Debt and LBOs

Question 1

What are syndicated loans

Answer 1

“A loan too big to be granted by a single body. Necessary to assemble pool of banks (syndicate), co-ordinated by lead bank.”

Question 2

What is a bond offering?

Answer 2

• corp or gov issued debt instrument
• Pre-‘bond’/debt is ultimately purchased by investors

Question 3

What are the 2 types of syndicated loans?

Answer 3

1) Revolving loans:
- highly flexible
- borrower can draw down, repay, borrow again
- finite period
- can be extended with syndicate’s approval
2) Term loans (2types):
- borrower can draw down money in limited time window
- regular date reimbursation: Amortising
- single repayment at maturity: bullet loan

Question 4

What are syndication strategies?

Answer 4

1) Fully underwritten vs best efforts
2) Sole mandate vs joint madate
3) General syndication v sub-underwriting prior to syndication:
-single stage vs 2-stage process (sell part/all exposure to sub-underwriters, pre/post syndicate formation)
- greater risk ss

Question 5

What did Sufi(2007) find regarding syndicated loans?

Answer 5

1)borrowers with little or no credit reputation:
-obtain s.loans similar to sole-lender bank loans.
-s concentrated
- s members closer to borrowing firm (geo, prev relation)
- lead arranger reduce need info gathering: participants who know firm
2) Reputable borrowers:
- s loans similar to public debt
- dispersed s
- lead arranger smaller share of loan

Question 6

Why are bonds easier to value than equity?

Answer 6

-credit rating
-coupon being paid

Question 7

Why do bond issues require lower IB underwriting fees than IPO?

Answer 7

Certainty! (less risk)

Question 8

What are the basic features of a debt/fixed income instruments?

Answer 8

A security that obligates issuer to make specified payments to holder on set dates in future
- borrower pays fixed amount of interest (coupon) periodically (1/2 yr) to holder of record
- borrower repays principal at maturity
- basically IOUs

Question 9

Name debt instruments categorised by maturity

Answer 9

1) money-market (short-term issues <1yr till maturity)
2) notes (1-10 years till maturity)
3) bonds (long-term >10 years to maturity)

Question 10

What are the 2 types of bonds commonly traded?

Answer 10

1) Corporate bonds (carries default possibilites: credit risk)
2) Government bonds

Question 11

What are 3 types of government bonds?

Answer 11

1) Treasury securities:
-Tbills, notes, bonds
2) TIPS:
-treasury-inflated-protected securities
3) Treasury strips:
- coupon/principal strips: issued by gov agencies

Question 12

What are 3 types of corporate bonds?

Answer 12

1) Secured (senior) bonds
- secured against assets
2) Unsecured bonds (Debentures):
- not backed by collateral
3) Subordinated (junior) debentures:
- lower priority in event of banktrupcy

Question 13

How are bond offerings classified?

Answer 13

According to market of issuance:
- onshore (national) (domestic market, obligation of domestic issuer in dom m)
- foreign market (foreign bond issued on foreign market by foreign issuer)
- offshore (‘Eurobond’ Market): bonds dominated in particular currency (other than country denomination currency, no registration requirements)

Question 14

How else can bonds be classified in 4 different categories?

Answer 14

1) Fixed rate:
- straight bonds (fixed coupon) & zero-coupon bonds
- p chgs based on underlying r/credit rating
2) Floating rate:
- coupon pmts indexed to reference r
- coupons can be “capped” or “floored”
3) Equity related:
-convertible bonds
4) Asset backed securities (ABS):
- SPV issuance
- backed by assets
- higher credit ratinds, lower risk

Question 15

What is the bond issuing process?

Answer 15

1) Originaton (14days):
- book manager (BR) receives madate
- syndicate formed
- term of issuance discussed
- BR prepares credit opinion
- IB starts pre-market activity
- provisional bond features announced to market

2) Book-building (10days)
3) Stabilisation (14days)
4) closing

Question 16

What are the fees assosciated with a bond offering?

Answer 16

Issue fee: discounts on p at which bonds sold to syndicate

Question 17

What are credit ratings?

Answer 17

opinion about likelihood of default of issuer or the specific issue
- impact on interest rate required by investor and fee paid to IB (lower rating, higher fee/interest)
- most ratings solicited: fee paid by firm to rating agency
- can unsolicited: less info and tend to be worse (safe side and no client relationship)

Question 18

What are the key determinants of bond valuation?

Answer 18

1) Credit ratings
2) Reputation of BR (certification effect)
3) Maturity
4) Face value (redemption amount)
5) coupon rate (v base rate)
6) Seniority of bond
7) Type: callable, convertible etc

Question 19

What are risk factors of bonds?

Answer 19

1) Yield curve risk (YC shows s-t future interest rate, but can change)
2) Spread risk (diff in p between 2 similary classed bonds: higher yield: riskier)
3) Credit risk (failure of borrower to pay contractual agreements, chg credit rating: decrease in “quality”, value decreases)
4) Interest rate risk (losses incurred due to increased interest rate decrease p of bond)

Question 20

What is the forward curve?

Answer 20

• shows short-term (instantaneous) interest rate for future periods implied in yield curve
• the par yield reflects hypothetical yields, i.e. interest rates the bonds would’ve yielded if priced at par (100)

Question 21

What are leveraged buyouts (LBOs)?

Answer 21

significant role in M&A activity
= the acquisition of a company, div, coll of assets, using debt to finance a large portion of purchase price

Question 22

What are the 2 methods of LBO?

Answer 22

1) KKR method:
- create NewCo (SPV)
- purchase all of targets shares
- target merged into NewCo
2) Oppenheimer method:
- create NewCo (SPV)
- purchase assets or business units

Question 23

Why would you use leverage to M&A?

Answer 23

• small equity input for larger investment
• tax benefits

Question 24

Who are the financial sponsors of LBO?

Answer 24

• PE firms
• merchant banking divisions of IB
• hedge funds
• venture capital funds
• SPACs

Question 25

What makes a good LBO candidate?

Answer 25

1) stable and predictable CF
(when credit market robust, increase willingness of debt investors to focus on CF generation and decrease size&quality of asset base)
2) substantial assets (large tangible assets based increase amount of secured debt available)
3) Leading & Defensible market positions
4) Growth opportunities
5) Efficiency enhancement opportunities
6) Low capital expenditure requirements
7) Proven management team

Question 26

What is the role of IB in LBO?

Answer 26

1) provider of financing
2) work with sponsors:
-develop and market optimal financing structure
3) serve on ‘buy-side’ M&A advisors
- sourcing deals, expertise or relationships
4) serve on ‘sell-side’:
- M&A advisors
- promote their portfolio companies to prospective buyers
- support selling companies in assessing appropriate value

Question 27

What are other key players in LBO?

Answer 27

1) Banks & Institutional Lenders (pension and hedge funds)
2) Bond investors (LBO accompanied by bond issue, HY&junk bonds)
3) Private credit funds (direct loands and secured debts)
4) Target mngt (equity interest to focus &drive commitment)
5) Mngt buyout (MBC) (special case, eliminate agency issue)

Question 28

What is the financing structure of LBO?

Answer 28

• Senior A
• Senior B
• Senior C (all seniors: 4x)
• Menzanine (5x)
• Equity (6.5)

Question 29

What is Mezzanine financing?

Answer 29

hybrid financial instrument that combines elements of both debt and equity financing
- 5-20% of total capitalisation project
- more flexible than traditional loan
- cheaper than issuing equity
- more costly than senior debt (unsecured)
- may involve some equity dilution
- includes financial covenants and creditor rights
- prepayment penalty for early redemption

Question 30

What are potential targets of LBO?

Answer 30

1) Stable Cash-Flow Firms (low-growth):
- stable cash generations reimburses debt
- no increase enterprise value (unchanged at exit)
- increase in EV (due to reduced debt)
- LT LBO with high leverage
2) High Growth Firms:
- Enterprise value increase over time (debt is unchanged at exit)
- so equity value increase
- ST LBO with lower leverage (benefits from ST operational improvements generating value enhancement)

Question 31

How does leverage enhance returns?

Answer 31

• using higher % of debt to find LBO: generates higher returns and more tax benefits
  BUT
• higher returns, means higher risk and higher probability of financial distress
• this limits fin flexibility
• increases susceptibility to businesss and economic volatility.

Question 32

What are 3 exit strategies for LBOs (after 5yrs)?

Answer 32

1) Sale to strategic buyer (synergies and consolidation, new entrant into sector: horizontal integration)
2) Sale to another sponsor (IB or financial intermediary, consolidate with current exposure/portfolio)
3) IPO (initially private with LBO, then refloat: company benefits from improved performance)