts from the analyst report on Philips. What evidence you do find about each of the Porter Five Forces? • Rivals: How intense is competition in these segments? • New entrants: Is this a realistic threat? • Buyer power: Any significant buyers exerting pressure? • Supplier power: Significant suppliers? • Substitute products: How important are substitutes/new products?
Industry Analysis, Philips Exercise Philips: Industry Outlook • Healthcare Equipment - The medical equipment industry is characterised by its consolidated nature especially in certain segments like imaging and scanning equipment which is largely dominated by Siemens, Philips and GE. Barriers to entry are high as a result of high capital requirements, regulatory approvals and large R&D budgets. Competition is high and marketing costs are typically the largest expense as companies attempt to differentiate their products and their technological superiority to competitors. The key success factor in the industry is product innovation that can keep pace with the rapid improvements of medical knowledge. Nevertheless, margins and returns on assets are high as many products are highly specialized. The long-term outlook is positive and driven by demographic trends (ageing population, increased healthcare requirements) although there continues to be pressure by governments and insurers to contain healthcare costs thereby somewhat restricting equipment budgets. Such pressure typically comes in the form of limitations on reimbursements to hospitals and doctors which require them to weigh the decision about new equipment purchases against potential life-time revenues of the apparatus. The US market remains key as it still represents 50% of global healthcare expenses.
Industry Analysis, Philips Exercise Philips: Industry Outlook • Lighting - Lighting is a mature, cash generative and stable business where Philips is the market leader followed by GE and Siemens. With the acquisition of Genlyte in 2007, Philips became the largest light bulb manufacturer in the USA surpassing GE, the company founded by Thomas Edison in the 1800s who discovered the incandescent light bulb. Customer base is extremely large due to the wide range of industries it serves including residential, automotive, industrial, roads, etc. While growth is limited and largely tracks GDP growth, it is driven by energy efficiency concerns and increasingly sophisticated solutions. Key components of maintaining performance are product innovation, a strong profile in the high-end of the market, while increasing low-end sales volumes in less traditional geographic markets such as China and Eastern Europe. While the industry is stable, major shifts towards more energy efficient lighting have become apparent with the European Union phasing out production of incandescent light bulbs between 2009 and 2012 and the United States set to phase out their use by 2012. These traditional but inefficient light bulbs will be replaced by other existing technologies from compact florescent and LED solutions. The long-term Outlook for the Lighting Industry is positive based on its mature status and constant need for replacement bulbs that should be further underpinned by more efficient and green technologies especially in light of the phasing out of incandescent bulbs. Nonetheless, the positive outlook is tempered in the short run by the continued weak outlook for commercial construction and automotive markets.
Industry Analysis, Philips Exercise Philips: Industry Outlook • Consumer Electronics – The industry is highly concentrated with the top 50 companies accounting for approx. 90% of market share and the industry is dominated by well known brands such as Sony, Philips, Panasonic, Toshiba and Samsung. Competitors in this space may compete in many sub-categories including televisions, speakers and sound systems, video game consoles, portable media players and peripherals such as game joysticks among others. Demand is primarily related to consumer income and employment as well as the level of innovation and new product introductions. Barriers to entry are high as large amounts of capital are required to develop economies of scale while consumers show some degree of loyalty to the well established brands. Competition is fierce with manufacturers often attempting to gain market share by reducing prices, which hurts margins. This has resulted in significant deterioration in the margins for televisions. Outlook for the industry is down-cycle late as consumer spending on discretionary purchases while still low as a result of high unemployment levels is expected to improve given a return to growth in the global economy. Economic stimulus packages launched in response to the financial crisis by many governments around the world are expected to support an increase in consumer discretionary spending in 2010.
Porter Competitive Model Healthcare, Lighting, and Consumer Lifestyle Industries Potential for new entrants is WEAK Potential New Entrants • Healthcare Equipment: High capital requirements • and regulatory approvals. Large R&D budgets. • Lighting: Mature industry, focus on innovation and • energy efficiency. High R&D expenses. • Consumer Electronics: 90% market share among top • companies. High capital requirements to gain • economies of scale. • Healthcare Equipment: Largely a human • capital and patent issue rather than supply. • Lighting: Suppliers of innovative compact • fluorescent and LED solutions have innovative • power. • Consumer Electronics: Mostly human capital • and patent issue rather than supply. Intensity of Intra-Industry Rivalry is VERYSTRONG Power of buyers is STRONG Power of suppliers is WEAK • Intra-Industry Rivalry • Healthcare Equipment: GE, Siemens. Consolidated & Competitive. • Lighting:Mature, stable, GE & Siemens. • Consumer Electronics: Concentrated, Sony, Panasonic, Toshiba, Samsung Bargaining Power of Suppliers Bargaining Power of Buyers • Healthcare Equipment: Buyers demand product • differentiation and technological superiority. • High marketing costs and R&D to meet needs. • Lighting: Increasing pressure for energy efficiency • and product innovation from buyers as phase-out • of incandescent bulbs grows. • Consumer Electronics: Demand based on • consumer income, innovation, and new product • introductions. Some degree of brand loyalty. • Healthcare Equipment: Relatively few, however, limits on reimbursement may create a ‘luxury’ good status. • Lighting: Older technologies, n/a • Consumer Electronics: Older technologies, n/a Substitute Products and Services Power of substitutes is WEAK
Financial Statement Analysis - Philips Using the Philips annual report, calculate for FY07, FY08, FY09: • Sales growth (FY08 and FY09 only) • EBITDA profitability • Interest coverage • Note: “Financial Expenses” shown on the income statement include a variety of charges. Consulting the footnotes you would find that actual interest expense is €279 in ‘07, €246 in ’08, and €297 in ‘09 Bank of America: Confidential & Proprietary FOR INTERNAL USE ONLY
Sales Growth Exercise Sales growth FY08 Sales growth = 26,385/26,793 – 1 = -1.52% FY09 Sales growth = 23,189/26,385 – 1 = -12.11% -1.52% -12.11% FY 08 FY 09 FY 07 --
EBITDA Profitability Exercise EBITDA Sales EBITDA Profitability 7.82% 8.98% 6.00% FY07 EBITDA = 1867+1083 = 2095 FY07 Sales = 26793 2095/26793 = 7.82% FY08 EBITDA = 54+1528 = 1582 FY08 Sales = 26385 1582/26385 = 6.00% FY09 EBITDA = 614 + 1469 = 2083 FY09 Sales = 23189 2083/23189 = 8.98% FY 08 FY 09 FY 07
Interest Coverage Exercise EBITDA Interest Expense Interest Coverage 7.51x 7.01x 6.43x FY07 EBITDA = 2095 FY07 Interest Expense = 279 2095/279 = 7.51x FY08 EBITDA = 1582 FY08 Interest Expense = 246 1582/246 = 6.43x FY09 EBITDA = 2083 FY09 Interest Expense = 297 2083/297 = 7.01x FY 08 FY 09 FY 07
Debt/Capitalization Exercise Debt/Capitalization 21.17% 2.87% 22.56% -0.63% FY08 Total Debt = 722+3466 = 4188 Cash = 3620 Net Debt = 4188-3620 = 568 FY09 Total Debt = 627+3640 = 4267 Cash = 4386 Net Debt = 4267-4386 = -119 FY08 Capitalization = 4188+15593 = 19781 Debt/Cap = 21.17% Net/Cap = 2.87% FY09 Capitalization = 4267+14644 = 18911 Debt/Cap = 22.56% Net/Cap = -0.63% FY 08 FY 09 FY 07 --
Debt/EDITDA Exercise Debt/EBITDA 2.65x 0.36x 2.05x -0.06x FY08 Total Debt = 722+3466 = 4188 Cash = 3620 Net Debt = 4188-3620 = 568 FY09 Total Debt = 627+3640 = 4267 Cash = 4386 Net Debt = 4267-4386 = -119 FY08 EBITDA = 1582 Debt/EBITDA = 2.65x Net/EBITDA = 0.36x FY09 EBITDA = 2083 Debt/EBITDA = 2.05x Net/EBITDA = -0.06x FY 08 FY 09 FY 07 --
S&P U.S. and European Industrial Financial Ratios • Three-year average ratio medians organized by rating • See Table 5 for EMEA Long-Term Financial Ratios • Note especially: • EBITDA interest coverage • Debt/EBITDA • Debt/Debt + Equity • Based on its 2009 performance, where does Philips fall for each ratio? What do you think its LTD is rated?
Exercise Using the five ratios you calculated and the S&P tables, summarize Philips performance over the past three years (2007-2009)
Summary • Credit analysis is fundamentally the comparison of two things: • Cash flow from the business • Company’s financial obligations • To determine a company’s creditworthiness, a credit analyst considers: • The Big Picture: the industry within which the company operates • Company’s financial statements, key ratios, and trends
Summary • Calculate key ratios and observe trends • Income Statement • Sales growth • EBITDA profitability • Interest coverage • Balance Sheet • Debt/Capitalization • Debt/EBITDA • S&P ratios tables provide context to gauge credit quality
Part 2 - Agenda • Loan Structuring
Loan Structuring Loan structuring consists of: • Loan Type • Amount • Repayment • Tenor • Amortization • Final Maturity • Guarantees and Support • Collateral • Covenants • Pricing
Loan Type Essentially there are two (2) types of credit facilities that banks offer clients: • Committed • Revolving Credit Facilities • Term Loans • Book Overdraft facilities • Uncommitted • Trading Lines • Intraday and (very) Short Term Settlement Limits: DOL, ACH, FX • Letters of Credit: Commercial and Standby
Amount The facility must be sized properly to: • The company’s needs • Its ability to repay Do not over-finance or under-finance a company. Do not over-finance or under-finance a company.
Repayment • Most corporate/FI bank loans (non-RE) do not have final maturities beyond 10 years, and are generally in the 5-7 year range. • Bank term loans amortize; they are not bullet repayments like a bond.
Repayment, continued • Tenor • Amortization • Final Maturity Principal Time Principal Principal Time Time
Guarantees and Support • Most desirable for the bank: • Unconditional Guaranty (of payment) • Other acceptable forms of support • Letter of Comfort • Letter of Awareness • Letter of Responsibility • Verbal Assurances
Guarantees and Support, continued A guaranty will include the following statements: • Provider of support unconditionally promises to pay to the Bank the debt of the direct obligor • Guaranty is continuous • Guarantor may be required to pay even if the bank does not proceed against the borrower or any collateral
Guarantees and Support, continued Guarantys Parent Holding Company Downstream Guaranty Weak Operating Co Operating Co Operating Co Operating Co Operating Co Strong, Consolidated Enterprise
Guarantees and Support, continued Significant Debt Parent Holding Company Upstream Guarantees Operating Company 1 Operating Company 2 Cash Flow
Guarantees and Support - Support Letters Letters of Awareness, Letters of Responsibility, Letters of Comfort In these documents, the provider of support typically states only that… • …it will take certain actions and assume certain responsibilities to enable the obligor (usually a subsidiary) to repay its debt, while the Bank has credit extended to the obligor being supported. • The provider of support does not make any promise to pay the indebtedness of the supported obligor (as is the case of a continuing guaranty).
Guarantees and Support - MNC Support Policy Requirements: Verbal Assurance
Collateral • Typical collateral packages include “hard assets:” • Accounts Receivable • Inventory • PPE • Investment grade borrowers typically have unsecured facilities. • Sub-investment grade borrowers are typically secured. TRUE or FALSE: A secured lender owns the collateral and if there is a default, the lender can repossess the collateral, sell it, and pay off the obligation.
Covenants • Financial tests or other conditions the borrower must meet as part of its contractual obligation under the loan agreement • “Early warning signs” of deterioration When a borrower defaults on a covenant… • What are the lenders legally entitled to do? • What do we usually do?
Covenants, continued For deteriorating credits, covenant amendments typically involve… • Shortened tenor • Asset sales • Collateral • Cancellation of unused commitments • Increased pricing • Increased monitoring
Covenants, continued Three principal families of covenants: • Leverage • Debt/(Debt + Equity) • aka Debt/Cap (Total Capitalization) • Debt/EBITDA • Coverage • Interest Coverage • Fixed Charge Coverage • Net Worth • Book Equity or Tangible Book Equity Key Rule - The higher the credit quality, the fewer number of covenants