Liquidity and Balance Sheet Analysis - …...Liquidity and Balance Sheet Analysis • Liquidity is the ability to meet short term financial obligations: • By having cash on hand
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A typical balance sheet: Financing [liabilities and net worth]
Equity capital
2015 LIABILITIES
Notes Payable $0 Current Maturity Long-Term Debt 7,600 Accounts Payable - Trade 7,130 Accrued Liabilities 563 TOTAL CURRENT LIABILITIES 15,293 Long Term Debt 12,400 Subordinated Debt 8,400 TOTAL LIABILITIES $36,039
NET WORTH Common Stock $1,000 Paid In Capital 12,541 Retained Earnings 18,609 NET WORTH $32,150
• Advertising giant Omnicom Group Inc. announced the pricing of its public offering of $1.4 billion 10-year senior notes. The notes will bear an interest rate of 3.60% per annum, and will mature on Apr 15, 2026.
• As the second biggest global advertising and marketing service agency group, Omnicom has an extensive geographic footprint, high client retention and a huge, diverse customer base. Despite slackening global economic growth, Moody's expects Omnicom to grow at a moderate pace in 2016. The company also has an edge over the traditional single-channel media firms and can navigate technology driven shifts more quickly and efficiently.
• Moody's has assigned a Baa1 rating to the issue, along with a stable outlook. • Omnicom intends to use the net proceeds from the offering for general corporate purposes, like working capital needs, acquisitions, fixed asset
expenditures, debt refinancing and stock repurchases. The proceeds will likely be used for the retirement of the company's existing 5.9% senior notes worth $1 billion, which will mature on Apr 15, 2016.
• The note issuance will extend the company's maturity profile while decreasing its cash interest costs by about $10-$15 million annually.
APPLE 6/30/12ASSETS:Current assets:Cash and and securities 27,654 Accounts receivable 7,657 Inventories 1,122 Deferred tax assets 2,309 Vendor non-trade receivables 6,641 Other current assets 6,560 Total current assets 51,943
Long-term marketable securities 89,567 Property, plant and equipment, net 10,487 Goodwill 1,132 Acquired intangible assets, net 4,329 Other assets 5,438
Appropriate Capital StructuresDoes the Current Capital Structure make sense?
• Mature / Stable [CP [with backup], bonds]• Cyclical [Cash, large revolver and long-term bonds]• Leveraged / Acquisition [Revolver, TLA & TLB, senior or sub Notes]
• [Term loan 3-4X EBITDA plus 1-2X EBITDA plus revolver]• TLA [3 – 5 years, senior secured, 75% of forecasted FCF]• TLB [1% amortization, maturity 1 yr after TLA]• Second lien loan [bullet maturity, maturity 1 yr after TLB]• Bridge Loan may be used to fund, repaid with term loans
• Volatile / High Tech [Low leverage and significant cash] • Start-up[Equity]• Seasonal/ [line of credit with a cleanup]• High Risk/High Growth [convertibles] • Declining [ABF, through a borrowing base]
1 EBIT interest coverage EBIT, including equity income Gross Interest Expense plus capitalized interest
2 EBITDA interest coverage EBITDA, including distributed equity income
Gross Interest Expense plus capitalized interest
3 Funds Flow/Total Debt Funds Flow All Debt
4 Free Operating Cash Flow/Total Debt
CFO - Cap X All Debt
5 Pretax Return on Capital EBIT All debt + Equity + Non Controlling Interest
6 Operating EBITDA margin Operating EBITDA Sales
7 Long Term Debt/Capital Long Term Debt Long Term Debt + Equity + Non Controlling Interest
8 Total Debt/Capital All Debt All debt + Equity + Non Controlling Interest
9 Total Debt/EBITDA All debt EBITDA, including distributed equity income
Need to adjust for operating leases & securitization. Must consider other debt like liabilities, pension etc and unconsolidated businesses. Also must consider deferred tax assets and liabilities and other assets [intangibles]. Is NCI treated as debt or equity by Rating Agencies
• Lease • A/R securitization vehicles [not a cash flow loan]• Pension underfunding may be debt
– Gross size of defined benefit pensions is risk– How much cash flow to DB trust p.a.
• Litigation [compared to industry peers]• Purchase Commitments• Backlog [compared to peers]• L/C [commercial and financial]• Contingent guarantees • Liabilities from affiliates• Any put events• If in doubt, put it back on the Balance Sheet [at least footnote]
Financial ProfileNot just quantitativeWhat is the Client’s Financial Policy
• How are the financial policies balanced between stockholders and creditors?– Risks in the Financial Policy– Balancing the Cost of Capital– Financing Decisions for Growth?
• Very strong credit metrics will always be maintained• Creditors share in proceeds from asset sales• Some debt financing of share purchases and/or acquisitions• Some ratings migration possible with acquisitions• Material debt financed acquisitions• Modest cushion for creditors
• Most large companies are structured with the parent as a holding company.• This is not an issue in ratings
– as long as there is no impediment that restricts access to cash.• Process:
– Identify the Legal Structure– Are there any critical issues in the choice of the legal structure?– Are any of the Opco’s regulated?– Are there any restrictions on intercompany cash flows?– What are the intercompany cash flows on a deconsolidated basis?
• The Parent company is better diversified than the operating companies• The Parent company usually has less debt• However,
– Parent debt is effectively [structurally] subordinate– Double Leverage exists at the parent company
• Legal structure– Parent holding company owns operating subsidiary
• Economic structure– Operating subsidiary owns productive assets and generates cash– Holding company owns stock of operating subsidiary
• Operating company creditors– Direct claim on operating assets and cash flows
• Holding company creditors– No direct claim on operating assets and cash flows– Structurally subordinated to operating company creditors
• Extensions of credit to holding companies without substantial assets other than equity in subsidiaries and where the subsidiaries have material levels of debt put the creditor in a structurally inferior position, resulting in incremental risks and a higher degree of potential loss.
• All debt at Parent Company• All debt at OpCo• Debt at Parent and Op Co• Debt at parent and OPCo, with OPCo guarantee of parent debt• OpCo is ring fenced• Debt at parent and OPCo, with parent support of OpCo debt• Debt at parent and OPCo, with OPCo not wholly owned• Parent debt with Captive Finance Sub, with debt
Operating Company A [100% owned]No Debt at Operating Company
Operating Company B [100% owned]No Debt at Operating Company
Parent CompanyAll debt at the parent level
What is the relationship between the debt rating of the parent and the debt rating of the operating [group] companies [parent borrows and advances funds to the operating companies]?
Operating Company A [100% owned]Ring Fenced by covenants or reg
Debt at Operating Company
Operating Company B [100% owned]Debt at Operating Company
Parent CompanyDebt at the parent level
What is the relationship between the debt rating of the parent and the operating [group] companies [parent borrows and and operating companies borrow and at least one of the
operating companies is ring fenced by covenants or regulation]?
Operating Company A [100% owned]Debt at Operating Company
Operating Company B [100% owned]Debt at Operating Company
Parent CompanyDebt at the parent level
Parent supports [not guarantees] operating company debt
What is the relationship between the debt rating of the parent and the operating [group] companies [parent borrows and and operating companies borrow and supports, but not
Captive Finance Sub [100% owned]Debt at Capitve Finance Company
Parent Company, operating companyDebt at the parent level
What is the relationship between debt rating at parent and the finance company [parent company borrows and is also an operating company, finance company also borrows]?
Debt Instrument Profile: TranchesAdding tranches increases debt capacity; However, lower tranches are less likely to get repaid in a distressed situationContractual Subordination
First lien Senior secured debt Generally for smaller firms or non investment grade firms, although some investment grade industries issue some senior secured debt
Second Lien Senior Secured debt
Commercial paper Investment Grade
Short term bank borrowings, seasonal
Senior Unsecured debt, Notes or Revolver
Subordinated debt Limited or no value available during distress
Subordinated zero coupon or PIK debt [ Limited or no value available during distress
Junior Subordinated debt Limited or no value available during distress
Preferrred Stock Limited or no value available during distress
Common Equity Limited or no value available during distress
• A forecast or projection is the output of a model– Forecast is prospective financial statements that present, to the best of the
responsible party's knowledge and belief, an entity's expected financial position, results of operations, and cash flows
– Projection is prospective financial statements that present, to the best of the responsible party's knowledge and belief, given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash flow
• Financial projection models should tell a story.– What is the business going to do?– How is it going to do it?– How is it reflected in the financials?
• Financial models capture the future operating, investing and financing activities that depict future
• The objectives of a financial forecast is an estimate of future financial outcome[s] for a firm
• The financial forecast model revolves around the Income Statement [and subsequently the Cash Flow], and the Model Drivers (which are called Assumptions) that are used to project future figures on the Income Statement.
• Relevant Assumptions– An assumption is relevant if it is likely to occur and to have a direct impact on the
financial variable being forecasted. This is why financial forecasting is considered a matter of judgment.
• Significant Assumptions– An assumption is significant if it is likely to occur and if the magnitude of its impact
on the financial variable under study will be large. For example, assume that the company in question is considering switching suppliers of heating oil for its main manufacturing plant. This would be significant if it has a measureable financial impact on the firm.
•Sensitivity Analysis– The explicit identification of assumptions in forecasts provides an opportunity to
perform sensitivity analysis.
•Sensitivity analysis is a process by which assumptions are adjusted and the impact of the adjustment[s] on the projection is examined, analyzed, interpreted and the implications are highlighted.
• Varying Assumptions to Examine What-if Scenarios• Sensitivity analysis is similar to what-if analysis.• Once a forecasting model has been developed and the forecasted
variable estimated, the model provides a basis for considerable information about the firm.
• Typically, a forecasting model will have several significant assumptions related to variables such as
– expected growth in sales, – expected cost of goods sold, – expected wage rates.
• The existence of the model permits the financial analyst to vary each assumption, thereby examining a range of possible outcomes [scenarios]
• Be aware, that many variables [assumptions] need to be dynamically linked
– i.e. Sales growth and cost of good sold– Sales growth and capital spending– Sales growth and the impact on working capital accounts– Interest rate assumptions and sales growth
• Projections should be for 5 - 7 projected years• Management Case• Bank [Base] Case should reflect your view of the most likely outcome• Downside should reflect stress
– Should look back through an entire economic cycle– But not a worse case
• As the model projects future cash flows, the following elements are key– EBITDA– Interest Expense– Tax Expense– Working Capital changes– Capital Spending– Distributions to Owners
• Revenue Growth Rate – Consider recent trends in revenue
• Reported and proforma?– Is the firm cyclical?
• What happened to revenue in the last downturn?– Is the firm impacted by currencies?– Is there customer concentration?– Is projected growth organic or through acquisition?– Have you considered prices
• quantities?– Does the firm work under contract?– What do the segment revenue look like?
• SGA– How does fixed vs variable cost structure impact the business– Has the firm demonstrated cost cutting in a downturn?– Do you have information on the components of SGA
• Do you understand the firms cash conversion cycle– Invoice terms, inventory holding period, supplier terms– Do you understand bargaining power with customers and suppliers
Subtract Net debt from EV and get Equity Value; then divide this equity value by the number of shares
131
Summary of ValuationPV of future Cash Flows $27,091PV of future Cash Flows $67,728DCF Enterprise Value $94,819Debt $26,445Cash $6,619Equity Value $74,993
Summary of ValuationPV of future Cash Flows $27,091PV of terminal EBITDA $81,303DCF Enterprise Value $108,394Debt $26,445Cash $6,619Equity Value $88,568
• Covenants – promises made in a legal agreement• Affirmative covenants – a promise to do something• Negative covenants – a promise not to do something• Financial covenants
• In addition to being an EWS, the three primary objectives of the covenants from the bondholders’ perspective are to
– (1) prevent the issuer from undertaking new obligations that could divert the issuer’s cash flows toward competing claimants
– (2) prevent the issuer from favoring another class of creditors over the bondholders by preserving the relative priorities of claimants, and
– (3) prevent the issuer from disposing of assets for less than equivalent value such that the remaining assets are not sufficient to discharge its remaining obligations, including debt service on the bonds.
• Borrowers with high profitability and low earnings volatility generally have – interest coverage and/or debt to EBITDA covenants. – These ratios, are informative for stable, profitable firms.
• In contrast, borrowers with low profitability and high volatility earnings are– likely to have net worth covenants.
• Risk plays an important role in debt contracting.• At loan inception, the lender estimates the expected credit risk of the borrower
over the life of the loan. • Without provisions to control increases in credit risk, the lender prices the
expected outcome in the interest rate of the loan. • Both lender and borrower suffer when the expected credit risk of the borrower is
high: the lender with increased risk over the life of the loan, and the borrower with a high interest rate. – A covenant that allows action by the lender when credit risk increases above
a specified level is valuable to the lender because they will no longer be left bearing the full cost of the risk increase. The borrower should be compensated with a lower interest rate for consenting to a covenant in the contract.
• Some covenants may decrease default risk, for a specific instrument– In evaluating the impact of covenants, one of the first questions is:
• Will this covenant require the company to behave significantly differently absent the covenant?
– For example, suppose a company noted for acquisitions agreed to a term loan that limited it to tight controls on leverage, acquisitions and other actions that would otherwise cause the credit to deteriorate
– Those well-covenanted debt holders are serious about enforcing their covenants» even to the point of demanding payment while the company was still
healthy rather than letting management degrade its own credit» we might conclude that the default risk profile was now better
• Some covenants may increase default risk: Covenants can be a two-edged sword. – In the previous example, covenants that force a company to be its “better self” and
behave more prudently than it normally would can lessen the firm’s chances of default and possibly improve its credit rating.
– But covenants that are drawn so tightly that they restrict an issuer’s room to maneuver or cause it to default too readily can have the opposite effect.
– They may end up decreasing the firm’s financial flexibility and creating operational “cliffs” that put its ongoing financial security in jeopardy over relatively minor “misses” in its business execution.
– Covenants like this, if severe enough, could actually decrease the issuer rating.
Business Risk Limit Acquisitions or MergersSale of assetsThe limitation on the sales of assets covenant does not prohibit an issuer from effecting asset sales. Although the covenant requires sales of assets to be made at fair value and that a large percentage (between 70% and 90%) of the consideration be received in cash, the main purpose of the covenant is to limit the uses of proceeds in the event that the issuer does sell assets
Change of business or controlFinancial risk Minimum interest or fixed charge coverage
Minimum Net Worth or Tangible NWMaximum financial leverageMaximum CapX, Max dividends and/or share repurchases
Structure risk Negative pledge and Sale LeasebackSubsidiary guarantiesMax Subsidiary debt [useful for loans to Holding Companies]Subsidiary Restricted Payments [limited, useful for Holdco loans]Restrict payments [dividends, share repurchase, investments in unrestricted subs or repay junior debt]
JOB AID: CREDIT STRUCTURE - TERM CASH FLOWS are the driving force in determining the length and repayment schedule of the loan. Availability is generally linked to the purpose of the loan but may also be affected by your assessment of the "soft issues" (character, management ability, and information quality).
ISSUE TERM (Length of Loan, Repayment Schedule, and Drawdown or Availability)
Purpose of the Loan
Working Capital: Businesses frequently borrow to finance a portion of their working capital needs (accounts receivable and inventory). Seasonal working capital loans are expected to be fully repaid in the liquid portion of the company's season. Non-seasonal working capital loans are repaid from operating cash flow or these are asset protection loans. Working capital loans are typically revolving up to the full amount of the facility and for rapidly growing companies, revolvers may be as long as three years with a term loan conversion feature. Term Loan: Businesses frequently borrow to finance fixed assets with these loans repaid through surplus operating cash flow. Bridge Loans: Bridge loans are generally short term loans borrowed to finance some type of long term investment. The bridge loan enables the company to complete the transaction, quantify its total borrowing requirements, and provides time to arrange the long term financing.
ISSUE TERM (Length of Loan, Repayment Schedule, and Drawdown or Availability)
Business, Economic and Country Risk
High business, economic or country risk usually manifests itself in low, unpredictable cash flows and uncertain asset values
Management Without strong management's character, lending is very high risk
Information Quality
Other things being equal, if you are uncomfortable with the amount and/or reliability of the information provided, then you should opt for a shorter-term loan with a well-defined repayment schedule and tie availability to the purpose of the loan
It is often desirable to take collateral. This gives the bank some control over the company and provides an extra measure of financial security for the loan. Collateral is absolutely required when cash flows are weak or you have any doubts about management or information quality. In these situations, collateral is vital to give you direct access to the second way out. Guidelines for Taking Collateral
If possible, take assets that are independent of the primary source of repayment. Take the most liquid assets available that have a predictable value. Make sure that the life of the asset exceeds the life of the loan
ISSUE COLLATERAL REQUIREMENTS Structure of the Borrower
The structure of the borrower is not an issue when the collateral is owned by the entity to whom the loan is made. It can become an issue if the assets that collateralize the loan are not owned directly by the borrower. When this is the case, there are potential fraudulent conveyance problems. To avoid fraudulent conveyance, the borrower must give some form of consideration to the entity providing the collateral or it must be clear that the support given will not make the entity insolvent.
• Agreement whereby borrower [pledgor] promises not to place a lien on pledgor’s property
• Double negative pledge– Contains a negative pledge– Also, agreement to abstain from offering others a negative pledge
• Springing Lien [often when RCF is more than 40% drawn]• Springing Maturity
– “Springing maturity” provisions are a tweak that may undercut the stability of revolvers. These provisions exist to allow a revolver to mature earlier, given certain circumstances.
• It is all but impossible to passively default on bond covenants.• Bond covenants limit “incurrence” not “maintenance”• Incurrence covenants only tested when the borrower takes an action
– generally require that if the issuer takes an action (paying a dividend, making an acquisition, issuing more debt), it would need to still be in compliance.
• For instance, an issuer that has an incurrence test that limits its debt to 5x cash flow would only be able to take on more debt if, on a pro forma basis, it was still within this constraint.
– If not it would have breached the covenant and be in technical default on the loan. – If, on the other hand, an issuer found itself above this 5x threshold simply because
its earnings had deteriorated, it would not violate the covenant.– Maintenance covenants are generally monitored quarterly
• Covenant - Lite loan structures have only incurrence covenants
• This is because they require an issuer to meet certain financial tests every quarter, whether or not it takes an action. So, in the case above, had the 5x leverage maximum been a maintenance rather than incurrence test, the issuer would need to pass it each quarter, and would be in violation if either its earnings eroded or its debt level increased.
• For lenders, clearly, maintenance tests are preferable because it allows them to take action earlier if an issuer experiences financial distress. What’s more, the lenders may be able to wrest some concessions from an issuer that is in violation of covenants (a fee, incremental spread, or additional collateral) in exchange for a waiver.
• Conversely, issuers prefer incurrence covenants precisely because they are less stringent.
In general, covenants are intended to control certain actions of the borrower. When they fail to do so, they can then serve as trigger mechanisms that enable the lender either to accelerate repayment or to renegotiate the loan. Covenants - no matter how strict -will not make a bad credit good.
COVENANTS PURPOSE OF COVENANT COVENANTS PURPOSE OF COVENANT Prohibition on Additional Borrowings: Avoids further claims on cash flow or assets. Change of Business: Merger or Sale of Business: Mandatory Prepayments: Borrower will prepay the loan if cash flow exceeds agreed on levels
To reduce principal outstanding
Divided Restriction: Conserves borrower's cash flow Interest Coverage: In highly leveraged transactions, it is common to see interest coverage computed as EBITDA to interest expense[or cash interest].
Interest coverage ratios are earnings related measures of performance and are extremely sensitive to a deterioration in operating earnings.
F Debt Service Coverage: Debt service coverage can be defined in a number of ways. These include Funds Flow less the increase in operating working capital or Funds Flow less capital expenditures (for a capital intensive company) divided by the principal to be repaid. Other variations on this ratio include EBITDA divided by principal and interest or EBITDA less the change in OPWC less Cap X divided by interest and principal.
Debt service coverage ratios are intended to measure the borrower's ability to generate cash flow to pay interest plus principal repayments. Like interest coverage ratios, this measure is sensitive to a deterioration in the borrower's operating performance.
A Due on Sale Clause: If company sells certain material assets the loan must be retired using proceeds of that sale.
N Negative Pledge: Company may not pledge any or specific assets to other creditors.
Reduces company's borrowing capacity by eliminating further secured borrowings.
N Restrictions on Guarantees: Maintains net asset value; preserves future cash flow F Liquidity: The most common
ratio used to address liquidity is the current ratio (current assets divided by current liabilities).
Liquidity covenants are designed to prevent a borrower from relying on short term debt to finance long term uses, thereby creating a liquidity issue. The current ratio and the absolute dollar amount of working capital are found most often. Current Ratio is good for a growing company and working capital for a seasonal company.
F Leverage: Balance Sheet leverage [used for higher risk borrowers] can be defined various ways. A common calculation is total borrowed funds to net worth (or tangible net worth), or more commonly total borrowed funds to total borrower funds plus equity [including quasi equity financings]. Often total borrowed funds are defined to include off balance sheet financing, such as operating leases, or securitizations. Additionally, these ratios are often defined to include material non-consolidated vehicles. These ratios can also be defined to distinguish between senior and junior positions. When this is the case, the ratio is defined as senior borrowings divided by senior debt plus subordinated debt plus equity (or tangible equity). In addition, the creditor can choose between net worth reported on financial statements or tangible net worth. Tangible net worth can be defined in many ways. Common adjustments exclude related party assets (intracompany investments, loans and advances; loans to affiliates; and loans to owners) goodwill, intangibles, deferred charges or deferred tax assets.
Leverage ratios indirectly specify the maintenance of a relationship between the debt and the assets of the firm. Generally speaking, lenders are willing to accept high leverage in businesses where cash flow generation is high and relatively predictable and asset values are relatively stable. Less leverage is permitted when cash flows are low and unpredictable and asset values are less certain.
F Minimum Tangible Net Worth: This covenant seeks to maintain a minimum level of equity in the
business so that shareholders have some level of capital at risk. By specifying a minimum level of tangible net worth this covenant also seeks to maintain a minimum level of net assets that are available to absorb unanticipated adverse events.
Cross Default Clause: If the borrower is in default on specified agreements (usually it is all credit agreements but there may be some instances where it would be limited), then it is an event of default on the agreement.
This covenant links your credit structure agreement with other creditors so that if the borrower defaults on any agreement, then you will have the opportunity to participate in any loan restructuring.
• short run perspective– Debt/EBITDA– Current ratio (good for fast growing companies)– Minimum Working Capital (seasonal companies)– Total Debt/Equity (equity cushion to absorb business risk)– Total Debt/Tangible net worth (when significant, but doubtful intangibles)– Total Debt/Effective Net Worth (including liabilities which have equity character, e.g. sub
debt or quasi equity or deferred tax liabilities)– Dividend and/or Treasury Stock Repurchase restriction or limits– Capital expenditure limits and/or operating lease limits– Sale of assets restriction or limit – Acquisition and/or Divestment prohibition or limits
• Tranching is a type of subordination– Shorter maturities get repaid earlier– Investors in longer maturities get paid for incremental risk– Tranching usually does not impact credit ratings
• No impact on recovery in bankruptcy• Benefits of subordinated and tranched structures
– Maximize debt capacity– Stagger Maturities– Access different pools of capital– Achieve lower pricing
• Process for Notching Non Investment Grade Loans– Determine an issuer rating– Calculate Valuation– First, allocate Value to Priority Parties– Then, distribute Value by Priority
• First Priority Secured, revolver is assumed to be fully drawn• Second Priority Secured • Operating Leases
– Check legal status of leases» In some jurisdictions, half of operating leases will not be
accepted by bankruptcy court and » next years lease obligation is senior unsecured claim.
• The aim of loan workout is a financial restructuring with one of the following goals:
– Extend the period of time to service the debt– Provide additional financing – Reduce the amount of company’s debt– Restructure the business’s operations
• Success is greatest when– Financial distress is detected as early as possible
• Because speed is a key in stemming the liquidity risk– Most loan workouts fail because the company runs out time– Value of the assets is reduced as time goes on– The longer the workout, the more additional money may be needed by
the firm• The range of available solutions is increased• The prospects for recovery are enhanced
• Stabilize the business– Agreed moratorium among the creditors and providing additional short-term credit
• Gather information– Appoint reporting accountants and hire lawyers– Determine cash needs and develop a financial plan– Determine the sustainability of existing financial structure– Relative recovery position of each major creditor
• Stabilize the business• Gather information• Evaluate Options
– Short or Medium term • Repayment of debt
– Full or part• Sale of assets, entire business or subsidiaries• Sale of the debt• Reduce debt, improve operating working capital, extend maturities• Inject equity • Declare insolvency
– Long run• Restructure the operations• Create joint venture• Debt for equity swap• Strategic investor• Restructure debt and/or interest payments
§ Shift to DVD [Purchase of DVD]§ Popular films are often rented as many as 75 times at about $3 a rental over the first year, generating $225 -- or three
times the tape's acquisition cost.
§ New Competition§ entry barriers drop with lower DVD prices
§ Large Dividend payment during 2004§ $5 per share with a share price of $15.12
§ Blockbuster failed to identify§ changed customer behavior and channel preference
§ High fixed costs § Can the earnings support the level of debt needed for a moderately capital
intensive business?§ What is the Cash Flow Profile
• due to large fixed costs, high operating leverage– New entrants [Netflix] have lower fixed costs– Entry barriers can disappear with a shift in distribution channel [i.e. net]
• Has the firm invested in the technology to deliver product to customers where and when needed?
• The movie rental market is forecasted to continue to grow in 2009– while the overall industry is forecasted to decline slightly due to a low cyclical
period for new game platform releases.
• For fiscal 2008, the total media business was $48 billion, with rental movies representing $9.9 billion.
• There are continuing channel and product shifts– primarily driven by introduction of next-generation game console release cycles – as well as the emergence of new channels of distribution for movie entertainment, such as
• Blockbuster's viability has been questioned for awhile. • In March 2009 there was speculation that it was set to file for bankruptcy
protection as it faced increased competition – as well as distribution of movies over the Internet and cable services.
• Blockbuster believes that:– It can cut expenses by least $200 million this year by
• renegotiating store leases and taking various other actions.– Average store lease is 2.5 years– Closing 500 stores will contribute $40 million, assuming 25% retention of customers
» Plus 500 stores will produce a one time operating working capital reduction of $26 million
– The business can be separated into domestic and international business• with a sale possible of the international business
• Blockbuster's viability has been questioned for awhile. • Current management believes the current liquidity problem has forced
them to focus on cash– They will be cutting back on CapX [$30 million]– Operating Working Capital requirements will not grow– Sale of UK and Danish businesses
• Blockbuster's viability has been questioned for awhile. • What steps can the Bank take now regarding the Revolver and Term
Loan A?
• On August 20, 2004, Blockbuster entered into $1,150 million credit facilities with a syndicate of lenders.
• The Credit Facilities provided for three facilities: • (i) a five-year $500 million revolving credit facility (“revolver”); • (ii) a five-year $100 million term loan A facility (the “Term A Loan
Facility”); and • (iii) a seven-year $550 million term loan B facility (the “Term B Loan
• Blockbuster's viability has been questioned for awhile. • The revolving credit facility and Term A loan facility are scheduled to expire in August 2009. • On April 2, 2009, Blockbuster amended the revolving credit facility and Term A loan facility and Term
B loan facility – to include commitments from the lenders to
• (a) replace the existing revolving credit facility with a $250 million revolving credit facility with a maturity date of September 30, 2010 and
• (b) amend certain covenants in the revolving Term A and B loan facilities. • The banks amended the Revolver to give Blockbuster a $250 million revolving loan, maturing on Sept.
30, 2010. • But the company is not just relying on amended agreements to help it survive. • It also plans to cut expenses by least $200 million this year by renegotiating store leases and taking
various other actions.• Part of Blockbuster's troubles stem from fewer consumers heading to its stores to rent videos
– due to the rising popularity of DVD-by-mail services like Netflix. • Adding to the pain are electronic distribution systems that use
– high-speed Internet connections and television set-top boxes to pump movies into homes within seconds.
• As part of the new facility, a repayment schedule was agreed upon:
– Date Amount• December 15, 2009 $ 25,000,000• January 31, 2010 $ 20,000,000• February 28, 2010 $ 20,000,000• March 31, 2010 $ 20,000,000• April 30, 2010 $10,000,000• May 31, 2010 $15,000,000• June 30, 2010 $50,000,000• July 31, 2010 $10,000,000• August 31, 2010 $10,000,000
• All repayments and prepayments of Revolving Loans effected on or prior to the Revolving Maturity Date will be accompanied by an exit fee equal to 3% of the aggregate principal amount
• In the event the aggregate principal amount of the Revolving Loans outstanding on April 30, 2010 shall exceed $75,000,000, the Borrower shall pay to the Revolving Lenders, a fee equal to the lesser of
– (i) 10% of the amount of such excess and (ii) $5,000,000.
2002: Blockbuster debuts Super Bowl ad starring the voices of Jim Belushi and James Woods. The company posts a $1.6 billion loss.2003: Netflix posts first profit, earning $6 million on revenues of $272 million. Redbox launches a kiosk rental service. 2004: Blockbuster enters online DVD rental market. Netflix CEO Reed Hastings tells analysts in an earnings call, “In the last sixmonths, Blockbuster has thrown everything but the kitchen sink at us.” The following day, Hastings receives a package from Blockbuster. Inside: a kitchen sink. 2005: Blockbuster launches a marketing campaign touting its new “No Late Fees” policy. Subsequently, 48 states launch investigationsinto the program, charging Blockbuster with misrepresenting its late fee policy to customers. 2006: Blockbuster surpasses its goal of two million subscribers for its online platform. Netflix reaches 6.3 million subscribers.2007: Blockbuster hires new CEO Jim Keyes, formerly of 7-Eleven. Keyes decides to roll back the company’s Total Access plans. “Clearly our spending on that one channel was exceeding our returns,” he said during a company earnings call. After losing a half-million subscribers in the third quarter, Blockbuster announces it will no longer report its subscriber count.2008: Blockbuster proposes buying struggling electronics chain Circuit City. Blockbuster soon withdraws its offer after it’s universally panned. Circuit City files for bankruptcy in November. Keyes also expresses doubt about Netflix in an interview: “I’ve been frankly confused by this fascination that everybody has with Netflix…Netflix doesn’t really have or do anything that we can’t or don’t already do ourselves.” 2009: Blockbuster rolls out Blockbuster Express, its kiosk system designed to compete with Redbox.
March 2010: Blockbuster touts 28-day exclusive window over Netflix for new releases. The company also reintroduces late fees, which had been costing the company $300 million in revenue annually.May 2010: In an interview with Fast Company, Jim Keyes is asked whether Blockbuster’s financial troubles were due in part to Netflix’s success. “No, I don’t know where that comes from,” he says. Keyes denies his company is going bankrupt. June 2010: Keyes compares Blockbuster to Apple, claiming that its On Demand service is the equivalent of the iTunes. July 2010: Blockbuster launches Droid X app. Blockbuster is de-listed from the New York Stock Exchange after shares hit all time lows.August 2010: Though ailing from a debt of $900 million, Blockbuster’s head of digital strategy explains, “We’re strategically better positioned than almost anybody out there. Never in my wildest dreams would I have aimed this high.” Blockbuster adds video games to by-mail subscription plans for no additional cost, but neglects to mention that new releases will not be available for three months. September 2010: Drowned in losses of $1.1 billion, Blockbuster plans to file for bankruptcy. The company is valued at just $24 million.
• Largest regional theme park company in the world• 30 parks located throughout North America• Unparalleled national footprint with extensive reach• Strategic Focus is:
– Increase market penetration with brand extension and marquee ad campaigns– Ride and attraction upgrades– Control costs to increase margins– Expansion of existing parks– Cross-promotional and sponsorship opportunities
• Modest increase in attendance – Significant capital campaign – Enhanced marketing
• 2.5 – 3.0% increase in per cap spending – Continuation of in-park spending initiatives– Selective price increases– Focus on improved guest service and length of stay
• Modest increase in operating expenses offset in part by savings on insurance and advertising
• In 2004, Six Flags began to close and sell properties in an effort to help alleviate the company's growing debt. • On March 10, Six Flags sold its European parks, with the exception of the Movie World park in Madrid, Spain, to Star
Parks Group. • The Madrid park was sold back to Time Warner and renamed "Parque Warner Madrid". • In April 2004, Six Flags determined that the investment required to keep Worlds of Adventure competitive with Cedar
Point would be too great, and thus the company sold the park to Cedar Fair, the owner of Cedar Point. • These sales raised $345 million in an effort to relieve Six Flags' massive debt.
• In 2005, Six Flags endured even more turmoil. • Some of the company's largest investors
– notably Bill Gates's Cascade Investments (which owned about 11% of Six Flags) and – Daniel Snyder's Red Zone, LLC (which owned 12%), demanded change.
• On August 17, 2005, Red Zone began a proxy battle to gain control of Six Flags' board of directors. • Later that month, Six Flags New Orleans was severely damaged by Hurricane Katrina.• On September 12, 2005, Six Flags Chief Executive Officer Kieran Burke announced that Six Flags
Astroworld would be closed and demolished at the end of the 2005 season. • The company cited issues such as the park's performance, and parking issues involving the
Houston Texans football team, Reliant Stadium, and the Houston Livestock Show and Rodeo, leveraged with the estimated value of the property upon which the park was located.
• Company executives were expecting to receive upwards of $150 million for the real estate– but ended up receiving $77 million when the bare property (which cost $20 million to clear) was sold to a development corporation in
• On November 22, 2005, Red Zone announced it had gained control of the board. • Kieran Burke was removed on December 14, 2005 and replaced by Mark Shapiro,
former Executive Vice President of Programming at ESPN. • Six Flags then named the following to the newly revamped board of directors
– former Congressman Jack Kemp, – entertainment mogul Harvey Weinstein, – and Michael Kassan, the former president of the Interpublic Group
• Even with the new management team, the sell-off would continue into 2006. • On January 27 2006, Six Flags announced the sale of the Frontier City theme park and
White Water Bay water park, both located in Oklahoma City, Oklahoma, at the conclusion of the 2006 operating season.
• At the same time, Six Flags also announced its plan to close corporate offices in Oklahoma City, moving its headquarters to New York City.
• Six Flags CEO Mark Shapiro said he expected the parks to continue operation after the sale, a lesson the company learned after its public relations debacle with the closure of Astroworld.
• In June 2006, Six Flags announced it was considering closing or selling up to six of its parks, including – Elitch Gardens, – Darien Lake, – WaterWorld in Concord, California, – Wild Waves and Enchanted Village in Federal Way, Washington,– Splashtown in Houston, Texas – and, Six Flags Magic Mountain.
• In addition, Six Flags also announced the sale of Wyandot Lake in Powell, Ohio to the Columbus Zoo and Aquarium, which is located next to the park.
• Ultimately, Six Flags Magic Mountain was spared, with the remaining six parks sold on January 11, 2007 to PARC Management for $312 million, $275 million cash and a note for $37 million.
• Since 2006 the firm has undertaken the following:– Partnering with brand names to build revenue per capita– Adjust the strategy by investing in family offerings at the parks– Implement a new marketing program with more spend in the early part of the
season– Increased licensing revenue by partnering with Tatweer for Six Flags Dubailand
• The company's operating cash flow had decreased by over 120 million dollars annually during the Shapiro years and in October 2008, Six Flags was warned its stock value had fallen below the required minimums to remain listed on the New York Stock Exchange.
• With the 2008-2009 global financial crisis weighing both on consumer spending and the ability to access credit facilities
– Six Flags was believed to be unable to make a payment to preferred stockholders due in August 2009.
• For the twelve months ended 3/31/2009– EBITDA 267– Cash Interest -173– Cap X -97– Cash Tax -6– Free Cash Flow -9– Debt Amortization -9
• During April 2009– Six Flags Mexico closed due to Swine Flu– Swine Flu impacts attendance at Parks in Texas– Park attendance in the Northeast impacted by weather– Attendance down and Per Capital Guest Spend down 3% in 2009– Full year EBITDA for 2009 forecasted at $200 million– Each attendee lost cost the firm $35 in EBITDA
• It is May 2009. • During 2009, Six Flags has required contractual obligations to pay in
the amount of $863 million.• Included in the payments are the Bank revolver and the PIERS.• What options/strategies can you develop to assist in the helping Six
• In April 2009, the New York Stock Exchange announced it would delist Six Flags' stock on April 20
– a decision that the company did not intend to appeal.• On June 1, 2009, Six Flags announced they would delay their $15 million debt
payment further using a 30-day grace period. • Less than two weeks later, on June 13, the firm filed for Chapter 11 bankruptcy
protection, but issued a statement that the parks would continue to operate normally while the company restructured.
• On August 21, 2009, Six Flags' Chapter 11 restructuring plan was announced in which lenders would control 92% of the company in exchange for canceling $1.13 billion in debt.
• On June 13, 2009 Six Flags agrees with Lenders for a reorganization plan– Reduction of debt by $1.75 billion – Eliminate PIERS
• A new capital structure with $600 million term loan with an undrawn $150 revolver
– 275 revolver will be notes of $150– 835 term loan will get notes for $450– The 600 million loan will be LIBOR + 7% with a 5 year maturity
• Senior secured lenders will get 92% of the equity of the firm• $400 million of the SFO notes will get 7% of the equity• $868 of SFI Notes will get 1% of the Equity
• The approval of this plan is pending per the decision of the presiding Bankruptcy Judge.
• One component of the restructuring was negotiating a new lease agreement with the Kentucky State Fair Board
– which owned much of the land and attractions for Six Flags Kentucky Kingdom.
– Six Flags had asked to forgo rent payments for the remaining nine years of its current lease agreement in exchange for profit-sharing from the park's operations.
– When it appeared that the offer had been rejected, Six Flags announced in February 2010 that it would not re-open the park.
– However, the Kentucky State Fair Board stated at the time that they were still open to negotiating a revised lease agreement.
• However, in the nine months of bankruptcy, the capital markets became more robust
• By April 28, 2010, the company's bondholders reached an agreement on a reorganization plan the Company agreed to the following– Junior note holders, including hedge funds Stark Investments and Pentwater
Capital Management assumed control of the company. • Eliminate PIERS• Eliminate all the debt at SFI [$868 million]
– Additional Equity Offering• Equity raised of $630 million
– Refinance the entire senior secured debt with a new senior secured credit facility
– Senior note holders were paid in cash • Convert $70 million of the SFO notes into 8.625% of the equity• Repay $330 million of the SFO notes
• Despite objections from some parties who stood to get nothing, the bankruptcy judge approved the plan on April 30, 2010.
• As part of the settlement, Chairman of the Board Dan Snyder was removed, while Chief Executive Officer Mark Shapiro briefly remained in his post.
• Six Flags officially emerged from bankruptcy protection on May 3, 2010• Six Flags announced plans to issue new stock• Relisted on the New York Stock Exchange.• Amid suspected disagreements regarding the future of the company with the board,
Shapiro left the company – Al Weber, Jr. was brought in as interim President and CEO.
• The company announced their corporate headquarters would move from New York City to Grand Prairie, Texas.
• Six Flags announced that Jim Reid-Anderson would replace Weber and become Chairman, President and CEO on August 13, 2010.