Corporate Financial Restructuring

1. Corporate FinancialRestructuring Prof. Ian Giddy New York University More to come

2. Corporate Financial Restructuring Why Restructure? Proactive Example: Sealed Air Defensive Example: Loewen 1996 Distress Example: Loewen 1999 Management acts to preserve or enhance shareholder value Management acts to protect company, stakeholders and management from change in control Lenders and shareholders lose, but try to work out best way to minimize loss

3. Corporate Financial Restructuring • Corporate restructuring – business and financial • Structured financing techniques • Proactive restructuring • Distress-induced restructuring • Mergers, divestitures and LBOs

4. A Simple Framework • A company is a “nexus of contracts” with shareholders, creditors, managers, employees, suppliers, etc • Restructuring is the process by which these contracts are changed – to increase the value of all claims. • Applications: • restructuring creditor claims (Conseco); • restructuring shareholder claims (AT&T); • restructuring employee claims (UAL)

5. “Nexus of Contracts” Franchisors Senior lenders Subordinated lenders Salespeople TDI Management Shareholders

6. Examples • SAP – upgrading shareholder control rights • Sealed Air – exploiting free cash flow • Marvel – post-bankruptcy negotiations • Westpac – structured finance • Novartis – merged and divested • Alphatec – rescuing residual value

7. Novartis: Financial Restructuring Divested Non-core business Fixed the cash and working capital Fixed the capital structure Assets Liabilities Cash Debt Equity Fixed Assets

8. Restructuring Checklist

9. Valuation is a Key to Unlock Value • Value with and without restructuring • Consider means and obstacles • Who gets what? • Minimum is liquidation value Valuation Going Concern After Restructuring Liquidation

10. Achieve lowest weighted average cost of capital May also affect the business side Getting the Financing RightStep 1: The Proportion of Equity & Debt Debt Equity

11. Getting the Financing RightStep 2: The Kind of Equity & Debt Short term? Long term? Baht? Dollar? Yen? Debt Bonds? Asset-backed? Convertibles? Hybrids? Equity Debt/Equity Swaps? Private? Public? Strategic partner? Domestic? ADRs? Ownership & control?

12. Capital Structure: Optimal Range? Nestle Loewen Optimal debt ratio? VALUE OFTHE FIRM DEBT RATIO

13. Cost of Capital and Leverage: Method Equity Debt Estimated Beta With current leverage From regression Leverage, EBITDA And interest cost Unlevered Beta With no leverage Bu=Bl/(1+D/E(1-T)) Interest Coverage EBITDA/Interest Levered Beta With different leverage Bl=Bu(1+D/E(1-T)) Rating (other factors too!) Cost of equity With different leverage E(R)=Rf+Bl(Rm-Rf) Cost of debt With different leverage Rate=Rf+Spread+?

14. Ratings and Spreads

15. Interest Coverage Ratios, Spreads and Ratings: Small Firms

16. Optimal Debt Ratio for a Private Company: Example Damodaran’s spreadsheets: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm

17. TDI Financial History

18. Restructuring Debt and Equity at TDI (A & B) Evaluate the financial restructuring taking place at TDI: • Effect of the LBO on capital structure? • How did LBO lenders protect their interests? • Alternative restructuring plans? • Post Dec 89 operational, portfolio and financial restructuring proposals? • 1992-93 restructuring, before-and-after comparison

19. Restructuring Debt and Equity at TDI (C) Consider the choices facing TDI in 1994: • Evaluate the alternatives available to take best advantage of TDI’s free cash flow: • Leveraged buyout • Leveraged ESOP • Leveraged recapitalization • Or: Invest cash or debt in growth opportunities • Or: Do nothing to retain flexibility

20. Restructuring Debt and Equity at TDI (D) Evaluate the possible means for cashing out shareholder value in a private company such as TDI in 1996: • Leveraged recap • IPO • Sale to financial buyer • Sale to strategic buyer • Which when?

21. Leveraged Recapitalization • Strategy where a company takes on significant additional debt with the purpose of paying a large dividend (or repurchasing shares) • Result is a far more leveraged company -- usually in excess of the "optimal" debt capacity • After the large dividend has been paid, the market value of the shares will drop.

22. Leveraged Recapitalizations • Motivations: • Defensive • Proactive • Ownership transition/liquidity • Which produces what value?

23. Exchange Offers • Give one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm. • Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock, • Or vice-versa • Motivations?

24. Exchange Offers-- Effect Depends On: • Leverage increasing or decreasing • Implied increases or decreases in future operating cash flows • Implied  undervaluation or overvaluation of common stock • Increase or decrease in management share ownership • Increase or decrease in management control over cash usage • Positive or negative signalling effects.

25. Asset-Backed Securities: Ford Credit Owner Trust 1999-A

26. Credit Enhancement: Guarantee Method Finance Co.’s Customers Rating Agency Hire-Purchase Agreement Top Rating Servicing Agreement Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Investors Proceeds Proceeds Sale of Assets Asset-Backed Securities Trustee Financial Guarantee Provider (if required) Trust Agreement Guarantee Agreement

27. Rating Agency Credit Enhancement:An Alternative Approach Top Rating Senior Lower Rating Subordinated Finance Co. Ltd (Seller) FCL 1997-A (Special Purpose Co.) Proceeds Sale of Assets No Rating More Subordinated Financial Guarantee Provider (if required) Guarantee Agreement

28. The Alternative: Synthetic ABS DB (Originator) REFERENCE POOL OF LOANS (Stay on balance sheet) CREDIT SWAP AGREEMENT SPECIAL PURPOSE VEHICLE ISSUES TOP QUALITY ASSET-BACKED INVESTMENTS CERTIFICATES

29. Corporate Financial Restructuring Why Restructure? Proactive Example: Sealed Air Defensive Example: Loewen 1996 Distress Example: Loewen 1999 Management acts to preserve or enhance shareholder value Management acts to protect company, stakeholders and management from change in control Lenders and shareholders lose, but try to work out best way to minimize loss

30. Match the Solution to the Problem Trouble! The financing is bad Business mix is bad The company is bad Reason Raise equity, or Do debt/equity swap Or change debt mix Sell some businesses or assets to pay down debt Change control or management through M&A Remedy

31. Reorganization Processes • Out-of-court negotiated settlement • Firm continues • Exchange: equity for debt • Extension: pay later • Composition: creditors agree to take less • Firm ceases to exist: assignee liquidates assets and distibutes proceeds on a pro-rate basis • Merger into another firm (which assumes or pays off debt) • Continues as subsidiary • Absorbed into other operations • Formal legal proceedings • Firm continues: Ch 11, court supervises composition or modification of claims • Firm ceases to exist • Statutory assignment: assignee liquidates assets under formal legal procedures • Ch 7 liquidation: bankruptcy court supervises liquidation

32. When Default Threatens, Value the Company

33. Zombie Inc Valuation

34. Contact Info Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org