Corporate And Capital Structures Notes

Corporate and Capital Structures:

• Balance Sheet:

• The restructuring generally occurs on the left hand side of the balance sheet.

  • E.g. Renegotiating interest payments on debt.

• It may also occur on the right hand side, although this is ancillary, and the principal focus is still on the left hand side.

  • E.g. Divestment of irrelevant assets.

• E.g. Single project financed by a loan of 200:

• This is because equity is subordinate to debt.

• Equity = Residual claim

• E.g. Single-project firm, to be liquidated after 1 year. Start-up costs = 10,000, of which 5,000 is debt.

  • 2,000 in a secured loan, with 5% interest rate.

  • 1,000 in senior unsecured subordinated notes, with 7.5% interest rate.

  • 2,000 in unsecured convertible debenture, with 3.5% interest rate.

  • 3 common shares.

  • Why the different interest rates?

    • Higher interest rate = Riskers; Lower interest rate = Safer.

    • Secured loan = Safest = 5% interest rate

    • Unsecured + Subordinated note = Riskiest = 7.5% interest rate

    • Convertible = Ability to share in the potential upsides by converting into equity if the company does well = Need to pay for this advantage = 3.5% interest rate

  • How much money will be owed to each class at the end of the year?

    • 2,000 x 105% = 2,100

    • 1,000 x 107.5% = 1,075

    • 2,000 x 103.5% = 2,070

  • How much cash flow does the firm need to generate in order to be solvent?

    • 2,100 + 1,075 + 2,070 = 5,245

    • Cash flow solvency = Ability to pay one’s debt as they fall due.

    • Balance sheet solvency = The nominal value of one’s assets must be equal or greater than the nominal value of one’s debts.

  • At what firm value does it become profitable to convert the debenture into equity?

    • After conversion = 3 + 1 = 4 shares

    • 4 x 2,070 per share = 8,280. This is because each share must be worth more than 2,070 in order for it to be profitable to convert

    • 8,280 + 2,100 + 1,075 = 11,455

PE-led LBOs:

• Re McCarthy & Stone plc:
  

  • They were in the business of retirement accommodation.

  • M&S plc was the entity that was publicly traded on the LSE. All outstanding shares in M&S plc was acquired by BidCo and delisted.

  • The assets of M&S plc are held by a subsidiary, M&S (D) Ltd.

  • M&S (D) Ltd holds the shares of the other subsidiaries further down in the corporate chain.

  • BidCo acted as the borrower in the acquisition financing.

    • Facilities A, B, and C: Senior term loans.
      First-ranking security over certain assets, second-ranking security over other assets. Guaranteed by other group companies.

    • Facility D: Senior property revolving credit facility.
      First-ranking security over assets over which ABC rank second, and second-ranking security over assets over which ABC rank first.

    • Facility E: Senior working capital revolving credit facility. Pro rata loss sharing agreement with ABC.

    • Facility F: Second lien facility.

    • Mezzanine facility.

    • Investor loan notes. These were structurally subordinated and held by an entity higher up in the corporate chain.

    • Numerous layers of debt, and complex interactions between different layers.

• IMO Car Wash:
  

  • They were the largest carwash company in the world.

  • Acquired by US-based PE fund, Carlyle, using leveraged financing.

  • Senior facility issued by Bluebrook.

  • Mezzanine facility issued by Spirecove.

  • Both facilities came with a first-priority security over all assets of Bluebrook, IMO (UK), and Spirecove.

    • They were linked through an intercreditor agreement.

    • Senior creditors to be paid first, and mezzanine second, only after full payment has been made to the senior creditors..

    • Mezzanine creditors had an option to purchase the senior facilities.

    • Waterfall clause: Proceeds deriving of enforcement to be paid first to senior creditors and then to mezzanine.

  • Mezzanine creditors argued that value broke at their level, and they therefore ought to have been entitled to participate in the scheme of arrangement.

  • But, if firm value really exceeded the nominal value of the senior facilities, they would have exercised their option to purchase the senior facilities.

• Re Countrywide plc:
  

  • Countrywide was in the business of making home mortgage loans.

  • Country wide was publicly traded.

  • The acquisition financing was injected into HoldCo 4.

    • Senior revolving credit facility (“SCRF”):
      Secured by first-priority fixed and floating charges over all assets of HoldCo 4, Countrywide, and guarantor subsidiaries. Priority in relation to proceeds of enforcement of floating rate notes (“FRNs”).

    • Senior secured floating rate notes (“Cash-pay FRNs”).

    • Senior secured floating rate election FRNs (“PIK election FRNs”):
      Both types of FRNs were secured by first-priority fixed and floating charges over all assets of HoldCo 4, Countrywide, and the guarantor subsidiaries. They were also subordinated to the RCF in relation to the proceeds of enforcement.

    • PIK = Payment in kind (i.e. additional debt) rather than cash, for tax purposes.

    • Senior notes:
      Secured by second-priority “pledges” of assets of HoldCo 4 and Countrywide.

    • RCF, FRNs, and senior notes secured by guarantees by Countrywide and the guarantor subsidiaries.

  • Note the comprehensive security interests that covered nearly all the group assets + comprehensive guarantees by the group subsidiaries.

• These are all leveraged buyouts.
  

  • Layered financing structures.

  • Series of NewCos that do not have any holdings; they are merely SPVs that issue the necessary deb instruments for acquisition financing.

  • The target essentially pays for its own acquisition. The debt is serviced using the cash flows generated by the target group, and the debt holders are given security over the target’s assets.

• The consolidated balance sheet of the target carries...

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