Debt-Equity Choice - Yale School Of Management

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Debt-Equity Choice
The Case of Allied Waste
The Company
• Second largest non-hazardous waste
management firm in the U.S.
– Sales 5,248.
– Waste Management is the largest.
• Sales 11,574.
– Republic Services is third.
• Sales 2,518.
• Vertically integrated.
– Collect refuse and “to the extent that it is
economically beneficial” dispose of it in their own
landfills.
EBITDA and FCF
• EBITDA and FCF each play a role when
analyzing a firm’s debt.
• EBITDA
– Excludes capital expenditures and taxes.
– If a firm is near bankruptcy this is the most it
has available to pay off its bonds.
• Firm can, at least temporarily, reduce all capital
expenditures associated with growth.
• No taxes since all free cash flow goes to make
interest payments which are tax deductible.
FCF Before Interest and Taxes
• The FCF before interest and taxes equals
the funds available to the debt holders in
the long run.
– This is just EBITDA – Net Capital
Expenditures.
• A firm that is “100% debt financed” can
pay interest equal to this amount and
continue to makes its ordinary capital
investments.
Allied Waste’s Debt Structure
• Cash and bank debt.
• Corporate bonds of varying maturities and
seniority.
• Asset backed secured debt. Sometimes
used to create off balance sheet debt.
Allied Waste Capitalization
As of March 31, 2004
(Short Term Loans)
Cash and cash equivalents(1)
126
Long-term debt:
Credit facility:
Revolving credit facility(2)(3)
97
2003 term loan B
1,185
2003 term loan C
250
2004 term loan D
150
Total credit facility debt
1,682
Credit Facility Debt
From the June 2004 10-Q
• Starts with a run down of each loan’s face value
and due date.
– Bank credit facility is a senior secured credit facility
(the 2003 Credit Facility) that includes:
– (i) a $1.5 billion revolver due January 2008 (the 2003
Revolver),
– (ii) a $1.2 billion term loan (Term Loan B),
– (iii) a $250 million term loan (Term Loan C),
– (iv) a $150 million term loan (Term Loan D), and
– (v) a $200 million institutional letter of credit facility.
Credit Facility Details About Due
Dates and Uses
• Term Loan D was funded in April 2004. The proceeds of
Term Loan D were used to fund a portion of the tender
offer of the senior subordinated notes due 2009.
– Translation: We repurchased some bonds due in 2009 with this
loan.
• All of the term loans under the 2003 Credit Facility
mature in 2010.
– Due date for items (ii) through (v). Item (i) was previously noted
as due in 2008.
• Of the $1.5 billion available under the 2003 Revolver, the
entire amount may be used to support the issuance of
letters of credit.
– Firm may use the available amount of the loan agreement to
issue another kind of short term debt.
Short Term Debt Outstanding
• At June 30, 2004, we had approximately $11.8 million
drawn and $590.0 million in letters of credit outstanding
under the 2003 Revolver.
• At June 30, 2004, we had approximately $898.2 million
available under the 2003 Revolver.
– This is the difference between what they can borrow and have
borrowed under the Revolver.
– Allows for quick access to cash, but potentially adds a lot of debt
without getting permission from the current debt holders.
• In addition, at June 30, 2004, we had $200.0 million in
letters of credit outstanding under the institutional letter
of credit facility.
Short Term Loan Interest Rates
• The 2003 Credit Facility bears interest at
(a) an Alternative Base Rate, or
(b) Adjusted LIBOR, both terms defined in
the 2003 Credit Facility, plus, in either
case, an applicable margin based on our
leverage ratio.
– LIBOR: London InterBank Offering Rate.
Standard among corporations. A lot like short
term U.S. Treasury rates.
Short Term Interest Rates
LIBOR
Treasury
1-Mo.
3-Mo.
6-Mo.
1-Yr.
6 Mo. Tr.
1 Yr. Tr.
3 Yr. Tr.
Sep-03
1.12
1.16
1.18
1.29
1.03
1.24
2.23
Oct-03
1.12
1.17
1.22
1.46
1.02
1.25
2.26
Nov-03
1.12
1.17
1.23
1.49
1.04
1.34
2.45
Dec-03
1.12
1.16
1.22
1.46
1.01
1.31
2.44
Jan-04
1.10
1.13
1.21
1.46
0.99
1.24
2.27
Feb-04
1.10
1.13
1.20
1.36
1.01
1.24
2.25
Mar-04
1.09
1.11
1.16
1.34
1.01
1.19
2.00
Apr-04
1.10
1.18
1.37
1.81
1.11
1.43
2.57
May-04
1.11
1.31
1.58
2.08
1.33
1.78
3.01
Jun-04
1.36
1.60
1.94
2.47
1.64
2.12
3.26
Jul-04
1.49
1.69
1.99
2.46
1.70
2.10
3.05
Aug-04
1.65
1.79
1.99
2.30
1.75
1.99
2.83
Short Term Loan Restrictions or
Lack Thereof
• Proceeds from the 2003 Credit Facility
may be used for working capital and other
general corporate purposes, including
acquisitions.
– Translation: We can do what we like with the
money.
Where in the Pecking Order are the
Short Term Loans
• We are required to make prepayments on the 2003
Credit Facility upon completion of certain transactions as
defined in the 2003 Credit Facility, including asset sales
and issuances of debt securities.
• Proceeds from these transactions are required to be
applied to amounts due under the 2003 Credit Facility
pursuant to the credit facility agreement.
• We are also required to make prepayments on the 2003
Credit Facility for 50% of any excess cash flows from
operations, as defined.
• Translation: If we generate any substantial free cash
flow or attempt to sell any assets we have to pay off the
short term loans before anybody else sees a nickel.
Allied Waste Capitalization
As of March 31, 2004
(Outstanding Bonds a.k.a. Senior Notes and Debentures)
1998 senior notes, weighted average effective rate of 7.99%(3)
2001 senior notes, weighted average effective rate of 8.94%
650
1,350
November 2002 senior notes, effective rate of 9.39%
377
2003 senior notes, weighted average effective rate of 6.38%
800
February 2011 outstanding notes, effective rate of 5.91%
400
February 2014 outstanding notes, effective rate of 6.33%
425
April 2011 outstanding notes, stated rate of 6.38%
275
April 2014 outstanding notes, stated rate of 7.38%
400
Senior subordinated convertible debentures, stated rate of 4.25%
230
BFI senior notes; net of discount
602
Sample Terms
• The February Notes due 2011 will mature on
February 15, 2011.
• Interest Payment Date to which interest has been paid or
provided for, payable semiannually on February 15 and
August 15 of each year, until the principal thereof is paid
or made available for payment, to the Person in whose
name the note (or any predecessor note) is registered at
the close of business on the preceding February 1 or
August 1, as the case may be.
– Translation: Checks go out on the 15th of February and August
of each year to whoever owned the bond on the 1st of that
month.
Sample Terms Continued
• Interest on overdue principal and premium (if any) and, to the extent
permitted by law, overdue interest at the rate per annum shown on
the front cover of this prospectus plus 2%.
– Translation: If the interest payments are late, the amount owed will
increase at a rate of 5.91% + 2% = 7.91% per annum. That is a 200bps
premium over what the company would normally owe.
– Real Life: If you own the bond and are hoping to invoke this clause
forget about it. If the interest payments are late the firm is probably
bankrupt. Your best hope is that the creditor’s committee can get you
back most of the money you were owed absent this penalty clause.
• Interest will be computed on the basis of a 360-day year of twelve
30-day months.
– Standard 360 day year used for calculating corporate bond interest.
“Guarantees”
•
•
The notes will be fully guaranteed by our parent, Allied Waste Industries,
Inc. In addition, the exchange notes will be guaranteed by substantially all
of our subsidiaries so long as they continue to guarantee our senior credit
facility.
Certain of our subsidiaries will not guarantee the exchange notes.
– As of and for the three months ended March 31, 2004, the non-guarantor
subsidiaries represented in the aggregate approximately 11% of our consolidated
assets and 4% of our consolidated revenues.
•
•
If Allied NA cannot make payments on the exchange notes when they are
due, Allied or the guarantor subsidiaries must make them instead.
For a discussion of the risks relating to the guarantees, see “Risk Factors —
Subsidiaries that guarantee the exchange notes may not guarantee the
exchange notes in the future under certain circumstances” and “Risk
Factors — Federal and state statutes may allow courts to further
subordinate or void the guarantees.
– Federal and state statutes allow courts, under specific circumstances, to void or
subordinate guarantees and require noteholders to return payments received
from guarantors.”
Guarantees Translated
• Allied Waste promises to pay off on the bonds if
they can.
• If Allied Waste cannot pay then their subsidiaries
will pay. That is unless the subsidiary is exempt
from this clause.
– About 11% or 4% of the subsidiaries depending on
how you count.
• It is possible that some court will tell Allied
Waste not to make a bond payment. If that
happens you are out of luck.
Redemption
a.k.a. Call Provisions
• The February Notes due 2011 will be subject to redemption, at the
option of Allied NA, in whole or in part, at any time, upon not less
than 30 nor more than 60 days’ notice mailed to each Holder of
February Notes due 2011 to be redeemed at such Holder’s address
appearing in the Security Register, in amounts of $1,000 or an
integral multiple of $1,000, at a redemption price equal to the greater
of:
– (1) 100% of their principal amount or
– (2) the sum of the present values of the remaining scheduled payments
of principal and interest thereon discounted to maturity on a semiannual basis (assuming a 360-day year consisting of twelve 30-day
months) at the Treasury Yield plus 50 basis points, plus in each case
accrued but unpaid interest (including Special Interest) to but excluding
the Redemption Date (subject to the right of Holders of record on the
relevant Regular Record Date to receive interest due on an Interest
Payment Date that is on or prior to the Redemption Date).
Call Provision Translation
• AW can call the bonds by giving mailing you a letter
saying they want the bond back within the next 30 to 60
days.
• The will only call say half a bond ($500). If they call a
bond it will be the whole bond ($1,000).
• If your bond is called you will get back at least $1,000,
clause (1).
– However, the second condition makes this clause irrelevant.
• Clause (2) says you will get the PV of the cash flows
discounted at treasury plus 50bps.
– This is better than then AAA rate and AW is a BB company.
– This clause is NOT typical of companies issuing BB grade debt.
Call Provisions Continued
• “Equity Claw Back”
• At any time, or from time to time, prior to February 15, 2007, up to
33 1/3% in aggregate principal amount of the February Notes due
2011 originally issued under the Indenture will be redeemable, at the
option of Allied NA, from the net proceeds of one or more Public
Offerings of Capital Stock (other than Redeemable Interests) of
Allied, at a redemption price equal to 105.750% of the principal
amount thereof, together with accrued but unpaid interest (including
Special Interest) to the Redemption Date (subject to the right of
Holders of record on the relevant Regular Record Date to receive
interest due on an Interest Payment Date that is on or prior to the
Redemption Date); provided that the notice of redemption with
respect to any such redemption is mailed within 30 days following
the closing of the corresponding Public Offering.
Equity Claw Back Translation
• The bonds come due on February 2011.
• If the company issues equity prior to
February 2007 the company can call 1/3 of
the bonds at 105.75.
– The money for the call has to come from the
equity issue.
• Typically this provision is in force for the
first three years after the bond is issued.
Why a Claw Back?
• Good for company.
– An option to do something never hurts.
– Allows the firm to reduce its debt load if the
equity markets make it attractive to do so.
• Good for bond holders.
– If the firm buys back bonds by issuing equity
the remaining bonds are worth more.
• Notice that only 1/3 of the bonds can be called this
way. Bond holders allowed to profit on the other
2/3rds.
Seniority Rights
• The notes and the guarantees will rank equal in
right of payment to our current and future senior
debt and will rank senior in right of payment to
our current and future subordinated debt.
• Translation: AW can in the future issue
additional senior debt. This debt will have equal
rank the all of the other senior debt.
– Seniority is an issue for when a firm goes bankrupt.
In theory, senior securities have to be paid in full
before junior securities. More on this when we
discuss bankruptcy.
– Note older “senior” debt is not more senior than more
recent debt.
Change in Control Provision
• Also known as “Event Risk Protection”
– Relatively rare these days.
• Within 30 days following the date Allied NA becomes aware of the
consummation of a transaction that results in a Change of Control
(as defined below), Allied NA will commence an offer to purchase all
outstanding notes, at a purchase price equal to 101% of their
aggregate principal amount plus accrued interest, if any, to the date
of purchase (subject to the rights of Holders of record on the
relevant Regular Record Date to receive interest due on an Interest
Payment Date that is on or prior to the date of purchase). Such
obligation will not continue after a discharge of Allied NA or
defeasance from its obligations with respect to the exchange notes.
See “— Defeasance.”
Event Risk Protection –Translation
• Change in control forces the firm to
automatically call all of its debt at 101.
• Why?
– Leveraged buyouts.
• In a leveraged buyout the bidder takes on a substantial
amount of debt to buy the target.
• The new debt causes the current debt to fall in value,
sometimes by a substantial amount.
– Note, this happens in part because the new debt has equal
seniority to the old debt.
• This clause prevents such buyouts from adversely impacting
the current bond holders.
What is a Change in Control?
• A “Change of Control” will be deemed to have occurred if
• (a) any Person, or any Persons (other than a Permitted
Allied Successor, as defined below), acting together …
beneficially own 50% or more of the total voting power of
all classes of Voting Stock of Allied,
– Translation: If a group manages to get 50% of the firm’s
common stock the bonds get called.
• (b) any Person or Group, … succeeds in having a
sufficient number of its nominees who have not been
approved by the Continuing Directors elected to the
Board of Directors … constitute a majority of the Board
of Directors of Allied, or
– Translation: If shareholders elect to the board a majority of
people that the old board does not approve of (the one that just
lost), the bonds get called.
More Changes in Control
• (c) there occurs any transaction or series of related transactions
other than a merger, consolidation or other transaction with a
Related Business in which the shareholders of Allied immediately
prior to such transaction (or series) receive:
– (i) solely Voting Stock of Allied (or its successor or parent, as the case
may be),
– (ii) cash, securities and other property in an amount which could be paid
by Allied NA as a Restricted Payment under the Indenture after giving
pro forma effect to such transaction, or
– (iii) a combination thereof, and the beneficial owners of the Voting
Stock of Allied immediately prior to such transaction (or series) do not,
immediately after such transaction (or series), beneficially own Voting
Stock representing more than 50% of the total voting power of all
classes of Voting Stock of Allied … ,
• Translation: Somebody offers to take over Allied Waste. They offer
to pay for the stock. They get over half the stock. Then the bonds
get called.
Rating Changes – Increases
(“Rating Event Date”)
• Following the first date upon which any series of notes are rated the
following: (i) Baa3 or better by Moody’s Investors Service, Inc.
(“Moody’s”) and BB+ or better by Standard & Poor’s Ratings Group
(“S&P”); or (ii) BBB-or better by S&P and Ba1 or better by Moody’s
(a “Rating Event”) … the covenants specifically listed under “—
Repurchase at the Option of Holders — Asset Dispositions,” “—
Certain Covenants — Limitation on Consolidated Debt,” “—
Limitation on Restricted Payments,” “— Limitations Concerning
Distributions by Subsidiaries, Etc.,” “— Limitation on Transactions
with Affiliates and Related Persons” and “— Unrestricted
Subsidiaries” in this prospectus will no longer be applicable to such
series of notes subject to the Rating Event.
• Translation: If by some miracle the rating agencies increase our
rating to investment grade then most of the limitations imposed on
Allied Waste by its bond covenants get turned off.
Rating Changes – Decreases after
an Investment Grade Rating
• … at no time after a Rating Event Date will the
provisions and covenants contained in the
Indenture at the time of the issuance of the
notes that cease to be applicable after the
Rating Event Date be reinstated.
• Translation: If the bonds go from investment
grade back to junk the covenants that were
turned off on the upswing stay off.
Allied Waste Capitalization
As of March 31, 2004
(Other Types of Debt)
Receivables secured loan
138
Solid waste revenue bond obligations
306
Notes payable and obligations under capital leases
1999 senior subordinated notes, effective rate of 10.22%
Current portion of long-term debt
21
397
-105
Total long-term debt, net of current portion
7,949
Current Prices and Yields
• Bloomberg provides “Bloomberg Fair Value”
prices.
• These are “matrix” prices.
• Based upon the bond rating, the coupon, the
treasury yield curve, and the current spread
above treasury for bonds of similar ratings.
• Not true prices, but better than nothing and often
accurate for bonds that have not recently gone
up or down in value by substantial amounts.
AW Long Maturity Debt
S&P Rating: BB5 ¾ 02/15/11
6 1/8 02/15/14
Date
Price
YTM
Price
YTM
9/2
97.29
6.267
95.18
6.826
9/1
97.75
6.179
95.83
6.728
8/31
98.01
6.128
96.19
6.674
8/30
97.72
6.183
95.84
6.726
AW Short Maturity Debt
S&P Rating: BB-
Date
7 5/8 01/01/06
Rating: BBPrice
YTM
8 7/8 04/01/08
Rating: BBPrice
YTM
9/2
105.027 3.665
111.25
5.361
9/1
105.059 3.648
111.56
5.276
8/31
104.805 3.871
111.70
5.243
8/30
104.912 3.798
111.51
5.302
Prices and Yields
• Note that the YTM on the bonds varies from bond to
bond.
– Implies that the number typically calculated for the company’s rD
depends on the maturity structure of its debt.
• This contrasts with the typical story that it depends on the firm’s
bond rating.
• Bonds have book values of 100 but can trade well above
or below that.
– This is an easy problem to fix. Check on the Bloomberg
terminal.
– Other than for the next case you do not need to do this for our
class cases. Just remember we are taking a potentially costly
shortcut. Do it right when there is real money at stake!
Allied Waste Capitalization Outstanding Debt – Part I
(As of September 1, 2004 via Bloomberg)
Maturity Date
Coupon
Book
Value
Price per
Bond
Yield to
Worst
Spread
Over Treas.
January 2006
7 5/8
599.5
105.30
3.388
+63
January 2006
7 5/8
0.5
104.56
3.963
+54
April 2008
8 7/8
591.695
111.81
5.18
+238
April 2008
8 7/8
8.385
109.57
5.844
+240
December 2008
8 1/2
750
108.82
6.088
+264
December 2008
8 1/2
750
111.26
5.464
+260
January 2009
7 7/8
0.3
104.11
2.644
-102
August 2009
10
921
105.95
-2.414
-628
November 2010
6 1/2
350
102.68
5.975
+323
February 2011
5 3/4
400
98.46
6.043
+258
April 2011
6 3/8
275
101.65
6.066
+260
Allied Waste Capitalization Outstanding Debt – Part II
(As of September 1, 2004 via Bloomberg)
Maturity Date
Coupon
Book
Value
Price per
Bond
Yield to
Worst
Spread
Over
Treas.
September 2012
9 1/4
375
113.12
5.811
+194
April 2008
7 7/8
450
108.18
6.284
+265
February 2014
6 1/8
425
96.62
6.612
+277
April 2014
7 3/8
400
98.45
7.604
+363
April 2014
4 1/4
230
91.97
4.758
-17
105.85
4.537
112.32
Market Value
Weighted Average
Total
6526.38
Negative Spreads?
• Look at the call and conversion provisions!
• January 2009, 7 7/8 bonds.
– Price: 104.1
– Call: 101 5/16 on 1/1/2005
• August 2009, 10 bonds.
– Price: 105.95
– Call: 103.33 on 8/1/2005
• April 2014, 4 ¼
– Convertible into stock. Price reflects the value of the
conversion provision.
AW More or Less Debt?
• If AW added or subtracted debt what
would that do to the yield it would have to
offer on its bonds?
• To find the answer look at the bond yield of
its competitors and their debt to equity
ratios.
Waste Management (WMI) Capitalization Outstanding Debt – Part I
(As of September 1, 2004 via Bloomberg)
Maturity Date Coupon
Book
Value
Price per
Bond
Yield to
Worst
Spread
Over
Treas.
Nov-08
6 1/2
400
109.81
3.922
+51
May-09
6 7/8
0.265
110.3
4.407
+101
May-09
6 7/8
499.735
111.652
4.103
+62
Feb-01
7 3/8
600
115.3103
4.389
+95
Mar-11
7 2/3
150
116.1702
4.73
+136
Nov-12
6 3/8
400
109.884
4.891
+74
Nov-12
6 3/8
400
106.0881
5.44
+129
Waste Management (WMI) Capitalization Outstanding Debt – Part II
(As of September 1, 2004 via Bloomberg)
Maturity Date
Coupon
Book
Value
Yield to
Worst
Spread
Over Treas.
Mar-14
5
350
99.2076
5.073
+85
May-18
8 3/4
250
115.2716
4.165
+5
May-29
7 3/8 249.9
25
111.9892
6.401
+129
May-29
7 3/8 0.075
108.8738
6.638
+165
May-32
7 3/4
120.6307
6.183
+125
112.03
4.902
88.60
500
Market Value
Weighted
Average
Total
Price per
Bond
3800
Republic Services (RSG) Capitalization Outstanding Debt
(As of September 1, 2004 via Bloomberg)
Maturity Date Coupon
Book
Value
Yield to
Worst
Spread
Over Treas.
May-09
7 1/8
375
113.07
4.022
+61
Aug-11
6 3/4
450
112.66
4.591
+127
112.85
4.332
96.94
Market Value
Weighted
Average
Total
Price per
Bond
825
Cross Firm Comparisons
Using Bonds Due 2009 and 2011
Firm
Spread
2011
+258
D/E
WMI
Spread
2009
+260,
+323†
+62
+136
1.52 3.68
20,659.98
RSG
+61
+127
0.71 5.40
5,499.78
AW
Interest
Enterprise
Coverage‡ Value (D+E)
3.11 1.11
10,183.77
† Bonds due 2008 and 2010. No AW bonds due 2009 unaffected by
call provisions.
‡ EBIT/Interest Expense
AW Less Debt?
• If AW reduced its debt by about 50% it appear
that it could reduce its spread over treasuries by
about 50%.
• Cost: reduced debt tax shield.
• How can AW accomplish this if it wants to?
– Bad: Buy back bonds.
• Benefits bond holders at the expense of shareholders. Why?
– Better: Do not reissue bonds when they come due or
can be called.
• Still benefits bond holders: Less debt = Happier bond
holders.
AW More Debt?
• Current Covenants (from the 10-K)
– Minimum Interest Coverage: 1.9 rising to 2.75.
• Currently: 1.11, but EBITDA may not be calculated for this
purpose as we have in class. Answer in “Exhibit 10.91”
which I do not have.
– Maximum Leverage (Total Debt/EBITDA): 5.75
dropping to 4.0.
• Currently: .15
• Not clear that the firm can issue more debt.
AW With Half the Debt
•
•
•
•
Assume 150bps drop in interest.
Total debt: 6526.38/2 = 3263.19
Total interest savings: 48.94 per year.
Tax rate of about 40% (official number is
higher): Lost tax savings of 19.57 per
year.
• Is it worth it?
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