Revising Equity Financing Strategies in Difficult times

Nikhil Atale July 27, 2009

Alternative financing Applicable regulations Shareholders right Implications on accounting system

Today’s landscape
Global economies in crisis mode since 2008 Money generating economies are virtually to standstill High imbalance in funds flow Emerging markets at the mercy of G8 Financials institutions in Thailand are very healthy. But…

Credit markets freeze
Banks unwilling to sell impaired assets Banks unwilling to substitute for shadow financial system
− Worries about borrower credit risk. − Worries about own liquidity if lenders want money back. − Worries about likely fire sales pushing securities prices further down – common discount rate for risky assets

Banks unwilling to raise enough equity Stability is not the major focus of the private sector in the midst of a crisis! Institutional overhang not a major problem right now because demand for credit low. But will hamper recovery.

Declining credit asset prices pull equity prices downwards
ABX.07-1 AAA versus BKX* index prices ABX.07-1 AAA versus BKX* index prices

Global IPO
1Q 2007 2Q 2007 3Q 2007 4Q 2007 1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009
No. Deals Total Proceeds (billions)

100 $32.1

169 $83.1

113 $47.2

172 $94.3

27 $34.8

67 $35.0

20 $9.3

6 $1.6

2 $0.9

Average Deal Size (millions)




$548.2 $1,289.3




Global IPOs include all with deal size greater than US$100mm.

- Global IPO value dips 95% at $1.6 bn in 2009

Xinyi Glass placement upsized to $127 million The company raises $67 million of fresh capital at a 7.6% discount, while the controlling shareholder takes the opportunity to secure some profit after this year's strong run-up in the share price. By Anette Jönsson | 27 May 2009 NAB raises $2.02 billion from upsized follow-on The fully underwritten deal, which was launched at a fixed 9.7% discount to the latest market price, drew significant demand and was increased by 50%. By Anette Jönsson | 11 November 2008

Cash is king in Thailand International banks are set to benefit as cash-rich Thai companies look to expand operations overseas, but the continued dominance of paper-based transactions proves a challenge.

China Metal Recycling prices IPO at the top The scrap metal recycling company raises $200 million to become the second-largest Hong Kong IPO year-to-date. Strong retail demand triggers a clawback that boosts the retail tranche to 30%. By Anette Jönsson | 18 June 2009 Italian-Thai convertible upsized to $150 million The deal, which is only the third CB from Thailand since 2002, is completed without stock borrow or credit protection, making it something of a rarity.

Equity Financing Choices



Equity ADRs Common

Private Equity

Large source of Capital
The US private equity market exceeded $300b in the US market for 1H 2007 – the last time the markets had ample liquidity. In the transportation sector, particularly aviation, private equity has been a large participant through the funding of equity and the purchase of secured/unsecured debt. Since 2001, it has been a significant player in the restructuring and mergers of several legacy airlines.
Model Strategic Investor

Control Financial Investor US Airways I $240 million
Simplified negotiations Provides endorsement of board/management POR Plan sponsor serves as forcing function in process Difficult to find deep pocketed investor Likely to require lower initial valuation Size likely requires greater depth of due diligence by prospects

Rights Offering With Private Equity Air Canada US$854 million
More attractive to bondholders Price validation by private investor

Multiple Private Equity Investors US Airways II 2 $866 million
Less need for deep pocketed investor Likely higher valuation than single investor

Example Amount Raised Pros

Continental II $140 million

Benefit to underlying business Possible improved valuation due to reciprocal benefits to investor


Possible antitrust or regulatory issues Possible strategic investor conflicts on business plan

Complicated if majority of claims are held by nonpublic bond holders and/or estimation of substantial portion of claims can’t be completed prior to equity raise May require cash component option for nontraditional investors (e.g., labor, trade creditors, etc.)

Negotiation process can be complicated Will still entail a “private equity” discount, albeit less than single investor

US Airways
US Airways’ equity raise was also a unique challenge – raising substantial equity capital to acquire a publicly traded company
Feb-Mar ‘05
Publicly pursued “standalone plan” for $250-350mm Private Equity, while privately secured preliminary merger agreement and quietly sought equity to fund merger

Merger with AWA used to build new business plan upon which equity was raised

May ‘05

$375mm Private Equity raised (merger announced 5/17/05)

Increased view of capital needs because of Southwest competition at PHL and dramatic spike in oil prices (Hurricane Katrina hit just weeks before closing),

June ‘05

$565mm Private Equity, potential Rights Offering considered and discarded
$6 0 $50 $4 0

Stock Price of LCC 12 Months Preand 10 Months Post Emergence

Overcame Katrina, oil price shock and built investor demand

May 17, 2005 merger announcement

September 27, 2005 emergence from Ch. 11 and acquisition of AWA

Sept ‘05

Final Structure $678mm Private Equity $188mm Public Equity $144mm Public Convertible Bond

$3 0 $2 0 $10 $0 Sep 04 N o v04 Jan05 M ar- M ay05 05 Jul 05 Sep 05 N o v05 Jan06 M ar- M ay06 06 Jul 06

Note: 1. LCC stock pre-emergence represents equivalent AWA stock price.

Structured Finance
Asset-backed securitization Corporate financial restructuring Structured financing techniques

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

When Debt and Equity are Not Enough

Value Value of future of future cash flows cash flows

Contractual int. & principal Contractual int. & principal No upside No upside Senior claims Senior claims Control via restrictions Control via restrictions

Residual payments Residual payments Upside and downside Upside and downside Residual claims Residual claims Voting control rights Voting control rights

When Debt and Equity are Not Enough

Value Value of future of future cash flows cash flows

Contractual int. & principal Contractual int. & principal No upside No upside Senior claims Senior claims Control via restrictions Control via restrictions

Collateralized Asset-securitized Project financing

Residual payments Residual payments Upside and downside Upside and downside Residual claims Residual claims Voting control rights Voting control rights

Preferred Warrants Convertible

Equity-Linked Bonds
Bonds with warrants Convertible Bonds Index-linked Bonds

These are all example of hybrid bonds and should be priced by decomposition

Stock-Purchase Warrants
Warrants are usually detachable and trade on the securities exchanges Warrants are often added to a large debt issue as “sweeteners” to enhance the marketability of the issue Exercise price Warrants usually have a limited life of about 10 years or less Warrants differ from rights and convertibles

Convertible Bonds
Bond may be converted into stock The Conversion Ratio is the number of shares of common stock that can be received in exchange for each convertible security The Conversion Price is the per share common stock price at which the exchange effectively takes place

Financing With Convertibles
Motives for using convertibles include: − It is a deferred sale of common stock that decreases the dilution of both ownership and earnings − They can be used as a “sweetener” for financing − They can be sold at a lower interest rate than nonconvertibles − They have far fewer restrictive covenants than nonconvertibles − It provides a temporarily cheap source of funds (assuming bonds) for financing projects Most convertibles have a call feature that enables the issuer to force conversion when the price of the common stock rises above the conversion price

Determining the Value of a Convertible Bond
There are three values associated with a convertible bond: − Straight Bond Value is the price at which the bond would sell in the market without the conversion feature − The Conversion Value is the product of the current market price of stock times the conversion ratio of the bond − The Market Value is the straight or conversion value plus a market premium based upon future (expected) stock price movements that will enhance the value of the conversion feature

Motivations for Issuing Hybrid Bonds
Company has a view There are constraints on what the company can issue The company can arbitrage to save money Always ask: given my goal, is there an alternative way of achieving the same effect (e.g., using derivatives?)

Accounting for Hybrid Bonds
Bonds which can be converted into other corporate securities are called convertible bonds.

Benefit of a Bond (guaranteed interest)

Privilege of Exchanging it for Stock (at the holder’s option)

Accounting for Hybrid Bonds
At Time of Issuance Convertible bonds recorded as straight debt issue, with any discount or premium amortized over the term of the debt. At Time of Conversion Companies use the book value method when converting bonds. When the debt holder converts the debt to equity, the issuing company recognizes no gain or loss upon conversion.

Induced Conversion Issuer wishes to encourage prompt conversion. Issuer offers additional consideration, called a “sweetener.” Sweetener is an expense of the period. Retirement of Convertible Debt Recognized same as retiring debt that is not convertible. Difference between the acquisition price and carrying amount should be reported as gain or loss in the income statement.

Accounting for CPS
Convertible preferred stock includes an option for the holder to convert preferred shares into a fixed number of common shares. Convertible preferred stock is considered part of stockholders’ equity. No gain or loss recognized when converted. Use book value method.

EPS in Simple Capital Structure
Simple Structure--Only common stock; no potentially dilutive securities. Complex Structure--Potentially dilutive securities are present. “Dilutive” means the ability to influence the EPS in a downward direction.

Preferred Stock Dividends

Subtracts the current year preferred stock dividend from net income to arrive at income available to common stockholders.

Preferred dividends are subtracted on cumulative preferred stock, whether declared or not.

EPS in Complex Capital Structure
Complex Capital Structure exists when a business has convertible securities, options, warrants, or other rights that upon conversion or exercise could dilute earnings per share. Company reports both basic and diluted earnings per share.

Diluted EPS includes the effect of all potential dilutive common shares that were outstanding during the period.

Companies will not report diluted EPS if the securities in their capital structure are antidilutive.

Diluted EPS – Convertible Securities Measure the dilutive effects of potential conversion on EPS using the if-converted method. This method for a convertible bond assumes:
(1) the conversion at the beginning of the period (or at

the time of issuance of the security, if issued during the period), and
(2) the elimination of related interest, net of tax.

EPS Presentation and Disclosure A company should show per share amounts for: income from continuing operations, income before extraordinary items, and net income. Per share amounts for a discontinued operation or an extraordinary item should be presented on the face of the income statement or in the notes.

Shareholders rights
All issuance needs shareholders approval A situation of 1997 crisis and present crisis is exception Banks/creditors virtually take over the companies and decide the faith in their “shareholders” interest Current crisis is classic example: Minority shareholders are burned in AIG, Citi, where US Govt. stepped in

Shareholders rights
Exceptions in case of Govt. bailouts Cases of issuing “not genuine” offers from “unknown” based in “unknown” locations Above actions led to high speculation in stock price, eventually, major shareholders found to have exited at peak Be watchful incase all of a sudden some company issues these instruments!

Shareholders rights
In Theory, shareholders take equal risks as that of promoters of the company In normal course, passing resolutions regarding these issues is “purely a number game” Funds acting in concert tend to block/raise voices against “unfair” practices Government intervention in special situation can be unfair to minority shareholders

Understanding Crisis
No two crisis are alike Banks and capital markets are ultimate victims of crisis Extensive deleveraging follows after crisis, thus, companies tend to issue equity to lower their D/E ratios Its desperate situation and loose loose proposition for all

Equity Funding in Crisis
Study the timing issue carefully If its for solid business expansion, or exciting acquisition (distress assets), investors would love it Debt tend to be cheap during crisis, so, if permits, tend to gear your balance sheets Thai banks are flooded with ample liquidity, what is lacking is good corporate story If you feel concerned with debt, then use hybrids and grab the opportunity

Equity Funding in Crisis
For normal business expansion… are my thoughts…
− Study in-depth, do you really need to expand with demand is virtually out − Secondly, as commodities are tend to be cheap, crisis is the best time to build capacities at cheap cost − Use debt, internal cash to expand − “distress” mentality persists during crisis mode, so don’t do a private equity deal for normal expansion − Unlock your value once, economic cycles turns upwards (e.g. IPO, etc.)


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