SIM/NYU
The Job of the CFO
Raising New Capital
Prof. Ian Giddy
New York University
Corporate Finance
CORPORATE FINANCE
DECISONS
INVESTMENT
FINANCING
PORTFOLIO
RISK MGT
MEASUREMENT
CAPITAL
DEBT
EQUITY
TOOLS
M&A
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 2
Capital Structure: East vs West
Intel
VALUE
OFTHE
FIRM
TPI
Optimal debt ratio?
DEBT
RATIO
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 3
Fixing the Capital Structure
Too little debt
 Managers like to control
shareholders’ funds
 Underestimate the cost
of equity
Produces
 Less discipline
 Excessive cost of
capital
 Takeover risk
Copyright ©2001 Ian H. Giddy
Too much debt
 Close control of equity
 Easy money
 Underestimate business
or financial risks
Produces
 Risk of financial distress
 Excessive cost of
capital
 Destroy operating value
 Takeover risk
giddy.org
Financing Turnarounds 4
TPI’s Refinancing
SE Asia’s biggest and baddest debtor
 Almost $4 billion in foreign currency
debt financing domestic revenues
 Protracted rescheduling results in $360
million debt/equity swap
 No change in management or effective
control
 Still needs $1.2 billion new equity

Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 5
Debt-Equity Swaps
Cosmetic or real?
 Choices for company under siege

Raise
new equity to pay off creditors
Example: Iridium
Give creditors equity in place of debt
Example: Sammi
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 6
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 ©2001 Ian H. Giddy
Lenders sell equity
Financial engineering
Bottom line “rationalization”
Divestitures & outsourcing
giddy.org
Financing Turnarounds 7
What Are The Alternatives?

Key: Make the new securities attractive
to:
Existing
lenders
New lenders
New bond investors
New equity investors
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 8
The Financing Spectrum
Equity
Expected Return


Residual returns
after contractual
claims
Control through
voting rights
Senior Debt


Returns independent
of the value of the
business
Control through
covenants
Risk
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 9
The Financing Spectrum
Expected Return
Equity
Preferred equity
Convertible debt
Subordinated debt
Senior unsecured debt
Senior secured debt
Risk
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 10
What Are The Alternatives?
Asset-backed or cash flow-backed debt
 Senior debt
 Subordinated debt
 Subordinated debt with upside
participation
 Subordinated debt with equity option
 Preferred equity
 Restricted shares
 Common stock

Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 12
Subordinated High Yield Debt






“Junk bonds” – like equity, but allow
increased financial leverage
Tax advantage over equity
Big market in USA (institutional investors) and
increasing in Europe
Leveraged loans favored by certain
commercial banks
Often used in connection with M&A and LBOs
Behave like equity – and often have equity
participation
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 13
Sub Debt -- Motivations
Optimization of financial leverage
 Regulatory-driven capital requirements
 Rated asset securitizations (senior-sub
structure in asset-backed securities)
 Insider or supplier-credit subordination
(eg in project finance)
 Work-outs and restructurings (existing
borrowers agree to seniority of new
loans, to buy time)

Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 14
Sub Debt’s Big Problem: High Interest!
Solutions
 Deep discount subordinated debt
 Subordinated debt with equity warrants
 Convertible subordinated debt
 Participating subordinated debt
 Puttable subordinated debt
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 15
Preferred Equity
Legally a form of equity
 Claim senior to ordinary equity
 May have fixed dividend, or may be
“participating”
 But cannot trigger liquidation if payment
missed
 Par value determines liquidation claim

Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 16
Convertible Preferred
Used by venture capital firms
 Permit investors to participate in growth
 But give preference in liquidation if the
venture fails
 And disguise share value (tax!)
 A variant – PERCS* give issuer right to
convert into common stock

*Preferred equity redemption cumulative stock
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 17
Preferred Stock: Pros and Cons
Advantages
 No dilution of control
 Dividends
conditional on
availability of
earnings
 Omission cannot
force liquidation
Copyright ©2001 Ian H. Giddy
Disadvantages
 Higher after-tax cost
than debt
 Lower return on
equity
 Limited investor
interest
giddy.org
Financing Turnarounds 18
The Difference



“The Ministry of Finance received a preferred
share while investors received a preferred
share and a warrant allowing them to
purchase the ministry's share at a 13.3%
premium (equivalent to the cost of carry)
during a three-year period. The preferred
shares carry a 5.25% dividend and full voting
rights”
"When institutions started buying the story,
they bought the convertible bonds, the sub
debt - you name it, they bought it."
Alternatives: Thai Farmers Bank: SLIPS,
Bangkok Bank: CAPs
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 19
Transparency and Disclosure


A 275-page prospectus, which provided a
breadth and depth of information previously
unseen in an Asian issue.
"We went and looked back at US bank
holding company offers - those that were US
SEC Grade 3 compliant. We also went
back and looked at a lot of the prospectuses
for the recaps of US banks, like Mellon and
Citibank. We looked at the level of disclosure
they achieved and committed ourselves to
exceeding that -- which SCB did."
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 20
What Globally Mobile Investors Look At
Macro
Factors
Structural
Factors
Firm-level
Factors
Copyright ©2001 Ian H. Giddy
• Currency overvaluation
• Capital restrictions
• Acctg & disclosure requirements
• IAS compliance
• Bankruptcy regime
• Creditor rights
• Govt-corporate nexus
• Trading infrastructure
• Price-Value ratio, Sharpe ratio, EVA
• D/E ratio
• Currency & maturity mismatch
• IAS conformity
• Insider control
• Objective research coverage
• Trading liquidity
giddy.org
Financing Turnarounds 21
Can the Form of Foreign Participation
Make a Difference?
Debt
Equity
Domestic
market
Asia
Lat Amer
Emerging Markets
Copyright ©2001 Ian H. Giddy
Foreign market
(Depositary Receipts)
BNY ADR Index MSCI Index
(1996-98)
-7.47%
-28.23%
-13.54%
-25.64%
-19.28%
-36.53%
giddy.org
Financing Turnarounds 22
Can the Form of Foreign Participation
Make a Difference?
Debt
Equity
Domestic
market
Foreign market
(Depositary Receipts)
Unsponsored Private
placement
Private
placement
IPO
Copyright ©2001 Ian H. Giddy
giddy.org
Exchange
traded
Global issue
or GDR
Exchange
traded IPO
Financing Turnarounds 23
Tracking Stock

Tracking stock, sometimes known as letter
stock or alphabet stock, is a class of stock
designed to reflect the value and track the
performance of a part of the issuer's assets,
usually a separate business or group of
businesses. Claimed advantages:
 preservation
of the efficiencies of a single
corporation
 ability of the market to more accurately value the
respective businesses of the issuer

What does it really add?
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 24
Restricted Stock: Pros and Cons
Advantages
 Overcome foreign
control restrictions
 Insiders retain
control
 If company well run,
value of control may
be low
Copyright ©2001 Ian H. Giddy
Disadvantages
 Nonvoting stock
trades at a discount
 Dual-class recaps
hurt stock price
 May allow
management to
avoid needed
reforms
giddy.org
Financing Turnarounds 25
The New Equity Option
Key: Make the new equity attractive to:
 Portfolio investors

Domestic
International
Reduce
no!”

agency costs or we’ll “Just say
Strategic/direct investors
Domestic
International
Cede
Copyright ©2001 Ian H. Giddy
control or we’ll go elsewhere
giddy.org
Financing Turnarounds 26
PT Astra International
?
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 27
PT Astra International
1997: Almost $2 billion USD debt
 1998: Steep losses
 Mostly IDR revenues
 1999: Debt restructuring, return to
profitability







Copyright ©2001 Ian H. Giddy
Bina Busana Internusa: February 1999 US $1 mio
PT Astra International: June 1999 US $1,149 mio.
Fuji Technica Indonesia: September 1999 US $16 mio
Federal International Finance: December 1999 US $107 mio.
Traktor Nusantara: December 1999 US $ 21 mio.
Astra Graphia: December 1999 US $82 mio.
giddy.org
Financing Turnarounds 28
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 ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 29
How Risky is Astra?
The riskier the better!
Mean
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 30
Common Stock as a Call Option



The equity in a firm is a residual claim, i.e., equity
holders lay claim to all cashflows left over after other
financial claim-holders (debt, preferred stock etc.)
have been satisfied.
If a firm is liquidated, the same principle applies, with
equity investors receiving whatever is left over in
the firm after all outstanding debts and other
financial claims are paid off.
The principle of limited liability, however, protects
equity investors in publicly traded firms if the value of
the firm is less than the value of the outstanding debt,
and they cannot lose more than their investment in
the firm.
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 31
Payoffs to Shareholders on Liquidation
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 32
The Conflict Between Bondholders and
Stockholders

Stockholders and bondholders have different
objective functions, and this can lead to conflicts
between the two.


For instance, stockholders have an incentive to take riskier
projects than bondholders do, and to pay more out in
dividends than bondholders would like them to.
Since equity is a call option on the value of the firm,
an increase in the variance in the firm value, other
things remaining equal, will lead to an increase in
the value of equity.

It is therefore conceivable that stockholders can take risky
projects with negative net present values, which while
making them better off, may make the bondholders and the
firm less valuable.
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 33
The Creditors are Prowling
Trouble!
Reason
The financing
is bad
Business
mix is bad
The company
is bad
Remedy
Raise equity
or
Change debt mix
Sell some businesses
or assets
to pay down debt
Change control
or management
through M&A
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 34
giddyonline.com
Ian Giddy
NYU Stern School of Business
Tel 212-998-0332; Fax 917-463-7629
ian.giddy@nyu.edu
http://www.giddy.org
Copyright ©2001 Ian H. Giddy
giddy.org
Financing Turnarounds 38