Prof. Ian Giddy New York University Corporate Financial Restructuring: Summary

Copyright ©2000 Ian H. Giddy Summary 3 What is Corporate Restructuring? l Any substantial change in a company’s financial structure, or ownership or control, or business portfolio. l Designed to increase the value of the firm Restructuring Improve capitalization Change ownership and control Improve debt composition

Copyright ©2000 Ian H. Giddy Summary 4 The Paths to Value Creation l Using the DCF framework, there are four basic ways in which the value of a firm can be enhanced:  The cost of capital can be reduced  The cash flows from existing assets to the firm can be increased  The expected growth rate in these cash flows can be increased  The length of the high growth period can be extended.

Copyright ©2000 Ian H. Giddy Summary 5 Getting the Financing Right Debt Equity n Short term? Long term? n Baht? Dollar? Yen? n Short term? Long term? n Baht? Dollar? Yen? n Bonds? Asset-backed? n Convertibles? Hybrids? n Bonds? Asset-backed? n Convertibles? Hybrids? n Debt/Equity Swaps? n Private? Public? n Strategic partner? n Domestic? ADRs? n Debt/Equity Swaps? n Private? Public? n Strategic partner? n Domestic? ADRs? n Ownership & control?

Copyright ©2000 Ian H. Giddy Summary 6 The Financing Life Cycle Operating Leverage Financial Leverage Operating Leverage Financial Leverage Size Maturity Information availability

Copyright ©2000 Ian H. Giddy Summary 7 The Wrong Capital Structure: East vs West VALUE OFTHE FIRM DEBT RATIO Optimal debt ratio? IntelTPI Asia in 5 years?

Copyright ©2000 Ian H. Giddy Summary 8 A Framework for Getting to the Optimal Is the actual debt ratio greater than or lesser than the optimal debt ratio? Actual > Optimal Overlevered Actual < Optimal Underlevered Is the firm under bankruptcy threat?Is the firm a takeover target? YesNo Reduce Debt quickly 1. Equity for Debt swap 2. Sell Assets; use cash to pay off debt 3. Renegotiate with lenders Does the firm have good projects? ROE > Cost of Equity ROC > Cost of Capital Yes Take good projects with new equity or with retained earnings. No 1. Pay off debt with retained earnings. 2. Reduce or eliminate dividends. 3. Issue new equity and pay off debt. Yes No Does the firm have good projects? ROE > Cost of Equity ROC > Cost of Capital Yes Take good projects with debt. No Do your stockholders like dividends? Yes Pay Dividends No Buy back stock Increase leverage quickly 1. Debt/Equity swaps 2. Borrow money& buy shares.

Copyright ©2000 Ian H. Giddy Summary 9 When The Creditors are Prowling Time for a Tiger The financing is bad The company is bad Business mix is bad Raise equity or Change debt mix Change control or management through M&A Sell some businesses or assets to pay down debt Reason Remedy

Copyright ©2000 Ian H. Giddy Summary 10 The Financing Spectrum Expected Return Risk Senior secured debt Equity Senior unsecured debt Subordinated debt Preferred equity Convertible debt

Copyright ©2000 Ian H. Giddy Summary 11 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 Lenders sell equity Existing management buys time Change of control means restructuring Change of control means restructuring n Financial engineering n Bottom line “rationalization” n Divestitures & outsourcing n Financial engineering n Bottom line “rationalization” n Divestitures & outsourcing

Copyright ©2000 Ian H. Giddy Summary 12 Siam Commercial Bank: Transparency and Disclosure l A 275-page prospectus, which provided a breadth and depth of information previously unseen in an Asian issue. l "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.“ l "When institutions started buying the story, they bought the convertible bonds, the sub debt - you name it, they bought it."

Copyright ©2000 Ian H. Giddy Summary 13 New Equity for Asia l What investors?  Portfolio investors  Financial investors  Corporate investors l What returns should they expect? = Risk-free rate + Corporate risk + Financial risk (leverage/debt mismatch) + “Agency cost” premium + Country risk l What restructuring?

Copyright ©2000 Ian H. Giddy Summary 14 Designing Debt: Match the Business l Fixed/floating:  How certain are the cash flows? Are operating profits linked to interest rates or inflation? l Currency:  Consider currency of the assets: currency of denomination vs. currency of location vs. currency of determination. l Maturity or availability:  Are the assets short term or long term? Should the firm assume ease of refinancing, or buy an option on access to financing?

Copyright ©2000 Ian H. Giddy Summary 15 Designing Debt DurationCurrencyEffect of Inflation Uncertainty about Future Growth Patterns Cyclicality & Other Effects Define Debt Characteristics Duration/ Maturity Currency Mix Fixed vs. Floating Rate * More floating rate - if CF move with inflation - with greater uncertainty on future Straight versus Convertible - Convertible if cash flows low now but high exp. growth Special Features on Debt - Options to make cash flows on debt match cash flows on assets Start with the Cash Flows on Assets/ Projects Overlay tax preferences Deductibility of cash flows for tax purposes Differences in tax rates across different locales Consider ratings agency & analyst concerns Analyst Concerns - Effect on EPS - Value relative to comparables Ratings Agency - Effect on Ratios - Ratios relative to comparables Regulatory Concerns - Measures used Factor in agency conflicts between stock and bond holders Observability of Cash Flows by Lenders - Less observable cash flows lead to more conflicts Type of Assets financed - Tangible and liquid assets create less agency problems Existing Debt covenants - Restrictions on Financing Consider Information Asymmetries Uncertainty about Future Cashflows - When there is more uncertainty, it may be better to use short term debt Credibility & Quality of the Firm - Firms with credibility problems will issue more short term debt If agency problems are substantial, consider issuing convertible bonds Can securities be designed that can make these different entities happy? If tax advantages are large enough, you might override results of previous step Zero Coupons Operating Leases MIPs Surplus Notes Convertibiles Puttable Bonds Rating Sensitive Notes LYONs Commodity Bonds Catastrophe Notes Design debt to have cash flows that match up to cash flows on the assets financed

Copyright ©2000 Ian H. Giddy Summary 16 When Debt and Equity are Not Enough Value of future cash flows Value of future cash flows Contractual int. & principal No upside Senior claims Control via restrictions Contractual int. & principal No upside Senior claims Control via restrictions AssetsLiabilities Debt Residual payments Upside and downside Residual claims Voting control rights Residual payments Upside and downside Residual claims Voting control rights Equity Alternatives n Collateralized n Asset-securitized n Project financing n Preferred n Warrants n Convertible

Copyright ©2000 Ian H. Giddy Summary 17 Why Use a Hybrid? Motivations for Hybrids Linked to business risk Linked to market risk Cannot hedge with derivatives Driven by investor needs Company hedges Company does not hedge Debt or equity are Not good enough

Copyright ©2000 Ian H. Giddy Summary 18 Corporation or Financial Institution requires additional funds to give customers financing or to finance a future revenue stream. Are funds freely available from banks ? Does the firm/FI have good, self-liquidating assets ? Do the assets have a sufficiently high yield to cover servicing and other costs ? Would the assets be worth more (have a cheaper all-in funding cost) if they were isolated from the company/FI ? Securitize the assets Borrow from banks Issue equity or mezzanine capital Get out of the financing business Use assets as collateral for on-balance sheet debt No Yes No Asset Securitization: The Decision Process

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Copyright ©2000 Ian H. Giddy Summary 21 The Building Blocks of Valuation

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Copyright ©2000 Ian H. Giddy Summary 23 What’s a Company Worth? The Options Approach Present Value of Expected Cash Flows if Option Excercised Value of the Firm or project

Copyright ©2000 Ian H. Giddy Summary 25 Ipoh-Kelantan

Copyright ©2000 Ian H. Giddy Summary 26 The Gains From an Acquisition Gains from merger SynergiesControl Top lineFinancial restructuring Business Restructuring (M&A) Bottom line

Copyright ©2000 Ian H. Giddy Summary 27 The Final Question How do we get paid?

Copyright ©2000 Ian H. Giddy Summary 31 Ian Giddy NYU Stern School of Business Tel ; Fax