1. Prof. Ian Giddy New York University
Turnaround Financing
Prof. Ian Giddy
New York University

2. Corporate Finance CORPORATE FINANCE DECISONS INVESTMENT FINANCING
RISK MGT
PORTFOLIO
MEASUREMENT
CAPITAL
DEBT
EQUITY
M&A
TOOLS

3. Capital Structure: East vs West
Intel
TPI
VALUE OFTHE FIRM
Optimal debt ratio?
DEBT
RATIO

4. 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
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

5. The Three Excesses
Labor
Capacity
Debt

6. TPI’s Refinancing
Asia’s biggest 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

7. Choices for company under siege
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

8. 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
Financial engineering
Bottom line “rationalization”
Divestitures & outsourcing

9. What Are The Alternatives?
Key: Make the new securities attractive to:
Existing lenders
New lenders
New bond investors
New equity investors

10. The Financing Spectrum
Equity
Residual returns after contractual claims
Control through voting rights
Expected Return
Senior Debt
Returns independent of the value of the business
Control through covenants
Risk

11. The Financing Spectrum
Equity
Preferred equity
Convertible debt
Expected Return
Subordinated debt
Senior unsecured debt
Senior secured debt
Risk

12. The Financing Spectrum
Equity
Preferred equity
Convertible debt
Expected Return
Subordinated debt
Senior unsecured debt
Asian bank NPLs
Senior secured debt
Risk

13. 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

14. 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

15. 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)

16. 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

17. 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

18. 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

19. Preferred Stock: Pros and Cons
Advantages
No dilution of control
Dividends conditional on availability of earnings
Omission cannot force liquidation
Disadvantages
Higher after-tax cost than debt
Lower return on equity
Limited investor interest

20. 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, Bankok Bank: CAPs

21. 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 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."

22. What Globally Mobile Investors Look At
Macro
Factors
Currency overvaluation
Capital restrictions
Acctg & disclosure requirements
IAS compliance
Bankruptcy regime
Creditor rights
Govt-corporate nexus
Trading infrastructure
Structural
Factors
Firm-level
Factors
Price-Value ratio, Sharpe ratio, EVA
D/E ratio
Currency & maturity mismatch
IAS conformity
Insider control
Objective research coverage
Trading liquidity

23. (Depositary Receipts)
Can the Form of Foreign Participation
Make a Difference?
Debt
Equity
Domestic market
Foreign market
(Depositary Receipts)
Asia
Lat Amer
Emerging Markets
BNY ADR Index
-7.47%
-13.54%
-19.28%
MSCI Index
-28.23%
-25.64%
-36.53%
( )

24. (Depositary Receipts)
Can the Form of Foreign Participation
Make a Difference?
Debt
Equity
Domestic market
Foreign market
(Depositary Receipts)
Unsponsored
Private placement
Exchange traded
Global issue or GDR
Private placement IPO
Exchange traded IPO

25. 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?

26. Restricted Stock: Pros and Cons
Advantages
Overcome foreign control restrictions
Insiders retain control
If company well run, value of control may be low
Disadvantages
Nonvoting stock trades at a discount
Dual-class recaps hurt stock price
May allow management to avoid needed reforms

27. Key: Make the new equity attractive to: Portfolio investors
The New Equity Option
Key: Make the new equity attractive to:
Portfolio investors
Domestic
International
Reduce agency costs or we’ll “Just say no!”
Strategic/direct investors
Cede control or we’ll go elsewhere

28. PT Astra International?

29. PT Astra International
1997: Almost $2 billion USD debt
1998: Steep losses
Mostly IDR revenues
1999: Debt restructuring, return to profitability
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.

30. New Equity for Astra What investors? What returns should they expect?
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?

31. How Risky is Astra?
The riskier the better!
Mean

32. 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.

33. Payoffs to Shareholders on Liquidation

34. 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.

35. The Creditors are Prowling
Trouble!
The financing
is bad
Business
mix is bad
The company
is bad
Reason
Raise equity or
Change debt mix
Sell some businesses
or assets
to pay down debt
Change control
or management
through M&A
Remedy

39. www.giddy.org Ian Giddy NYU Stern School of Business
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