Debt and LBOs Flashcards
What are syndicated loans
“A loan too big to be granted by a single body. Necessary to assemble pool of banks (syndicate), co-ordinated by lead bank.”
What is a bond offering?
- corp or gov issued debt instrument
- Pre-‘bond’/debt is ultimately purchased by investors
What are the 2 types of syndicated loans?
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
What are syndication strategies?
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
What did Sufi(2007) find regarding syndicated loans?
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
Why are bonds easier to value than equity?
-credit rating
-coupon being paid
Why do bond issues require lower IB underwriting fees than IPO?
Certainty! (less risk)
What are the basic features of a debt/fixed income instruments?
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
Name debt instruments categorised by maturity
1) money-market (short-term issues <1yr till maturity)
2) notes (1-10 years till maturity)
3) bonds (long-term >10 years to maturity)
What are the 2 types of bonds commonly traded?
1) Corporate bonds (carries default possibilites: credit risk)
2) Government bonds
What are 3 types of government bonds?
1) Treasury securities:
-Tbills, notes, bonds
2) TIPS:
-treasury-inflated-protected securities
3) Treasury strips:
- coupon/principal strips: issued by gov agencies
What are 3 types of corporate bonds?
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
How are bond offerings classified?
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)
How else can bonds be classified in 4 different categories?
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
What is the bond issuing process?
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
What are the fees assosciated with a bond offering?
Issue fee: discounts on p at which bonds sold to syndicate
What are credit ratings?
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)
What are the key determinants of bond valuation?
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
What are risk factors of bonds?
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)
What is the forward curve?
- 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)
What are leveraged buyouts (LBOs)?
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
What are the 2 methods of LBO?
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
Why would you use leverage to M&A?
- small equity input for larger investment
- tax benefits
Who are the financial sponsors of LBO?
- PE firms
- merchant banking divisions of IB
- hedge funds
- venture capital funds
- SPACs
What makes a good LBO candidate?
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
What is the role of IB in LBO?
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
What are other key players in LBO?
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)
What is the financing structure of LBO?
- Senior A
- Senior B
- Senior C (all seniors: 4x)
- Menzanine (5x)
- Equity (6.5)
What is Mezzanine financing?
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
What are potential targets of LBO?
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)
How does leverage enhance returns?
- 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.
What are 3 exit strategies for LBOs (after 5yrs)?
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)
