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Structured Finance
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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).
Copyright 2002 Ian H. Giddy
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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 Divestiturea reverse acquisitionis evidence that "bigger is not necessarily better" Going privatethe 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-offsa pro-rata distribution by a company of all its shares in a subsidiary to all its own shareholders Equity carve-outssome of a subsidiary' shares are offered for sale to the general public Split-offssome, 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-upsall of the parent company's subsidiaries are spun off and the parent company ceases to exist.
Copyright 2002 Ian H. Giddy
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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.
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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-Outmanagement 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.
Copyright 2002 Ian H. Giddy
Structured Finance 9
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
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Company gets bloated or slack and stock price falls LBO offer made LBO completed
3-9 months
5-7 years
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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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Financing Sources Bank Loan Loan from Mr Case Venture Capitalists' Investment
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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
Copyright 2002 Ian H. Giddy
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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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$5762 Other current 3236 Fixed & other 2184 Good will 10084
Cash
Total
21,266
21,266
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WACC
John M. Case LBO How 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 Cash Other current Long term Goodwill otal Liabilities Current Bank loan Seller note VC plug Managers' equity Nominal Effective 0% 0.00% 12% 8.40% 4% 8.17% 9% 21.40% 30% Weight Product 5.95% 0.00% 28.21% 2.37% 18.81% 1.54% 44.67% 9.56% 2.35% 0.71% 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 companys 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
Copyright 2002 Ian H. Giddy
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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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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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Pri i al epayment Coupon payments Total Repayments Return @ NPV NPV @ yr0 E uity Total VC
I) F F# : Or g n Cor Bu n FCF after financing: NPV of FCF after financing NPV of FCF @ yr 0 NPV of VC E uity Total E uity II) FCF#2: xp n on Plan Turnover Profit (margin of 6%) NPV of FCF after financing NPV of FCF @ yr 0 III) To al qu Valuation $ 2,
1448 1702 1920 2114 1982 2002 1268.257 1305.681 1290.083 1244.113 1021.639 903.8505 7034 4486 11520 39%
1000 1400 1960 2744 3073.28 3442.074 60 84 117.6 164.64 184.3968 206.5244 52.55209 64.44019 79.01755 96.89255 95.04891 93.24036 481 , 8
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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?
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www.stern.nyu.edu
www.giddy.org
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
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