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Amsterdam Institute of Finance Joseph V. Rizzi October, 2014

Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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Page 1: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

Amsterdam Institute of FinanceJoseph V. RizziOctober, 2014

Page 2: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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 October, 2014 2

Page 3: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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

3Amsterdam Institute of Finance

October, 2014

Page 4: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

100%= 30 (equity)

+ 70 (debt financing)

Players LBO financing package Target company (2)

Equity30%

LBO funds (1)

Banks

Hedge funds

CLO

Senior debt60%

Debt financing 70%

Second lien loans5%

Subordinated debt5%

Debt financing

70%

Leverage effect =debt/EBITDA

=70/12=5.8

(EBITDA 12%)Mezzanine funds

Public Markets High Yield, PIK

Amsterdam Institute of Finance October, 2014

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Page 5: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

Equity#1

Equity#2

EuropeanHolding Company

United StatesHolding Company

NEWCO

United States Target

ForeignOperating

Subsidiary*

DomesticOperatingSubsidiary

DomesticOperatingSubsidiary

DomesticOperatingSubsidiary

Collapsed

After Closing

Equity

Preferred Stock

High Yield/Sub Notes

Due to the structural nature ofSubordination in Europe, bankDebt would be placed at the Operating subsidiary level.

Bank Deal with Upstream Guarantee

* Tax limitations surrounding guarantees from foreign subs.

Guarantee

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Page 6: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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

Amsterdam Institute of Finance October, 2014

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Page 7: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

Total FL 2L Other

1H14 5 4 0.5 0.52013 4.75 3.9 0.1 0.752012 4.8 3.6 0.1 0.92011 4.5 3.8 0.1 0.62010 4.5 3.5 __ 12009 4 3 __ 12008 5.1 3.6 0.5 12007 6 4.5 0.5 12006 5.5 4.2 0.3 12005 5.3 4 0.2 12004 4.5 3.5 __ 1

7Amsterdam Institute of Finance October, 2014

Page 8: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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Senior Secured, but with Junior or Second Lien-Lower recovery

Competing with EURO Mezzanine◦ Investors – hedge funds and CLO

Spread differential between Second Lien and First Lien currently around 325 BP

Volume: U.S. 1H14 $24B v YE06 $28.3BEUR 1H14 $1.1B YE07 $18.6B

Issues: - Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout

- CLO Rating Impact

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Page 9: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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 – Now dominant form >90%◦ Europe – Majority of new issuance >50%

Almost no incremental yield over first lien loans with financial covenants

Amsterdam Institute of Finance October, 2014

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Page 10: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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’.

REIT

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.

Amsterdam Institute of Finance October, 2014

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Page 11: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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

Financing Notes

OpCo PropCo

BidCo

Rental Payments

Approx.100%

Approx.100%

Amsterdam Institute of Finance October, 2014

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Page 12: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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

Availability: Difficult Post Crisis; primarily UK

Amsterdam Institute of Finance October, 2014 12

Page 13: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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)

• Markets Issuance ($) Market Size 1H14 2013 1H14

U.S. $175B $325B $1.4TEuro $ 75B $100B $400B

Amsterdam Institute of Finance October, 2014 13

Page 14: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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

Amsterdam Institute of Finance October, 2014 14

Page 15: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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 + * Warrants for total return* TBD

Liquidity * Low

Disclosure: * Limited

Marketing * No research coverage, no roadshow

Rating Requirements * None

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Page 16: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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PIKPIK• Pay if you can togglePay if you can toggle

• Ratings – NR or CCCRatings – NR or CCC

• Eats up equityEats up equity

• Holding Company IssuerHolding Company Issuer

• CharacteristicsCharacteristics

Spread 825/900

Toggle 900-1000

Term 7.5-10

Call 5xNC

Leverage 6.5x+

Amsterdam Institute of Finance October, 2014

Page 17: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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Staple financing term sheet to deal book

Be prepared to fund

Establishes ceiling

Conflicts of interest

Stapled FinancingStapled Financing

Amsterdam Institute of Finance October, 2014

Page 18: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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ACCORDIAN LOAN

Incremental Loan Facilities

• Option allowing increase in principal under existing terms subject to certain conditions• Existing lenders can participate or new lenders can be sought

Dilution of Lender Interest

• Uncommitted – access requires lenders willing to provide• Suffer dilution if you elect not to participate and facility approved

Amsterdam Institute of Finance October, 2014

Page 19: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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

Amsterdam Institute of Finance October, 2014

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Page 20: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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Increasing layers of debt Directed at different investors Intercreditors conflicts

2004 + 2H07 - 2011

• Common equity

• Unsecured/mezzanine (1x)

• Senior secured bank loan (4x)

- Amortizing T/LA – 40%

- B/C tranches – 60%

FDX – 5x + PPX – 7.5 +

2012 - Present

• 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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Page 21: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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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)

Amsterdam Institute of Finance October, 2014 21

Page 22: Amsterdam Institute of Finance Joseph V. Rizzi October, 2014 PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products)

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HCA HCA Legal StructureLegal Structure

Europeansubs

Sub C

Healthtrust Holdings

Management

Euro T/L

Unrestricted subs Restricted subs(guarantors)

Sub D Sub ESub BSub A

Acquisition CorpHCA, Inc

Equity

Bank Loans

Existing Notes

Sponsors

Merge

Amsterdam Institute of Finance October, 2014 22