Joseph V. Rizzi
Amsterdam Institute of Finance
October, 2014



Goal of deal structure should be to maximize value – but
different parties have different objectives.
Some Buyer Shareholder Objectives:
– Minimize after-tax price paid for the acquisition
– Minimize the dilution of their pre-merger ownership stake
Some Seller Shareholder Objectives:
– Maximize after-tax price received
– Minimize risk of the offer (for a given dollar value of the
deal)
Amsterdam Institute of Finance
October, 2014
2

Price

Form of Transaction

Form of Payment

Control and Governance

Social Issues

Timing and Deadlines

Transaction Hedges
Amsterdam Institute of Finance
October, 2014
3
Creditors
Rights
Regulatory
and Antitrust
Contract
Business
Plan
Market
Conditions
Deal
Accounting
Transaction
Characteristics
Securities
Financial
Preferences
Corporate
Law
Tax
Competing
Bidders
Amsterdam Institute of Finance
October, 2014
4
Competing Bids
Size
Financial Strength
Dilution Analysis
Strategic Fit
Tax
Capital Gains to Seller
WHT on divs and int
Basis
NOL’s
Interest deductibility
Tax treaties
Consolidation
Exit planning
Rating Agencies
Regulatory
Amsterdam Institute of Finance
October, 2014
Contract
Form
Consideration
Pricing
Conditions
Repos and Warranties
Indemnities
Change of Control
Covenants
Securities
Notice
S/H Vote
Tenders
Preemption Rights
Triggers
Bankruptcy Framework
(Inter-creditor Concerns)
Subordination
Guarantees
Corporate
Notice
Percent by Region/State
Lock-Up/Break Up Fee/No Shop
Pills/Defenses
Merger/Consolidation
Antitrust
Hart/Scott/Rodino
Sherman Act
HHI
European Commission
Monopolies & Mergers
Commission
Accounting
Goodwill
Fair Market Value
Net Worth
Consolidation
5
HSR Review Period (30 Calendar Days)
Pre-Commencement
Day 1
Calendar
Calendar
Calendar
Calendar
Period (1 Week)
Week 2
Day 10
Day 20
Day 30
Day 40
•Engage
Investment
Bankers
• Prepare Merger
Agreement,
Stockholders
Agreement & HSR
Premerger
Notification
• Due Diligence
• Fairness Opinion
Issued and Boards
Approve Merger
Agreement
• Arrange Financing
• Determine
Structure (Tax,
Accounting, Form,
Consideration)
• Sign Merger
Agreement &
Stockholders
Agreement
• File HSR
Premerger
Notification
• Commence
Preparation of
Preliminary
Proxy Materials
(Schedule 14A)
• Issue Press
Release
• File 8Ks and
Schedules 13D
Amsterdam Institute of Finance
October, 2014
• File
Preliminary
Proxy Materials
(Schedule 14D)
with SEC
• Print and Mail
Proxy Materials
To Target
Stockholders
(Assumes
Definitive
Proxy Materials
Are Available)
• HSR
Waiting
Period
Expires,
Assuming
No Second
Request
• Target
Stockholder
Meeting
Week 7
• Close
Merger
6
Bank Financing
Acquisition
Bridge
Takedown
Determine
Capital
Structure
Asset Carveout
Securitization \ Prop Co
Fixed-
Hedge No Action
Financial
Flexibility
Credit
Rating
FloatingRate
Target
Credit
Rating
Advisory / Origination
Amsterdam Institute of Finance
October, 2014
Refinance
Bridge
Bank
Funding
Rate
Fixed Income
Equity / Near Equity
Underwriting
Product Execution
7
Purchase/Sale
•
Nondisclosure Agreement
•
Offering Memorandum
•
Data Room
•
Letter of Intent
•
Sale and Purchase Agreement
Financing
•
Commitment Letter(s)
•
Term Sheet
•
Credit Agreements
•
Intercreditor Agreements
Amsterdam Institute of Finance
October, 2014
8
Business
Legal
Entity Basis
Bankruptcy
Payment Priorities
Provisions
Reps/Warranties: What are the facts?
Operating Covenants: Stop digging
Financial Covenants: Preserve deal
Remedies
Structures to reduce credit risk
Guarantees
Pledges of Stock
Subordination
Amsterdam Institute of Finance
October, 2014
9
Parties
Definitions
Form: Merger, Tender, Asset Sale,…
Consideration: Type, Payment, Mechanics, Calculation,…
Reps/Warranties: Duration, Survival
Target: MAC
Buyer: Issue when stock used
Ordinary Course Covenants: Target will operate as usual during signing/closing gap period
Other Agreements: Filings, Meetings,…
Closing Conditions: Regulatory, Shareholder
Termination & Expenses: Drop Dead Fee, Drop Dead Date, Termination Fees
Other Stuff: Choice of Law, Specific Performance
Useful Sites
apps.americanbar.org/…/mspd-letter-of-I
contracts.onecle.com
PLI.edu
Amsterdam Institute of Finance
October, 2014
10
Commitment Letters
MAC
Due Diligence
Syndication
Flex
Marketing Periods
Fraudulent Conveyance
Loan Documentation
Intercreditor
Covenants
Conditions
See: lma.eu.com/documents for drafts
Amsterdam Institute of Finance
October, 2014
11


Rule of Thumb Measures
◦ Balance Sheet Model
◦ Cash Flow Model
Detailed Model
◦ Matching markets to the need
◦ Reverse inquiry
◦ Projections (amortization capability)
Amsterdam Institute of Finance
October, 2014
12
LHS
(value)
(A) Income / DCF
FOCF = NOPAT–(WCI + T + CAPEX)
WACC
Ke – Rf x 2 or CAPM
Debt = ref rate + spread
(B) Relative Value
Comps
Multiples
Trading
Transaction
(C) Breakup Value
Amsterdam Institute of Finance
October, 2014
Transaction
(A) Mechanics
Issues
Tax
Legal
Accounting
Regulation
Focus
Form
Payment
(B) Purchase Price Multiple
(C) Value Allocation
Vp = PreBid Trading + Premium
Vr = PreBid value + Synergy
NVAs = Premium - Synergy
RHS
(Claims)
(A) Concerns
Ratings targets
Market availability - menus
IRR
MDC
(B) Funded Debt Multiples (FDX)
(C) Framework
R/C – tied to BB
Senior (SDX)
TL/A (amortization tied to projections)
3 – 4X FLL
0.5 – 1X SLL
T/LB
SDX - T/LA
Other Debt
FDX - SDX
Equity
PPX – FDX
Subject to IRR constraint
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

Purchase Price
◦ Minimum/Maximum
◦ Recapitalization Dividend
Debt Refinancing
◦ Callability
◦ Premiums
◦ Tax Issues

Expenses

Other Uses
Amsterdam Institute of Finance
October, 2014
14
Senior Secured
First Lien



Revolver
o
o
Tied to advance against current assets
Crossing liens
o
o
Macro: Ratio of 3-4x EBITDA
Micro: Amortization analysis tied to cash flow in years 1-7
o
o
Senior debt ratio less Term Loan A amortization
1% P.A./Balloon
Term Loan A
Term Loan B
Second Lien
o Macro: 0.5-1x EBITDA
o Limited amortization
o Longer term
Senior/Subordinated Unsecured

Other Debt
o

Total Debt/EBITDA less Senior Debt/EBITDA
Equity
o
Funding need less Total Debt/EBITDA
Amsterdam Institute of Finance
October, 2014
15

Current Asset approach
◦ Use standard advance rates
 Accounts Receivable
 Inventory
 PP&E/Net
80%
60%
40%
◦ Consider the following factors
 Seasonal Needs
 Future Working Capital Growth
 Unexpected Liquidity Needs
Amsterdam Institute of Finance
October, 2014
16

Term Loans = Maximum Senior Debt - Revolver

Focus is on Free Operating Cash Flow


Market conditions also dictate the maximum tenor of
the loan and the amount required to be amortized
Acceptable asset coverage is also a consideration in
determining the size of the term loans
Amsterdam Institute of Finance
October, 2014
17

Typical bank financings as structured as follows:
Revolving Credit
Term Loan A (amortising)
Term Loans B & C (bullet/balloon)
• T/LC Rare
Large unfunded revolvers are seldom used today due to the fact that it is capital
unfriendly to banks and companies don’t like to pay for unused commitments.
In the interest of keeping flexibility for the long term, additional indebtedness baskets
should be negotiated upfront. This allows companies to access either the bank or
bond markets under their existing credit agreements and saves the costs of having to
refinance.
Amsterdam Institute of Finance
October, 2014
18


Long Term Debt = Max Total Debt - Max Senior Secured Debt
◦ Senior unsecured
◦ Sub Debt
Equity:
◦ Equity = Total Uses - Max Total Debt
◦ Common
◦ Hybrids
Amsterdam Institute of Finance
October, 2014
19
Senior lenders are concerned with the implications of
having high yield investors at the table during a
restructuring.
EURO High Yield investors to date have not been as vocal
as senior bank lenders, viewing the issue as one of pricing
rather than principle.
All other things being equal, sophisticated investors will
probably price structural subordination at 60-120 bps
premium.
Amsterdam Institute of Finance
October, 2014
20
High Yield Bonds
Holding Company
Subordination
Agreement
100% Equity
Interest
Issues
Intermediate
Holding Company
Operating
Company
Amsterdam Institute of Finance
October, 2014
Operating
Company
Senior Secured
Loan
Operating
Company
21
Issues
Holding Company
High Yield Bonds
100% Equity
Interest
Issues
Intermediate
Holding Company
Senior Secured
Loan
Support Package
Operating
Company
Amsterdam Institute of Finance
October, 2014
Operating
Company
Operating
Company
22
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

There are no standard covenants.
They must be tailored to fit each deal and loan structure.
The steps in structuring the covenants are:
o Identify the risks (business, financial and structural)
o Select Covenants to monitor the risks
• Need to prioritize the risks to monitor because it will be
impossible to monitor every risk
• The time and cost to monitor the covenants must be considered
(i.e., sometimes one covenant can cover multiple risks)
o Set Appropriate Levels
• Want the covenants to trigger a warning before any principal or
interest payments become delinquent. Need to factor in any
seasonal needs to the covenant levels.
Amsterdam Institute of Finance
October, 2014
23
Major Covenants (financial maintenance) – Industry Variation
CAPEX
Debt Service
Fixed Charge
Funded Debt
Reason for Decline
Institutional Loan Investors
High Yield Market
Competition
Amsterdam Institute of Finance
October, 2014
24
• Making sure you get what you thought you were getting
– Legal
 Contingencies: ABB
– Accounting:
McKesson/HBOC
– Business




Licenses
Employment
Leases
EPA
– Etc.
Amsterdam Institute of Finance
October, 2014
Earnings Revisions Study (Messod D. Beneish)
Typical violations of U.S. GAAP include:
– Recording revenues that are fictitious, unearned, or
uncertain
– Recording fictitious inventory
– Improperly capitalizing costs
Violators tend to be smaller (by sales and assets),
more leveraged, and faster growing.
Warning signs include:
– Increase in days receivables
– Decrease in gross margin
– Increase in percentage of total assets represented by
assets other the PP&E.
– Comparatively hgh rate of sales growth
– Increase in percentage of total assets represented by
accruals.
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