Review of
Corporate Financial
Restructuring
Prof. Ian Giddy
New York University
Corporate Financial Restructuring
Why Restructure?
Proactive
Example:
Sealed Air

Management acts to
preserve or
enhance
shareholder value
Copyright ©2002 Ian H. Giddy
Defensive
Example:
Loewen 1996

Management acts to
protect company,
stakeholders and
management from
change in control
Distress
Example:
Loewen 1999

Lenders and
shareholders lose,
but try to work out
best way to
minimize loss
Corporate Financial Restructuring 2
Corporate Financial Restructuring





Corporate restructuring –
business and financial
Structured financing
techniques
Proactive restructuring
Distress-induced
restructuring
Mergers, divestitures and
LBOs
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 3
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)
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 4
“Nexus of Contracts”
Franchisors
Senior lenders
Salespeople
Subordinated
lenders
Management
Copyright ©2002 Ian H. Giddy
Shareholders
Corporate Financial Restructuring 5
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

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 6
Novartis: Financial Restructuring
Fixed the cash
and working
capital
Assets
Liabilities
Cash
Debt
Fixed
Assets
Equity
Fixed the
capital
structure
Divested
Non-core
business
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 7
Restructuring Checklist
Figure out what the business is
worth now
Use valuation model – present value
of free cash flows
Fix the business mix – divestitures
Value assets to be sold
Fix the business – strategic partner
or merger
Value the merged firm with
synergies
Fix the financing – improve D/E
structure
Revalue firm under different
leverage assumptions – lowest
WACC
Fix the kind of equity
What can be done to make the
equity more valuable to investors?
Fix the kind of debt or hybrid
financing
What mix of debt is best suited to
this business?
Fix management or control
Value the changes new control
would produce
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 8
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
Copyright ©2002 Ian H. Giddy
After Restructuring
Liquidation
Corporate Financial Restructuring 9
Getting the Financing Right
Step 1: The Proportion of Equity & Debt

Debt

Equity
Copyright ©2002 Ian H. Giddy
Achieve lowest
weighted average
cost of capital
May also affect the
business side
Corporate Financial Restructuring 10
Getting the Financing Right
Step 2: The Kind of Equity & Debt


Debt


Equity
Bonds? Asset-backed?
Convertibles? Hybrids?

Debt/Equity Swaps?
Private? Public?
Strategic partner?
Domestic? ADRs?

Ownership & control?



Copyright ©2002 Ian H. Giddy
Short term? Long term?
Baht? Dollar? Yen?
Corporate Financial Restructuring 11
Capital Structure: Optimal Range?
Nestle
VALUE
OFTHE
FIRM
Loewen
Optimal debt ratio?
DEBT
RATIO
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 12
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+?
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 13
Ratings and Spreads
Corporate bond spreads: basis points over Treasury curve
Rating
1 year
2 year
5 year
10 year
30 year Typical Int Coverage Ratios
Aaa/AAA
40
45
60
85
96 >8.50
Aa1/AA+
45
55
70
95
106 6.50-8.50
Aa2/AA
55
60
75
105
116 6.50-8.50
Aa3/AA60
65
85
117
136 6.50-8.50
A1/A+
70
80
105
142
159 5.50-6.50
A2/A
80
90
120
157
179 4.25-5.50
A3/A90
100
130
176
196 3.00-4.25
Baa1/BBB+
105
115
145
186
208 2.50-3.00
Baa2/BBB
120
130
160
201
221 2.50-3.00
Baa3/BBB140
145
172
210
232 2.50-3.00
Ba1/BB+
225
250
300
350
440 2.00-2.50
Ba2/BB
250
275
325
385
540 2.00-2.50
Ba3/BB300
350
425
460
665 2.00-2.50
B1/B+
375
400
500
610
765 1.75-2.00
B2/B
450
500
625
710
890 1.50-1.75
B3/B500
550
750
975
1075 1.25-1.50
Caa/CCC
600
650
900
1150
1300 0.80-1.25
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 14
Interest Coverage Ratios, Spreads and
Ratings: Small Firms
If interest coverage ratio is
greater than
≤ to
-100000
0.499999
0.5
0.799999
0.8
1.249999
1.25
1.499999
1.5
1.999999
2
2.499999
2.5
2.999999
3
3.499999
3.5
4.499999
4.5
5.999999
6
7.499999
7.5
9.499999
9.5
12.499999
12.5
100000
Copyright ©2002 Ian H. Giddy
Rating is
D
C
CC
CCC
BB
B+
BB
BBB
AA
A+
AA
AAA
Spread is
14.00%
12.70%
11.50%
10.00%
8.00%
6.50%
4.75%
3.50%
2.25%
2.00%
1.80%
1.50%
1.00%
0.75%
Example:
EBIT
Interest expense
LT Govt bond rate
10000
2500
6.00%
Interest coverage ratio =
Estimated Bond Rating =
Estimated Default Spread =
Estimated Cost of Debt =
4
BBB
2.25%
8.25%
Corporate Financial Restructuring 15
Optimal Debt Ratio for a Private
Company: Example
Debt RatioBetaCost of EquityB ond RatingInterest Rate
AT Cost of Debt
Cost of CapitalFirm Value
0%
1.03 12.65%
AA
7.50%
4.35%
12.65% $26,781
10% 1.09 13.01%
AA
7.50%
4.35%
12.15% $29,112
20% 1.18 13.47%
BBB
8.50%
4.93%
11.76% $31,182
30% 1.28 14.05%
B+
9.50%
5.51%
11.49% $32,803
40% 1.42 14.83%
B11.25%
6.53%
11.51% $32,679
50% 1.62 15.93%
CC
13.00%
7.54%
11.73% $31,341
60% 1.97 17.84%
CC
13.00%
7.96%
11.91% $30,333
70% 2.71 21.91%
C
14.50%
10.18%
13.70% $22,891
80% 4.07 29.36%
C
14.50%
10.72%
14.45% $20,703
90% 8.13 51.72%
C
14.50%
11.14%
15.20% $18,872
Damodaran’s spreadsheets:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 16
TDI Financial History
TDI
140
$ millions
120
100
80
Debt
60
EBITDA
40
20
0
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 17
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
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 18
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
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 19
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?
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 20
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.

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 21
Leveraged Recapitalizations

Motivations:
Defensive
Proactive
Ownership

transition/liquidity
Which produces what value?
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 22
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?

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 23
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.
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 24
Asset-Backed Securities:
Ford Credit Owner Trust 1999-A
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 25
Credit Enhancement: Guarantee Method
Finance Co.’s
Customers
Hire-Purchase
Agreement
Finance Co. Ltd
(Seller)
Rating Agency
Top Rating
Servicing Agreement
Proceeds
FCL 1997-A
(Special Purpose Co.)
Sale of Assets
Proceeds
Investors
Asset-Backed
Securities
Trustee
Trust
Agreement
Copyright ©2002 Ian H. Giddy
Guarantee
Agreement
Financial Guarantee
Provider
(if required)
Corporate Financial Restructuring 26
Credit Enhancement:
An Alternative Approach
Rating Agency
Top Rating
Senior
Lower Rating
Finance Co. Ltd
(Seller)
Proceeds
FCL 1997-A
(Special Purpose Co.)
Subordinated
Sale of Assets
No Rating
More Subordinated
Guarantee
Agreement
Copyright ©2002 Ian H. Giddy
Financial Guarantee
Provider
(if required)
Corporate Financial Restructuring 27
The Alternative: Synthetic ABS
DB (Originator)
REFERENCE
POOL OF LOANS
(Stay on
balance sheet)
CREDIT SWAP
AGREEMENT
SPECIAL
PURPOSE
VEHICLE
TOP QUALITY
INVESTMENTS
Copyright ©2002 Ian H. Giddy
ISSUES
ASSET-BACKED
CERTIFICATES
Corporate Financial Restructuring 28
Corporate Financial Restructuring
Why Restructure?
Proactive
Example:
Sealed Air

Management acts to
preserve or
enhance
shareholder value
Copyright ©2002 Ian H. Giddy
Defensive
Example:
Loewen 1996

Management acts to
protect company,
stakeholders and
management from
change in control
Distress
Example:
Loewen 1999

Lenders and
shareholders lose,
but try to work out
best way to
minimize loss
Corporate Financial Restructuring 29
Match the Solution to the Problem
Trouble!
Reason
The financing
is bad
Business
mix is bad
The company
is bad
Remedy
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
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 30
Reorganization Processes

Out-of-court negotiated settlement

Firm continues





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)



Exchange: equity for debt
Extension: pay later
Composition: creditors agree to take less
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


Copyright ©2002 Ian H. Giddy
Statutory assignment: assignee liquidates assets under formal legal
procedures
Ch 7 liquidation: bankruptcy court supervises liquidation
Corporate Financial Restructuring 31
When Default Threatens,
Value the Company
Highest Valuation of Company?
Merged Value
Sale to Strategic Buyer
Going Concern Value
Auction
Voluntary Reorganization
Existing Management
Copyright ©2002 Ian H. Giddy
Ch 11 Reorganization
Liquidation Value
Voluntary Liquidation
Ch 7
New Management
Corporate Financial Restructuring 32
Zombie Inc Valuation
Share Valuation
Shares
Book Value
Acquisition Value
Management Est.
NPV, based on
EBITDA
WACC
Growth
Debt
Debt at 65%
Option value?
Bank lenders
Debt (at market)
Equity (NPV value)
Total
Copyright ©2002 Ian H. Giddy
$
$
$
Before
400,000
10.00 $
8.00
20.00 $
After
850,000
10.00
9.41
1,000,000
1,000,000
17.43%
10.68%
2%
2%
10,100,000
5,600,000
$
(8.72) $
7.23
$
0.11
Before
5,850,000
0
5,850,000
After
3,600,000
3,254,631
6,854,631
Corporate Financial Restructuring 34
Valuation in Distress Restructuring
Liquidation value
 Acquisition price
 Enterprise value

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 35
Enterprise Valuation in Distress
Restructuring
Multiples
 FCFF discounted at WACC
 APV
 Capital Cash Flows
 Option Value

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 36
Marvel

Banks


Choices:
Accept Perelman’s plan
Sell the debt at $.14-$.17
Reject plan and propose own

Controls Marvel equity
NPV is negative
Option value may be positive
Icahn et al.
Perelman


Copyright ©2002 Ian H. Giddy
Secured and senior
Get fully repaid under plan
Corporate Financial Restructuring 37
Marvel’s Option Value, Nov. 96
Option Value
When Marvel’s stock
price is below $9.18,
Perelman’s investment
in the Holding
Companies is
worthless on a
liquidation basis, but
still has option value.
Breakeven stock price
=Debt value/No. of collateral shares
 Debt value=Mkt price*face value (Ex 6)
 Collateral shares=77.3m
=$709.5/77.3
=$9.18
Breakeven stock price
Nov 96 stock price
Copyright ©2002 Ian H. Giddy
$4.63 $9.18
Marvel Ent. Price
Corporate Financial Restructuring 38
Mergers and Acquisitions
Gains from merger
Synergies
Top line
Copyright ©2002 Ian H. Giddy
Bottom line
Control
Financial
restructuring
Business
Restructuring
(M&A)
Corporate Financial Restructuring 39
AOL-Time Warner
Possible motivations
 Economies of scale and scope
 Diversification
 Access to new technology
 Regulatory arbitrage
 Hubris
Copyright ©2002 Ian H. Giddy
Possible problems
 Overestimating synergy
 Slow pace of integration
 Poor strategy
 Payment in stock
 Overpaying
 Poor postmerger
communication
 Conflicting corporate cultures
 Weak core business
 Large size of target company
 Inadequate due diligence
 Poor assessment of technology
Corporate Financial Restructuring 40
AMP/AlliedSignal/Tyco
What defenses
did AMP
employ?
 Who won? Who
lost?

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 41
Comparables
Value Indicator
 Earnings
 Cash Flow
 Revenues
 Book
Copyright ©2002 Ian H. Giddy
Average
Comparable
 Industry
 Firms
 Deals
Target
Company
Numbers or
Projections
Estimated
Value of
Target
Corporate Financial Restructuring 42
What’s It Worth?
Valuation
Liquidation
Dissolve
Break-up
Going concern
Comparables
Acquisition
PV Cash Flows
Synergies
Top line
Copyright ©2002 Ian H. Giddy
Bottom line
Control
Business mix
Rival Advantage
Financial
Corporate Financial Restructuring 43
Optika-Schirnding with Synergy
Schirnding-Optika
Optika
Growth
Tax rate
Initial Revenues
COGS
WC
Equity Market Value
Debt Market Value
Beta
Treasury bond rate
Debt spread
Market risk premium
Revenues
-COGS
-Depreciation
=EBIT
EBIT(1-Tax)
-Change in WC
=Free Cash Flow to Firm
Cost of Equity (from CAPM)
Cost of Debt (after tax)
WACC
Firm Value
Increase
Copyright ©2002 Ian H. Giddy
5%
35%
3125
89%
10%
1300
250
1
7%
1.5%
5.50%
Schirnding
5%
35%
4400
87.50%
10%
2000
160
1
7%
1.5%
5.50%
T+1
3281
2920
74
287
187
16
171
12.50%
5.53%
11.38%
2278
Combined
5%
35%
7525
10%
3300
410
1
7%
1.5%
5.50%
Synergy
5%
35%
7525
86.00%
10%
3300
410
1
7%
1.5%
5.50%
T+1
4620
4043
200
378
245
22
223
12.50%
5.53%
11.98%
7901
6963
274
664
432
38
394
12.50%
5.53%
11.73%
T+1
7901
6795
274
832
541
38
503
12.50%
5.53%
11.73%
3199
5859
7479
1620
Corporate Financial Restructuring 44
Conrail:
Obstacles to an Unfriendly Takeover

Pennsylvania
 “Fair
Value” statute: bids >20% all get same price
 Bidder’s voting rights maxed at 20% unless
management approves
 “Constituency” statute: protect unions

Conrail
 Break-up
fee to CSX
 CSX has “lock up” option to buy 16m new shares
 Poison pill (suspended for CSX): shareholders get
new shares at half price if outsider buys 10%
 6-month “no talk” clause
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 45
Takeover Defenses

Poison Pills





Shark Repellants








Preferred flip-over stock
Flip-over rights
Flip-in rights
Poison put bonds
Limitations on board changes
Limitations on shareholder actions
Supermajority rules
Anti-greenmail limits on share repurchases
Fair-price provisions
Supervoting stock exchange offers
Reincorporation
Golden parachutes
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 46
Post-Takeover Bid Responses







“Just Say No”
Litigation
White Knight
Greenmail
ESOP
Pac-Man
Restructuring, including






Copyright ©2002 Ian H. Giddy
Leveraged Recapitalization
Share Buybacks
Using cash for acquisitions
Divestitures
Going private
Liquidation
Corporate Financial Restructuring 47
Breaking Up




Why—The business may be worth more
outside the company than within
How—Sell to another company, or to the
public, or give it to existing shareholders
Tax Aspects—As a rule if you get paid in cash
you realize a taxable gain; not otherwise
Effect on Shareholders—The bigger the part
sold off, the greater the percentage gain
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 48
Tax-Free Breakups
Spin-Off




Tax-Free
Split-Up
Tracking Stock
Spin-offs—pro-rata distribution by a company of all
its shares in a subsidiary to all its own shareholders
Split-offs—some parent-company shareholders
receive the subsidiary's shares in return for their
shares in the parent
Split-ups—all of the parent company's subsidiaries
are spun off and the parent company ceases to exist
Tracking Stock—special stock issued as dividend:
pays a dividend based on the performance of a
wholly-owned division
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 49
Taxable Breakups
Taxable
Divestiture


Equity Carve-Out
Split-Off IPO
Bust-Up
Divestitures—the sale of a division of the
company to a third party
Equity carve-outs—some of a subsidiary‘s
shares are offered for sale to the general
public
 Split-off
IPOs—a private company offers a part
of the company to the public

Bust-ups—voluntary liquidation of all of the
company’s business
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 50
Break-up Computation
PPR with Finaref PPR without Finaref Finaref Standalone Finaref with CA
EBITDA
€ 800
€ 500
€ 300
€ 330
Tax rate
40%
40%
40%
40%
Beta
1.4
1
1.6
1.6
Growth rate
3.50%
2.50%
4%
4.50%
Equity
€ 8,000
€ 6,000
€ 3,000
€ 3,500
Debt
€ 7,000
€ 5,000
€0
€0
Risk Free
3%
3%
3%
3%
Mkt Risk Premium
7%
7%
7%
7%
Debt spread
3%
2%
4%
2%
Re
12.80%
10.00%
14.20%
14.20%
Rd
6.00%
5.00%
7.00%
5.00%
WACC
8.51%
6.82%
14.20%
14.20%
Enterprise PV
€ 16,538
€ 11,868
€ 3,059
€ 3,555
Equity PV
€ 9,538
€ 6,868
€ 3,059
€ 3,555
Additional Gains/losses
€ 1,187
€0
-€ 1,400
Choice
€ 9,538
€ 11,114
€ 10,155
Source: breakup.xls
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 51
LBO: A Temporary Capital Structure
Stage 1: Pre-LBO
Stage 2: LBO
financing
COST
OF
CAPITAL
Stage 4: Debt
paydown
Stage 3: LBO
refinancing
DEBT
RATIO
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 52
Cost of the Deal
Estimating cost of deal
Shares
Price
Premium
Equity cost
Debt cost
Fees
Capex & restructuring
Total cost of deal
$
$
5% $
10% $
$
10
45
15%
518
$ 55
29
57
658
lbocapacity.xls
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 53
Borrowing Capacity
Estimating borrowing capacity
Given:
EBIT
Min EBIT int coverage ratio
Interest capacity
Interest rate
Debt capacity
$
95
1.3
$
73
16.00%
$
457
From table
lbocapacity.xls
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 54
Cost of Debt
Estimating the cost of debt
Enter the type of firm =
2 (1 if large manufacturing firm, 2 if smaller or riskier firm)
EBIT
$ 95
Current interest expenses =
$ 73
Current long term government bond rate =
0.06
Output
Interest coverage ratio =
1.3
Estimated Bond Rating =
CCC
Estimated Default Spread =
10%
Estimated Cost of Debt =
16%
For large manufacturing firms
If interest coverage ratio is
>
≤
Rating is
-100000 0.199999 D
0.2 0.649999 C
0.65 0.799999 CC
0.8 1.249999 CCC
1.25 1.499999 B1.5 1.749999 B
1.75 1.999999 B+
2 2.499999 BB
2.5 2.999999 BBB
3 4.249999 A4.25 5.499999 A
5.5 6.499999 A+
6.5 8.499999 AA
8.5
100000 AAA
Copyright ©2002 Ian H. Giddy
Spread is
0.14
0.127
0.115
0.1
0.08
0.065
0.0475
0.035
0.0225
0.02
0.018
0.015
0.01
0.0075
For smaller and risk ier firms
If interest coverage ratio is
>
≤
Rating is
-100000 0.499999 D
0.5 0.799999 C
0.8 1.249999 CC
1.25 1.499999 CCC
1.5 1.999999 B2 2.499999 B
2.5 2.999999 B+
3 3.499999 BB
3.5 4.499999 BBB
4.5 5.999999 A6 7.499999 A
7.5 9.499999 A+
9.5
12.5 AA
12.5
100000 AAA
Spread is
0.14
0.127
0.115
0.1
0.08
0.065
0.0475
0.035
0.0225
0.02
0.018
0.015
0.01
0.0075
lbocapacity.xls
Corporate Financial Restructuring 55
Capital Structure
Preliminary capital structure
Debt
Missing
Mgt equity
Total financing
$
$
$
$
457
177
25
658
lbocapacity.xls
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 56
LBO Financing
NEWCO
Cost of
purchasing
the
business
Copyright ©2002 Ian H. Giddy
Senior
debt $457
Mezzanine
What securities?
What returns?
What investors?
Equity $25
Corporate Financial Restructuring 57
Case Case
Does it work?
 How much equity for management?
How much for the VCs?

Management
Bankers
Copyright ©2002 Ian H. Giddy
VC Investors
Corporate Financial Restructuring 58
How the Asian Bet
Was Lost
The three excesses
 Too much debt
 Too much labor
 Too much capacity
Vulnerable economies, newly liberalized,
succumbed to currency crises
 Vulnerable corporate financial structures
 Companies were unable to service even
domestic debt, never mind foreign
currency debt
 Many Asian companies resisted reform
even after the crisis, and remain
misfinanced

Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 59
What’s Needed?





Corporations must implement the key
principles of corporate finance – estimate
realistic cost of capital and discard
investments below the WACC
Shareholders must exercise ownership rights
Banks must break the link between loan
origination and collection
Governments have to leave insolvent
borrowers to their fate
Regulators should get tough on loan
classification standards.
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 60
What Do Debt-Equity Swaps Do?
Overleverage creates financial distress
Actual or potential default
Lenders take equity in lieu of repayment
Lenders hold equity passively
Lenders replace management
Change of control
means restructuring
Existing management buys time



Copyright ©2002 Ian H. Giddy
Lenders sell equity
Financial engineering
Bottom line “rationalization”
Divestitures & outsourcing
Corporate Financial Restructuring 61
New Equity for Astra

What investors?
 Portfolio
investors
 Financial investors
 Corporate investors

What returns should they expect?
= Risk-free rate
+ Corporate risk
+ Financial risk (leverage/debt mismatch)
+ “Agency cost” premium
+ Country risk

What restructuring?
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 62
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
Copyright ©2002 Ian H. Giddy
Corporate Financial Restructuring 66