Amsterdam Institute of Finance Joseph V. Rizzi November, 2009 PRODUCTS: EXPANDED DEBT CAPACITY...

Amsterdam Institute of FinanceJoseph V. Rizzi

November, 2009

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Rising purchase price multiples and ROE concerns drove acquirers to seek ways to expand their debt capacity. Some of the most common techniques are:

Adjusted (Increased) EBITDA- Operating improvements- Normalization

Asset Sales- Bridges to asset sales- Liquidity is key in case bridge cannot be taken out

Innovative Securities- Defer interest- Push out amortization- Increase flexibility

Amsterdam Institute of Finance November, 2009

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Term Amortization Covenant Call Seniority Secured

Revolver 5 – 7 Bullet FULL YES YES YES

Term Loan A 5 – 7 40% in first 5 years FULL YES YES YES

Institutional Term Loans

7 - 8 1% per annum / bullet FULL YES YES YES

Covenant Lite 8 - 10 1% per annum / Bullet LIGHT PREMIUM YES YES

Mezzanine 10 + Bullet LIGHT PREMIUM NO Depends

High Yield 10 + Bullet LIGHT PREMIUM NO NO

Holding Company PIK

10 + Bullet LIGHT PREMIUM NO NO

Bridge Term Loans 1 - 3 Bullet FULL YES YES YES

Securitization 1 - 5 Revolver with Borrowing Base

FULL YES YES YES

Second Lien 8-9 Bullet FULL YES YES YES

Bifurcated Lien(cross lien)

8-10 1% P.A./Bullet Yes Yes Yes Partial

Unsecured 1-10 1% P.A./Bullet Yes Yes Yes No

OPCO/PROPCO 10+ Bullet Yes Yes Yes Yes

The above table shows the features of different debt options available to issuers The availability of the different options is subject to market conditions


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Innovative securities allow for the expansion of debt capacity by one or more of the following mechanisms:

Reduce Annual Debt Service - Reducing cash interest expense - Lengthen duration (Reduce/Delay amortization)

Increasing Flexibility - Covenants - Public Disclosure - Cash flow control - Call Premium - Bridging - Partial/fully Unsecured

Tranching (sequential ordering of payment or priorities) - Holding Company instruments - Restricted Subsidiaries - Second lien/bifurcated collateral-crossing liens - Senior/Subordinated

Cost – Second Lien vs Mez


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• Understand the motivation behind the structure

• Satisfy the demands of the bank group lending at the operating level

• Tax driven• Provide greater financial flexibility to re-lever• Position the company to make an acquisition• Tap unserved investor base

• Understand how they will fare in insolvency• Understand how they are priced


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Holding company debt◦ relies on funds from the sub through dividends or tax sharing

agreements◦ may be secured by the stock of the operating subsidiary

◦ the exercise of the pledged shares by the bondholders at the holding company may constitute a change of control provision of the debt at the subsidiary

◦ may be guaranteed through upstream guarantees◦ may contain cross default clauses to the debts of other

entities

Measure effective leverage through use of consolidated financial statements◦ Look for multiple leveraging or the use of debt borrowed at

one entity as equity in another to support further leveraging


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Senior Secured, but with Junior or Second Lien◦ Higher default◦ Lower recovery

Originally developed as Rescue Finance Competing with EURO Mezzanine

◦ Investors – hedge funds and CLO Formerly Attractive Pricing: Spread differential between

Second Lien and First Lien 350 BP. Issues:

- Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout- CLO Rating Impact


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Covenant Issues◦ Creditor – preserve deal; recovery value◦ Debtor - flexibility

Covenant Lite – liquidity vs. structure◦ Similar to Investment Grade◦ One or No Financial Covenants

Rating Agency impact on CLO Volume

◦ US 1H07 – 104B (35% of loans) 3H07 – Virtually 0

◦ Europe – Shut down 1Q08 difficult


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Example:-◦ Target company de-merged into ‘PropCo’, which owns the real estate

assets, and ‘OpCo’, the operating company.◦ Banks finance ‘PropCo’ acquisition of properties at agreed Loan to

Value ratio.◦ ‘PropCo’ leases the real estate assets to ‘OpCo’.◦ ‘PropCo’ debt refinanced by traditional Property Lenders or via

Commercial Mortgage Backed Securities (CMBS) market. ◦ ‘OpCo’ required to service the acquisition debt not assumed by

‘PropCo’.

By structuring the financing of a pool of assets with a credit quality stronger than the

corporate credit as a whole, ‘OpCo’ \ ‘PropCo’ financing can provide a cost effective source of

(acquisition) financing.


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‘‘OpCo \ PropCo’ Financing (2)OpCo \ PropCo’ Financing (2)

Financing Notes

OpCo PropCo

BidCo

Rental Payments

Approx.100%

Approx.100%


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Requirements:◦ Stable and resilient cash flows from business◦ Control over cash flows through sale of assets or

adequate legal structure◦ Target investment grade rating to maximize access

to investors and lower cost of capital

Different leverage measurements

Issues◦ Favorable bankruptcy laws◦ Inter-creditor issues◦ Flexibility

Closed: 2H07 to present


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• Longer Term Bonds

7-10 years and longer

4/5 NC

• Public or Private

Usually issued in private form with exchange rights

Pricing would step up if bonds not public within short period (say 180

days of close)

• Usually issued as subordinated debt but can also be senior

unsecured

• Markets

US - $871B size

Euro - €65B size


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• Registration Rights

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Key High Yield TermsKey High Yield Terms

• Registration Rights

• Issuer

• Status

• Degree of Subordination

• Limitations on liens

• Limitations on indebtedness

• Restricted payments

• Asset sales

• Change in control


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Covenants * Extensive (bank type) * Maintenance basis (tested quarterly)

Security * Second secured

Call Provisions * Generally callable immediately (103,102,101)

Maturity * Ten year

Pricing * LIBOR + 800 bps (400 cash, 400 PIK) * Warrants for total return (15-17%)

Liquidity * Low

Disclosure: * Limited

Marketing * No research coverage, no roadshow

Rating Requirements * None


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November, 2009

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Trend: Increasing segmentation of loans with reduced covenant or collateral◦ Percentage of institutional loans with impaired covenants or collateral

1H07 47%, 2H07-Nil 2006 24%

◦ Breakdown 2007 1H07 47% 11% Second Lien 6.4% Bifurcated 23% Covenant Lite 7% Unsecured

Bifurcated/Crossing Liens – See HCA for an example◦ Asset backed revolving credit backed by first lien or receivables and inventory◦ Term loans back by lien on other non-current assets

Property, plant and equipment Stock pledge

◦ Pricing premium – 100 bps compared to revolver◦ Inter-creditor complications


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PIKPIK•Pay if you can togglePay if you can toggle

•Eats up equityEats up equity

•CharacteristicsCharacteristics

PIK SLL

Spread 825/900 500

Toggle 900-1000 n/a

Term 7.5-10 9.5

Call 5xNC n/a

Leverage 6.5x+ 6x+


(Source: LCD)

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Staple financing term sheet to deal book

Be prepared to fund

Establishes ceiling

Conflicts of interest

Stapled FinancingStapled Financing


Bridge LoansBridge Loans

Equity◦ Bank provides equity

Find other equity investors later or keep Reduce PE equity Lowers need for club or larger deals

◦ Rationale – pay to play

◦ Bonds


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Increasing layers of debt Directed at different investors Intercreditors conflicts

2004 + 2H07 - Present

• Common equity

• Unsecured/mezzanine (1x)

• Senior secured bank loan (4x)

- Amortizing T/LA – 40%

- B/C tranches – 60%

FDX – 5x + PPX – 7.5 +

2006 – 1H07

• Common equity

• Hybrid preferred (0.5x)

• PIK notes (0.5x)

• Unsecured/mezzanine (1x)

• Carve-out collateral (1x)

- securitization

- OPCO/PROPCO

• Second lien loans (1x)

• Senior secured bank loan (4x)

- Amortizing T/LA – 20%

- B/C tranches – 80%

FDX – 6x + PPX – 8.5 +Amsterdam Institute of Finance

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HCA – 33 bln USD (corp rating B2/B+)◦ FDX – 6.53x (LTM)◦ PPX – 7.7x◦ Club – Bain, KKR, ML (5 bln)◦ W/W – BofA, JPMC, Citi, ML ◦ Debt Package

1st Lien (3.46x) TermSpread

Amortization

(cum. At maturity)

- R/C 2.000 bln

- ABL 2.000 bln

- T/LA 2.250 bln

- T/LB 9.300 bln

- EUR T/L 1.250 bln

6

6

6

7

7

250

175

250

250

250

0

0

50%

7%

7%

2nd Lien (1.33x)

- Cash 4.200 bln

- PIK/T 1.500 bln

8

8

9.75%

10.0 %

8%

8%

Existing unsecured

7.470 bln 2009 7.5 % --

Equity 4.965 bln -- -- --

◦ EBITDA/I – 1.9x (2007E)◦ EBITDA – CAPEX/I – 1.1x (2007E)


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HCA HCA Legal StructureLegal Structure

Europeansubs

Sub C

Healthtrust Holdings

Management

Euro T/L

Unrestricted subs Restricted subs(gurantors)

Sub D Sub ESub BSub A

Acquisition CorpHCA, Inc

Equity

Bank Loans

Existing Notes

Sponsors

Merge


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Strategic Buyers Pricing Primarily a function of synergies

Financial Buyers Pricing Primarily a function of Debt Capacity

(FD/EBITDA)*EBITDA + Equity + Asset Sales

Developing The Funded Debt Multiple:

Maximum Debt Capacity = [EBITDA/(I + 1/N)] + Asset Sales + Refinancing

Multiple =1/(I + 1/n)

Increasing Debt Capacity:

i = by decreasing interest expense (rates + spread)

1/n = by lengthening maturities through changes to the structure (bridges, hybrids, etc.)


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Purchase Price MatrixPurchase Price Matrix

10% 15% 20%

25% 30% 35% 40%

3.0x 333 353 375 400 429 462 500

3.5x 389 412 438 467 500 538 583

4.0x 444 471 500 533 571 615 667

4.5x 500 529 563 600 643 692 750

5.0x 556 588 625 667 714 769 833

5.5x 611 647 688 706 750 800 917

6.0x 667 706 750 800 857 923 1,000

6.5x 722 765 813 867 929 1,000 1,083

7.0x 778 824 875 933 1,000 1,077 1,167

7.5x 833 882 938 1,000 1,071 1,154 1,250

Assuming an acquisition where the Target’s EBITDA is $100 mln, the maximum purchase price that could be paid given the sponsor’s desired level of equity injection and the amount of leverage that the market will bear.

Equity Contribution

Le

ve

rag

e M

ult

iple


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Purchase Price MatrixPurchase Price Matrix

10% 15% 20% 25% 30% 35% 40%

3.0x 333 353 375 400 429 462 500

3.5x 389 412 438 467 500 538 583

4.0x 444 471 500 533 571 615 667

4.5x 500 529 563 600 643 692 750

5.0x 556 588 625 667 714 769 833

5.5x 611 647 688 733 786 846 917

6.0x 667 706 750 800 857 923 1,000

6.5x 722 765 813 867 929 1,000 1,083

7.0x 778 824 875 933 1,000 1,077 1,167

7.5x 833 882 938 1,000 1,071 1,154 1,250

As can be seen below, when the leverage multiple decreases, the required equity contribution can increase significantly. Depending on the buyers internal rate of return requirements, this may or may not cause them to abort the transaction.

Equity Contribution

Le

ve

rag

e M

ult

iple

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Purchase Price MatrixPurchase Price MatrixThe shaded area of the chart below reflects the financing gap that develops when leverage multiples do not keep up with increasing purchase price multiples. Innovative securities have been developed to close the financing gap.

Debt Multiple

Pu

rch

as

e P

ric

e M

ult

iple

2.00 2.50 3.00 3.50 4.00 4.50 5.00

4.50 160 110 60 10 (40) (90) (140)

5.00 200 150 100 50 - (50 )100)

5.50 240 190 140 90 40 (10) (60)

6.00 280 230 180 130 80 30 (20)

6.50 320 270 220 170 120 70 20

7.00 360 310 260 210 160 110 60

7.50 400 350 300 250 200 150 100

8.00 440 390 340 290 240 190 140

8.50 480 430 380 330 280 230 180

9.00 520 470 420 370 320 270 220


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DisclosureDisclosure

This information has been prepared solely for informational

purposes and is not intended to provide or should not be relied

upon for accounting, legal, tax, or investment advice. The factual

statements herein have been taken from sources believed to be

reliable, but such statements are made without any representation

as to accuracy or completeness. Opinions expressed are current

opinions as of the date appearing in this material only. These

materials are subject to change, completion, or amendment from

time to time without notice and CapGen Financial is not under any

obligation to keep you advise of such changes. All views expressed

in this presentation are those of the presenter, and not necessarily

those of CapGen Financial.

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Amsterdam Institute of Finance Joseph V. Rizzi November, 2009 PRODUCTS: EXPANDED DEBT CAPACITY...

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