Joseph V. Rizzi
Amsterdam Institute of Finance
June, 2010

Hedge Finance

Speculative Finance

Ponzi Finance

Fantasy Finance
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June, 2010
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June, 2010
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• Cash Flow

Impacts default risk
• Balance Sheet

Determines Loss in Event of Default (LIED)

Liquidity
Valuation
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June, 2010
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•
•
•
Business Risk: EBITDA Volatility
◦ Industry Characteristics
◦ Firm Characteristics
Financial Risk: EBITDA Relative to Debt
Structural Risk
◦ Issues
 Priority of claim on assets and income
 Control
◦ Focus
 Covenants, Seniority, Security
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June, 2010
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•
Quantitative
◦
◦
◦
Capitalization
 Cash Equity
 Total Debt
 Senior Debt (1)
 First Lien
 Second Lien
>25%
<6.0x
<4.5x
<4.0x
<0.5x
Cash Flow
 LTM EBITDA / PFI
 7 x LTM FFOCF / TLA(2)
>2:1
>1:1
Liquidity
 Cash + MS + RCA / P+I
(3)
> 1.5 : 1
1:- TLA usually >20% of senior debt and amortizes at least 30% by year 5
2:- FFOCF = LTM EBITDA - (WCI + CAPEX + Taxes + PF Interest)
3:- Liquidity tested day 1. MS (Marketable Securities). RCA (Revolving Credit Availability). Revolver usually set at 1 x EBITDA
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June, 2010
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•
Debt capacity is derived from firm’s assets
◦ Operating Cash Flows
◦ Asset Sales / Asset Quality
◦ Leveragability
Market Conditions
Credit curve shifts over
time depending on the economy
•
Rates
•
Target financing structure
Amsterdam Institute of Finance
June, 2010
2H
07
Cris
is
Overheated 1H07
Rating
7

There are two different approaches to designing the capital structure:
Amsterdam Institute of Finance
June, 2010
Cash Flow
Model
Balance Sheet
Model
3 - 4x
EBITDA
50%
4 - 6x
EBITDA
30%
Equity
20%
Senior Debt
Sub Debt
Equity
8
•
Ratio Approach
•
Cash Flow
•
Advance Rate
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June, 2010
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Market
◦ Maximum senior debt and total debt ratios
◦ Vary over cycle
Peers
◦ Identify
◦ Rating Classification
◦ Key Ratios
Rating Agencies
◦ Credit Statistics
Amsterdam Institute of Finance
June, 2010
10
12 Months Ended
Sales
Gross Margin
EBITDA
Margin
Interest Expense
Capex
% of Sales
Total Assets
ABC
DEF
GHI
JKL
MNO
PQR
STU
02/10/20xx 30/09/20xx 01/01/20xx 30/09/20xx 31/10/20xx 30/11/20xx 31/12/20xx
3073.8
8294.9
6165.2
852.4
2345.8
1682.1
2133.4
25.6%
14.4%
16.3%
19.8%
22.0%
16.6%
17.1%
153.7
430.1
272.3
35.9
130.8
77.3
100.3
5.0%
5.2%
4.4%
4.2%
5.6%
4.6%
4.7%
34.4
78.6
49.6
13.2
19.5
15.3
25.0
32.1
40.7
37.1
9.8
25.8
11.3
27.8
1.0%
0.5%
0.6%
1.1%
1.1%
0.7%
1.3%
1482.0
3835.4
2790.1
360.5
1099.5
829.3
961.5
Secured Bank Debt
Unsecured Bank Debt
Other Senior Debt
Total Senior Debt
Subordinated Debt
Total Debt
Equity
Total Capitalization
455.4
0.0
111.7
567.1
0.0
567.1
419.9
987.0
Total Debt/EBITDA
Senior Debt/EBITDA
Total Debt/Capital
EBITDA/Interest (incl. A/S)
3.7
3.7
57.5%
4.5
2.5
2.1
42.8%
5.5
BBBNR
AA3
Credit Ratings
S&P
Moody's
Market Capitalization
Enterprise Value
Ent Value/EBITDA
Ent Value/Sales
Ent Value/Book Value
Earnings per Share
Amsterdam Institute of Finance
June, 2010
468.2
1035.3
6.74
0.34
2.47
$
1.78
0.0
504.6
391.4
896.0
197.6
1093.6
1461.1
2554.7
1482.0
2575.6
5.99
0.31
1.76
$
1.73
0.0
175.9
708.2
884.1
0.0
884.1
1293.3
2177.4
117.8
0.0
6.3
124.1
0.0
124.1
150.2
274.3
0.0
208.0
179.2
387.2
0.0
387.2
473.8
861.0
0.0
210.0
0.0
210.0
0.0
210.0
414.4
624.4
0.0
37.6
75.0
112.6
143.7
256.3
262.5
518.8
3.2
3.2
40.6%
5.5
3.5
3.5
45.2%
2.7
3.0
3.0
45.0%
6.7
2.7
2.7
33.6%
5.1
2.6
1.1
49.4%
4.0
A
A2
NR
NR
NR
NR
NR
NR
BB
Baa3
1295.8
2179.9
8.01
0.35
1.69
$
2.83
$
104.4
228.5
6.36
0.27
1.52
(0.06)
$
510.9
898.1
6.87
0.38
1.90
2.37
$
249.2
459.2
5.94
0.27
1.11
1.69
$
177.9
434.2
4.33
0.20
1.65
1.09
Peer
Average
3506.8
18.8%
171.5
4.8%
33.7
26.4
0.9%
1622.6
XYZ
Actual
31/12/20xx
3025.4
17.8%
122.6
4.1%
55.2
10.7
0.4%
950.5
211.9
0.0
42.6
254.5
289.2
543.7
(69.0)
474.7
3.0
2.8
44.9%
4.8
4.4
2.1
114.5%
2.2
XYZ
Pro-Forma
31/12/20xx
3205.3
17.4%
134.5
4.2%
55.8
10.7
0.3%
952.3
83.2
0.0
8.3
91.5
289.2
380.7
96.4
477.1
2.8
0.7
79.8%
2.4
BBBa2
612.6
1115.8
6.32
0.30
1.73
$
1.63
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
Important:
Loan Market Evolution from a
bank to an institutional market
(back to a bank market?)

Impact:
Majority of syndicated loans are
rated

Pricing:
Affected by rating
Amsterdam Institute of Finance
June, 2010
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Transformation: European LBO market transformed during 202-2007 from
conservative cash flow based largely bank funded (OTD) originate to rated
distribute market funded by non bank CLO demand.
Credit Quality: Ratings mitigration - 2002 – 75% B+/B or higher
2010 – 59% B – or lower
Amsterdam Institute of Finance
June, 2010
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Amsterdam Institute of Finance
June , 2010
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1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
10YTD
Amsterdam Institute of Finance
June, 2010
PPX
FDX
7.9
7.23
6.07
5.81
6.44
7.0
6.92
8.16
8.15
9.51
9.15
7.43
8.13
5.4
4.7
4.2
4.1
4.0
4.6
4.8
5.25
5.43
6.23
4.9
4.0
4.37
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June , 2010
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
Maximum debt capacity formula:MDC = f(operations, amortization, rate, asset sales)
MDC = [EBIT / (i+ 1/n)] + AS + RF
EBIT
i
n
AS
RF
Amsterdam Institute of Finance
June, 2010
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Earnings Before Interest and Taxes
Interest Rate
Straight line loan amortization
Proceeds from Asset Sales
Refinancing
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



Issues
◦ Adjustments (beware of solving for cash flows to justify price)
◦ Normalization
 Cyclicality
 Bad Management
Value Test
◦ Projections implied price
Reverse Engineer - Management implied forecast
◦ Firms
◦ Peers
Tie Into
◦ Compensation
◦ Covenants
Amsterdam Institute of Finance
June, 2010
18

Macro/Market Level
◦ Determine rating target
◦ Use target rating level financial characteristics
 Funded Debt/EBITDA
 EBITDA/Interest Expense
 Funded Debt/Total Cap

(A)
(B)
(C)
(D)
(E)
Example:
Target Rating
EBITDA/Int for Target Rating
Firm EBITDA
Interest Rate for Target Rating
Maximum Debt Capacity
Amsterdam Institute of Finance
June, 2010
BB
c3.0x
$300mln
10%
= (C/B)/D
= (300/3)/10%
= $1,000
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June, 2010
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Source S&P
Amsterdam Institute of Finance
June, 2010
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


Tend to default at same rate as similarly rated non sponsored
firms
Larger deals tend to have worse performance
PE underwriting performance varies
Firm
Defaulted and Distressed Deals (D&D) (%)
Cerberus
4(67%)
Apollo
13 (65%)
TH Lee
6 (55%)
Carlyle
16(52%)
Bain
10(45%)
Goldman
8(38%)
Warburg
5(36%)
Providence
4(33%)
TPG
6(32%)
Welsh
4(31%)
JPM
2(29%)
Blackstone
6(27%)
Madison
3(25%0
KKR
3(15%)
Amsterdam Institute of Finance
June, 2010
Source: Moody’s
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Initiation of Bankruptcy
-
Who has the right to file for bankruptcy?
What kinds of enterprises should be eligible to file for bankruptcy?
Can the decision to file be challenged?
When should inappropriate cases be terminated?
Preserving Firm Value / Minimizing Business Losses in Bankruptcy
- Should the business be reorganized or liquidated?
- How should creditors be prevented from dismembering the business?
- Should the debtor be required to honor pre-bankruptcy contracts with
suppliers and lenders?
- Should debtor-in possession (DIP) financing be made available?
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June, 2010
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Corporate Governance in Bankruptcy
- Should the debtor’s decision making authority be limited?
- How should debtor management be monitored?
Choosing the Plan of Reorganization
-
Should the process be consensual or formulaic?
Who has the right to propose a plan?
How should the plan be voted upon?
How should dissenting claimholders be treated?
Should there be a time limit?
How should the debtor’s new capital structure be determined?
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June, 2010
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Equilibrium
Restructure
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June, 2010
ASSETS
LIABILITIES
+
EQUITY
ASSETS
LIABILITIES
+
EQUITY
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How Big is the pie?
- Valuation of LHS
How much does each claimholder receive?
- RHS waterfall analysis
- Legal System
How should this consideration be paid?
- Cash
- Instruments
How much debt can the company support after a reorganization?
- Debt capacity
Amsterdam Institute of Finance
June, 2010
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•
•
•
Determining debt capacity using credit
analysis
Expanding debt capacity
What to expect when you exceed debt
capacity
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June, 2010
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Banks Lose $3.7B in loans - $20.9B
Goldman - $850
ABN Amros/RBS - £1B write-off on $3.4B
claim
UBS - $500
Out of Season – 2H07/1H07
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June, 2010
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Purchase Price
20% Premium to 7/16/07 closing price
Commodity
Basell/Blavatnik and Lyondell – Russian
Rule
DIP – Debt converted into post petition
financing
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June, 2010
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June, 2010
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June, 2010
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June, 2010
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June, 2010
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This information has been prepared solely for informational purposes and is not
intended to provide or should not be relied upon for accounting, legal, tax, or
investment advice. The factual statements herein have been taken from sources
believed to be reliable, but such statements are made without any representation
as to accuracy or completeness. Opinions expressed are current opinions as of the
date appearing in this material only.
These materials are subject to change,
completion, or amendment from time to time without notice and CapGen Financial
is not under any obligation to keep you advise of such changes.
All views
expressed in this presentation are those of the presenter, and not necessarily those
of CapGen Financial.
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June, 2010
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