This action might not be possible to undo. Are you sure you want to continue?
Natt Niljianskul / NATT,
Topics in Finance II: Corporate Restructuring Term 4 2013 Due date: July 9, 2013 (Tuesday) Assignment 6
ICS Recovery Fund (Help Me Company)
You are the Managing Director of the ICS Recovery Fund, a private equity fund specializing in the investment into troubled companies. You already raised $300 million dollars from institutional investors two years ago. The target return was set at 20% annual IRR. But, you have not found any suitable investment opportunities since then. Institutional investors, who pay the ICS Recovery Fund an annual 2% management fee, are restless and demand that you find deals with a good return within the next six months. Luckily, two opportunities have emerged. Investment Opportunity 1: Help Me Corporation (HMC) Help Me Corporation is a family owned company engaged in the designing, manufacturing, and selling of fashion goods. HMC has two strengths: 1) A strong brand known as “Shining Silver,” a traditional fashion line targeting older ladies. 2) A strong fashion retail shop network in the Osaka region where it owns 10 shops. One weakness is the low operating profitability due to out-of-date designs in its fashion brands “Musume,” targeting young ladies, and “Ojisan,” for middle aged men. However, HMC’s biggest weakness is its huge debt burden. It expanded aggressively in manufacturing plants and direct shops in Osaka by borrowing money from Go-Go Bank, a medium sized regional bank in Osaka. The drop in property values in that area forced HMC to realize a $50 million loss last year due to the new mark to market accounting rule. Consequently, HMC only has $10 million shareholders equity against $300 million in debt. The Debt/EBITDA ratio (300/20=15) and Debt/FCF ratio (300/14=21.5) indicate HMC is financial weak. The Go-Go Bank, which extended a $200 million loan to HMC, finally sought to turnaround the company through a Privately Arranged Restoration. Two options were proposed, and each requested the ICS Recovery Fund to participate as the principal equity investor.
approached you stating he believes he has a talent for fashion design and only he can lead HMC. He will stay as the CEO. ICS Recovery Fund can sell its equity share to the market in two steps. The owner/CEO of HMC. Appropriate Enterprise Value is 7 times of EBITDA. His proposal to the ICS Recovery Fund is as follows: EBITDA can be quickly improved to $22M. Proper financial structure is $30M equity and $124M debt. Existing equity share holder (the CEO) will accept a 20% devaluation. He would like to use this turnaround opportunity to maximize debt forgiveness by the banks. 80% of this forgiveness by Go-Go Bank. Thus. a 60-year-old third generation member of the founder’s family. Thus $17M of new capital injection from ICS Recovery Fund is needed. $10M in 2012 and $7M in 2013. 2 . ICS Recovery Fund will get two of the six seats in the Board of Directors. asking bank to give up $176M in debt. of course. EBITDA in 2011 is reasonably estimated to be $24M. Half of the annual Free Cash Flow will be used to pay debt. Go-Go Bank may accept $5M of DES.IM12Y011 Option A: Privately Arranged Restoration Name Natt Niljianskul / NATT. IPO HMC in 2012. which is estimated as $154M. Market value is estimated by the Enterprise Value (EV=EBITDA x 8) minus the Debt.
Enterprise Value is estimated as 8 times of EBITDA. Half of the annual FCF will be used to pay debt. the sub-main bank of HMC with an $80 million outstanding loan. Existing equity share is devalued by 50%. 3 . SFC will send its own senior executive and managers to run HMC. which is $192M. you are also approached by the Smart Fashion Company (SFC). one of the leading companies in the fashion industry with an excellent reputation for operations management. SFC welcomes two of five Board of Directors to be appointed by ICS Recovery Fund. At the same time. SFC will buy the equity share held by ICS Recovery Fund at the beginning of 2012. an injection of $40M in new capital is required. SFC does not intend to consolidate HMC until it is comfortable the company can be integrated without risk. and the banks can swap $5M debt to equity. supports SFC. It is asking for $20M from the ICS Recovery Fund.IM12Y011 Option B: Privately Arranged Restoration Name Natt Niljianskul / NATT. SFC invites the ICS Recovery Fund to invest jointly in HMC. The price of this purchase will be calculated based on the EV (EV=EBITDA x 8) minus the debt at the end of the third year. Coincidentally. Financial conservatism is important. This is why SFC invited the ICS Recovery Fund as a co-investor. SFC’s proposal to the ICS Recovery Fund is as follows: EBITDA can be improved quickly to $24M. SFC will keep HMC as a minority owned subsidiary and establish a business collaboration. SFC is interested in HMC’s Osaka shop network where it can sell its own branded fashion goods. Naniwa Bank. Thus the request for debt forgiveness is $158M. SFC plans to license the “Shining Silver” brand and sell it using its existing distribution network. With the help of SFC. Proper financial structure is $50M equity and $142M debt. Brand license fees and sales fees will be charged to HMC. SFC is confident it can easily turnaround the company’s operation – if has full management control. EBITDA by 2011 is anticipated to reach $30M. Thus.
Privately Arranged Restoration Option B: Forecast by SFC 2008 Sales Operating Profit Depreciation EBITDA CAPEX Change of W/C FCF 400 12 8 20 6 1 8.IM12Y011 P/L of Help Me Corporation: Name Natt Niljianskul / NATT. Privately Arranged Restoration Option A: Forecast by CEO 2008 Sales Operating Profit Depreciation EBITDA CAPEX Change of W/C FCF* 400 12 8 20 6 1 8.2 2008 400 16 8 24 6 -3 14.8 2011 430 20 10 30 9 0 13 (current) (after restructuring) B/S of Help Me Corporation (2008) Asset Cash Current Asset Fixed Asset Total Asset 20 110 260 390 Liability Liability Debt Equity Total 80 300 10 390 4 .6 2009 410 17 9 26 7 -3 15.2 2008 400 14 8 22 6 -2 12.4 2009 405 14 8 22 7 -2 11.4 2010 410 15 8 23 7 0 10 2011 415 15 9 24 8 0 10 (current) (after restructuring) *FCF=Operating Profit After Tax(Tax rate 40%) + Depreciation –CAPEX-Increase of Working Capital.2 2010 420 18 9 27 8 -1 12.
DES .1 89.8 Buy up by SFC ** Estimated Debt Reduction from 2008 to 2011 is half of the accumulated FCFs during the period Question 1: Fill the blank boxes in the above Exhibits 5 .debt giving up Proposed Equity .8 114.2 125.New Capital by Fund .existing equity .IM12Y011 Name Natt Niljianskul / NATT.9 IPO in 2012 Proposal by SFC 24 8 times 192 142 ( 158 ) 50 5 5 20 20 30 8 times 240 27.9 102.New Capital by SFC Expected EBITDA in 2011 Enterprise Multiple (EV/EBITDA) in 2012 Expected Enterprise Value (EV) in 2011 Estimated Reduction of Debt** Estimated Debt in 2011 Estimated Equity Value in 2011 Ways of realizing value 22 7 times 154 124 ( 176 ) 30 8 5 17 24 8 times 192 21. Comparison between the Two Privately Arranged Restoration Proposals Proposal by CEO Base EBITDA Enterprise Value Multiple Enterprise Value Proposed Debt .
As this is a turnaround PE deal. Naniwa Bank will be more incline towards such proposal as the amount of debt forgiveness proposed was much lower than in option A.ally with SFC) and why? When deciding consider the following points: What will be the expected investment return of each option? How feasible is of the earnings turnaround? How will you persuade the banks to forgive debt? Who should manage the company? Explain using 10 sentences (or 3-4 bullets) I would choose option B to ally with SFC for the following reasons (collectively judge from all the reasons below): Although the return on invested capital of option A is higher (calculation: vs ). too.IM12Y011 Name Natt Niljianskul / NATT. The earnings turnaround is more likely to be achievable under SFC’s proposal because SFC can bring in their expertise to help HMC. Naniwa Bank and ICS fund should send in corporate governance personnel to keep eyes on day-to-day operations and to verify that the turnaround proposal go as planned. This will reinforce confidence amongst all stakeholders as well. 6 . we also have to worry about viability revitalisation for an exit. it could be deceptive to make decision solely based on this because there is no guarantee that each proposal will achieved the promised EBITDA level. SFC should manage the company but to ensure that there is no information asymmetry problems. Question 2: Compare the two private restoration options. or Option B . SFC’s proposal also has support from Naniwa Bank. Which one would you choose (Option A go with the CEO.
I would nominate some of the capable people from ICS Fund Management Entity to HMC in preferably a CFO position but I would prefer to have the top guy (CEO) being from SFC because they are the one who had the expertise in this business. this investment is already risky enough (despite the outcome make justify it as a good risk) and I do not want to put more at stake. Nonetheless.IM12Y011 example. Will you ask the CEO or SFC to protect your interests. However. if necessary? How and why? For Do you want to change the financial scheme? Do you want to add any covenant clauses? Do you want to send your own candidates as top management? Explain using 5 sentences I have no intention to change the financial scheme because the amount of debt forgiveness is extremely high (towards 80%+ forgiveness) and at the same time. as mentioned in answer to Q2. Question 3. I would like to propose that the structure of the board of directors be modified a little bit. Ideally. 1 to the bank and another 1 to the one of the previous executives. I want to have it in a form so that we hold a put option for our stake because then there could be some other opportunities if the turnaround is extremely positive that we could strike the option at a higher in-the-money value. I would want to add an anti-dilution clauses and lock in SFC with some obligation to buy up our shares. By introducing external directors and increase the number of seats in the board to 6+ and give 2 to SFC and us. 7 . consider the following options: - Name Natt Niljianskul / NATT.
Blue’s reliance on bank loans has increased. CSO anticipates selling Blue at these levels. The future plan of Blue is shown below. they are very different in character. He also asks that you first choose which subsidiary you want to bid on. The Blue Subsidiary is a profitable and growing company with innovative technology. Current debt is $110 million and equity is $30 million. Both subsidiaries are of similar sizes in terms of sales ($200 million) and assets ($160 million). who recently announced his intention to resign to protest the parent company’s decision to divest Blue.6 7. Now he asks if you are interested in one of the two subsidiaries targeted for divestiture. After several years of poor performance.6 4. The CEO of CSO was your classmate at Hitotsubashi University and the two of you have maintained a long-term friendship.2 2011 280 25 12 37 18 3 6. P/L & Cash Flow of Blue 2008 Sales Operating Profit Depreciation EBITDA CAPEX Increase of W/C Free Cash Flow Interest payment Ordinary Profit Net Profit 200 16 8 24 12 1 4. If your offer is reasonable and competitive.0 2009 220 18 9 27 14 2 3. CSO faced criticism from institutional investors and banks about its unfocused business strategy and it agreed to divest non-core business subsidiaries. The market values of equi valent listed companies have a PER of 16 to 20. Investment Opportunity 2: Company Spin Off (CSO) The Company Spin Off is an $8 billion dollar company consisting of widely diversified businesses. or Enterprise Value (market value of equity plus debt outstanding) multiples of 8 to 11 times. due to the aggressive capital expenditure and high R&D. Its operating earning rate is as high as 8% and annual sales growth rate constantly exceeds 10%. Blue can go for an IPO in year 2012 with an anticipated Enterprise Value multiple of 10 times. However.8 of Buyout 2010 250 22 10 32 16 2 5.0 Depend Upon Financial Scheme 8 . EBITDA in 2008 is $24 million and ROE (net profit based) is 23%. Blue’s growth is attributed to the entrepreneurial leadership of its current CEO.4 11. the CEO promises to prioritize your proposal above others.IM12Y011 Name Natt Niljianskul / NATT. But.
The Red Subsidiary is a low growth company of average profitability in a saturated market where technology is commoditized. Red’s earning and growth potential is inferior to Blue’s. Because the market is fragmented among so many players. one security analyst anticipates industry consolidation will soon take place. He is good at cost cutting.2 9 . The Pro Forma of Red is below: P/L & Cash Flow of Red 2008 Sales Operating Profit Depreciation EBITDA CAPEX Increase of W/C FCF 200 10 10 20 8 0 8 2009 205 11 10 21 7 0 9.0%. where economies of scale can reduce costs and improve profitability. the M&A price of competitors is around 8 times of the enterprise multiple (EV/EBITDA) or a PER of 16. but will never take big risks. Obviously. By the way. if anyone becomes the industry leader.6 2011 215 12 10 22 7 1 9. According to the analyst. that company may be able to IPO for 10 times the enterprise multiple. Red’s EBITDA in 2008 is $20 million. This would be good because market growth is so low the only way to increase sales and profitability is through mergers and acquisitions. It has $100 million in shareholders equity and only $40 million of debt. Red’s CEO is a conservative person seconded from CSO.IM12Y011 B/S of Blue (2008) Asset Cash Current Asset Fixed Asset Total Asset 10 50 100 160 Liability Liability Debt Equity Total 20 110 30 160 Name Natt Niljianskul / NATT. but since Red capital expenditure needs are limited. The operating profit margin is 5% and net profit ROE is just 5. This stems from the nature of a high fixed cost industry. But. Although Red is competitive in the industry. On the top of this. Red also has $50 million in cash – it is a financially rich company.6 2010 210 11 10 21 7 0 9. it has accumulated profits. its profitability is unattractive. He is relatively new to the market and has a limited personal network with the CEOs of competitor companies.
Question 4: Which subsidiary will you bid on? Why? I would bit on the Red Subsidiary. not an M&A deal.5 times multiple. I will pay $170 million. The structure at buy-out will be equity of 60 (Financial Leverage = Total Asset / Equity) and debt of 110 (assuming short-term liability stays the same. I will get interest discount. this opens the door to easy exit How much will you pay to buyout the subsidiary? Explain your rationale for this amount. What is your proposed financial structure (equity and debt mix)? Explain your rationale for this structure. The amount is derived from EV – Net debt (Calculation: = 20*8 – (50 + 40) = 170) or 8. Also because industrial consolidation is foreseeable in the near future. (2 sentences) I will use LBO and will increase the leverage to ~4 (less than 4) buy entering into a structure loan deal with the bank such that if proportion of debt is paid back sooner. Hence.IM12Y011 B/S of Red (2008) Asset Cash Current Asset Fixed Asset Total Asset 50 20 90 160 Liability Liability Debt Equity Total 20 40 100 160 Name Natt Niljianskul / NATT. The rationale of why I don’t want to pay premium is because this is a spin-off deal from CSO. paying at the valuation price is already good enough. Below is a projected balance sheet: B/S of Red (2008 after acquisition) Asset Cash Current Asset Fixed Asset 50 20 Liability Liability Debt 90 20 40 Extra debt 110 10 . The reason is because Red has a huge debt capacity that we could exploit so that we can acquire them through LBO. (Explain using 4 sentences).) I will subsequently use excess cash to pay back some portion of debt as aforementioned.
cash = 15.e. If Blue’s CEO is already resigned.33% (Calculation: ) 11 . if EBITDA exceeds the projection.6). return is 247. I will increase CAPEX) How much investment return do you expect? (1 sentence) Assuming that the balance sheet structure evolve from post-acuisition and all the strategy explained above comes into fruition (equity = 60. If the earnings exceed expectations. Equity Total 60 230 What will you do to the management structure? Why? (2 sentences) I will maintain most of the management people but I will mostly ask the current CEO to step down from the CEO position to assume the Chairman position. What is your future strategy to maximize the enterprise value? (3 bullet points) First of all I will use the excess cash to repay the existing debt and repay some portion of the new debt. debt = ~86. I will use ~50% of FCF generating every year to repay some portions of yearend outstanding debt. I will also try to hire Blue’s CEO or make it a condition of this deal to my friend. I will then introduce good corporate governance structure but having board members and independent board members. I will use the excess amount to re-invest into the company (i. I will hire him straight away.IM12Y011 Goodwill Total Asset - Name 70 230 Natt Niljianskul / NATT.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue listening from where you left off, or restart the preview.