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Valuation
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Table of Contents
V. Financial Model
2
Distressed Securities
The private equity firms that will thrive in the year ahead
are those that know how to profit from others'
misfortunes
3
What Are Distressed Securities?
Distressed securities are securities of companies that are either
already in default, under bankruptcy protection, or in distress and
heading toward such a condition
Distressed fixed income securities are rated below investment grade
The most common types of distressed securities are bonds and bank debt
While there is no precise definition, fixed income instruments with a yield
to maturity in excess of 1,000 basis points over the risk-free rate of return
(e.g. Treasuries) are commonly thought of as being distressed
While sound methodologically, the absolute 1,000 basis-point
benchmark may not be appropriate in all market environments
Average credit risk spreads can fluctuate widely
A basis point (often denoted as bp, bps) is a unit that is equal to 1/100th
of a percentage point
As we will see later in the presentation, the market for distressed
securities is less efficient than other markets, enabling skilled
investors to earn superior risk-adjusted returns
4
10 Largest Bankruptcies in US 1980 - 2007
6
Description of Bond Ratings (S&P)
AAA highest rating assigned to a debt instrument, indicating
an extremely strong capacity to pay principal and interest.
Bonds in this category are often referred to as gilt edge
securities
AA high quality bonds by all standards with strong capacity to
pay principal and interest. These bonds are rated lower
primarily because the margin of protection are less strong than
those for AAA bonds
A these bonds possess many favorable investment attributes,
but elements may suggest a susceptibility to impairment given
adverse economic changes
Bonds are regarded as having adequate capacity to pay
principal and interest, but certain protective elements may be
lacking in the event of adverse economic conditions that could
lead to a weakened capacity for payment
7
Description of Bond Ratings (S&P)
BB Bonds regarded as having only moderate protection of
principal and interest payments during both good times and
bad times
B Bonds that generally lack characteristics of other desirable
investments. Assurance of interest and principal over any long
period of time may be small
CCC Poor quality issues that may be in default or in danger of
default
CC Highly speculative issues that are often in default or
possess other marked shortcomings
C lowest class of bonds. These issues can be regarded as
extremely poor in investment quality
D Issues in default with principal or interest payments in
arrears. Such bonds are extremely speculative and should be
valued only on the basis of their value in liquidation or
reorganization
8
Bond Ratings of Companies
As of the spring of 2008, there were only six companies left with
"AAA" ratings from both S&P and Moody's. They are Automatic Data
Processing (ADP), Berkshire Hathaway (BRK), GE (GE), Johnson &
Johnson (JNJ), Exxon (XOM), and Toyota (TM) April 2008. In the late
seventies this number was 58 and in the nineties it was 22
Competition and willingness to take on more debt possible reasons
Rating agencies conduct a very thorough review of the companies
that they rate. There are numerous considerations that are weighed,
the most important of which is a companys cash flow
Basically, if a company is a cash cow, it is very likely to have a high credit rating.
Rating companies look closely at the source of a companys cash flow as well as its
variety, availability, and source
Companies with high credit ratings have quick-turning, high quality accounts
receivable, meaning that they are getting paid on time and getting all that they are
due. Rating agencies also consider it important that a company have the ability to
sustain their profitability
Aside from cash flows, rating agencies scrutinize a companys management for their
competence, structure, strategic planning, and composition. Other considerations
include scrutiny of a companys appetite for risk and competition
Rating agencies must always consider external factors such as the economic cycle
but the fundamentals of the companies that they rate always get first consideration
and have a far greater bearing on a companys overall rating
Nevertheless, rating agencies have increased their responsiveness to and consideration of the economic cycle in
recent years given the large impact that the economic cycle has on many companies
9
Investing in Distressed Debt?
Distressed debt is not a particularly suitable or practical investment
for individual investors:
Significant risk of loss
Annual total market returns could vary dramatically
Professional participants in the market could have significant
information advantages
Distressed securities market is often fairly illiquid, which means
there can be very high transaction costs for individuals investing
on a modest scale
Transaction costs increase the relative risks and make it very difficult to earn appropriate risk
adjusted returns
Size of the average trading unit or block is so large that, except
for the most wealthy, it is difficult to have an adequately
diversified portfolio
Risk of this asset class is such that investing should generally be done on a diversified basis
Bank debt and corporate bonds generally trade in blocks of $5mm and $1mm respectively.
Though distressed securities may trade at significant discounts, this still implies that to own a
diversified portfolio of approximately 15 companies could require a significant amount of
capital
10
How to look for Distressed Companies
Public Stock
Trading at 52-week/all-time low stock price
Bonds
Rating downgrade(s)
Sell-off in bonds
Distressed bond investors start accumulating bonds
Bank Debt
Liquidity crunch and concerns or ability to make coupon/amortization
payments
Reduced borrowing base and availability
Waivers or amendments
Internal Signals
Declining operating performance
Management turnover
Extensive and recurring restructuring charges/asset write downs
External Signals
Weak economy
Industry cyclical downturn
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V. Financial Model
12
Revolver, Term Loans and Bonds
13
High Yield Debt
High-yield bonds are issued by organizations that do not qualify
for investment-grade ratings by one of the leading credit
rating agencies - Moodys Investors Service, Standard & Poors
Ratings Services and Fitch Ratings
High yield bond/non-investment grade bond/speculative grade
bond or junk bonds have a higher risk of default or other adverse
credit events, but typically pay higher yields than better quality
bonds in order to compensate for their added risk and make them
attractive to investors
Credit rating agencies evaluate issuers and assign ratings based
on their opinions of the issuers ability to pay interest and
principal as scheduled. Those issuers with a greater risk of
defaultnot paying interest or principal in a timely manner
are rated below investment grade
These issuers must pay a higher interest rate to attract investors
to buy their bonds and to compensate them for the risks
associated with investing in organizations of lower credit quality
14
High Yield Debt Levels and Default Rates
Moodys said in a December 2007 report that Defaults by
speculative-grade companies will quadruple next year as the
era of easy credit comes to an end and economic growth
slows
The global default rate will rise to 4.2 percent by November from
1 percent now, the lowest since 1981
Forecast is based on an assumption that the U.S. economy slows
without falling into recession. In a recession, defaults may
approach 10 per cent
More than one in 10 of the borrowers to which Moody's assigns
ratings are treated as distressed by bond traders, the highest
proportion since global defaults reached 10.5 percent in 2002
At that time, bondholders charged as much as 11.4 percentage
points of extra yield to buy high-risk, high- yield debt rather than
government bonds, double the current spread of 5.73 percentage
points, according to Merrill Lynch & Co. indexes
15
Credit Deterioration - Phase 1 and Phase 2
16
Credit Deterioration - Phase 3
Phase 3: Company files subsequent 10-Q
Disclosure of further credit deterioration which may include
Violation of senior secured credit facility
Total Debt/EBITDA increases above 8x
EBITDA/Interest falls below 1x
Further decline in bond price with stop at around 50 (estimated) -
dependent on size and condition of the shorts
Bond price settles between 25-40 as mutual funds continue to exit
credit and distressed buyers evaluate the opportunity
Distressed buyers that started work on the credit early in the
process dominate volume and may accumulate a control position
OR
The Company may report an improvement in operations and
securities trend towards 75-90 takes 2 quarters of continued
steady / improvement in operations
17
Credit Deterioration - Phase 4
Phase 4: Further material adverse credit event
Event of default under indenture but no Chapter 11 filing
Bonds prices trend flat and trend towards approximately 20, material
downward asset re-valuation which may result in almost zero value for
unsecured creditors
Voluntary Chapter 11 filing which could be a prepackaged or a
prearranged deal
Reorganization Plan and disclosure statement make recovery analysis
clearer
Prices dependent on asset valuation, capital structure and timing of
emergence
Free fall Chapter 11 will lead to chaos and lack of disclosure
pushing bonds to 15-25
18
Recovery and Restructuring Phases 5, 6, 7
Phase 5: Emergence
Court approval of plan, NewCompany capital structure
becomes effective
Pricing of old debt securities contingent on equity and or
debt prices of NewCo securities
Phase 6: Post restructuring
First 4 quarters of stronger operating statistics therefore
credit profile improves and equity value increases
Phase 7: Post restructuring
NewCompany experiences 6-8 quarters of steady operating
performance
Process of refinancing restructured debt securities begins
Newco seeks access to new issuance market
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V. Financial Model
20
Current Situation
Companies are coming under increasing pressure from lenders
at an earlier stage than before
Banks have a large number of distressed credits in their loan
portfolio
The leveraged loan market has experienced a sharp
contraction
Banks no longer have patience with troubled companies
Less willing to extend waivers indefinitely
Demanding more in fees and amendments
Banks are forcing more companies to go to auction or sell
assets quickly
Relationship lending is not as prevalent
Presents an opportunity for creative investors
21
How to Get Control of Distressed Asset
Out of Court
Purchase bonds and exchange for equity in a privately negotiated
transaction
Exchange offer to completely recapitalize the Company
In Court
Formal process of a Chapter 11 reorganization
Chapter 7 liquidation
22
Advantages and Disadvantages of In Court and Out-of
Court for Distressed Investor
In Court Advantages
Can acquire assets free and clear of liabilities and encumbrances
In Court Disadvantages
Transaction costs associated with bankruptcy proceeding
Potential for competing bidders and plans as part of the bankruptcy
process
Higher and Better offers
Out of Court Advantages
Can avoid competing bidders in open auction process
Avoid bankruptcy costs
Can privately negotiate a debt for equity swap that creates the right
capital structure
Out of Court Disadvantages
Possibility of acquiring hidden liabilities
May be stuck with acquired securities if situation deteriorates further
23
Debt for Equity Swaps
Buying bonds at a discount and swapping into equity through a
privately negotiated transaction with the company
Can approach the original equity sponsor before buying the bonds to
ensure a friendly transaction and potentially access detailed due
diligence information
Acquire enough of the bonds so that a swap will engineer the best
capital structure for the company
Exchange the bonds for most of the equity
Leave original sponsor with a stub equity portion (5%-15%), warrants or
other consideration
More favorable than a long drawn out restructuring
Other bondholders remain in place
Now have par paper
Senior lenders should be more comfortable and willing to stay committed to the
credit
Must get in early and exploit the situation before the credit is too
distressed
24
Exchange Offers
A more comprehensive approach could involve the combination
of an exchange offer and new money investment
Combines the restructuring of the old debt with a change of
control
Can often prove the most efficient method to gain control in
the public forum
Accomplished relatively quickly
Low transaction costs compared to bankruptcy
Avoid large number of competing bids
Difficult to accomplish in complex situations
Large vendor listings
Publicly listed equity
Diverse group of bondholders
25
Chapter 7 vs. Chapter 11
Distressed opportunity typically arises when a company, unable to
meet all its debts, files for Chapter 11 (reorganization) or Chapter 7
(liquidation) bankruptcy
Chapter 7 involves shutting a companys doors and parceling out its
assets to its creditors
Chapter 11 gives the company legal protection to continue operating
while working out a repayment plan, known as a plan for
reorganization, with a committee of its major creditors
These creditors can be banks whove made loans, utilities and other
vendors owed for their goods and services, and investors who own bonds
Stock holders are also among the constituents, though when it comes to
dividing up the assets of the company they are paid back last and usually
very little, if anything
If in a bankruptcy, a company does not have sufficient assets to repay all claims,
the stock holders will get wiped out as they are last in line to receive any of the
proceeds from the liquidation or reorganization
26
Chapter 11
Equity nearly always wiped out
Intense pressure to sell the Company
Most restructuring advisors are bankruptcy or M&A specialists
High risk of change of management
Lawyers control process with constant court appearances
Most restructuring advisors are bankruptcy or M&A specialists
Average time in Chapter 11 is over 12 months
Extremely costly in fees with $3 mm to $10 mm in fees for
lawyers and advisors in large assets
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V. Financial Model
28
Company Overview
Samsonite is the worlds largest designer and manufacturer
and distributor of luggage products
Only global luggage brand
Approximately 31% market share in Europe and 19% in US in 2002
Competed in a highly fragmented market against much smaller
regional companies
Products marketed under Samsonite and American Tourister
brands - 90% brand recognition in the U.S. and over 70% in
Europe; 80% American Tourister brand recognition in U.S.
Expanded product line to include casual bags and computer cases
Europe market share 31% in 2002 CAGR of 11% growth in sales
since 1996
Asia sales growing at CAGR of 19% from fiscal 1997 to 2002
US market share fell from 30% in 1996 to 17% in 1999 due to
product and marketing, strategic decisions taken by management
Recovered to 18% in fiscal 2001 under new CEO
29
Background and Situation in Late 2002/early
2003
Companys capital structure has had many issues:
Company stock was virtually illiquid at the end of 2002
Traded an average of under $5,000 per day and the bid ask spread is
approximately 65% of the bid price
Absence of institutional support/coverage for common stock
Total obligations (debt and preferred stock) senior to the
common stock have a face value of approximately $800 mm
Existing preferred is increasing through PIK dividends at such a
high rate that it grows by approximately $50 mm per year
Onerous terms of the Existing Preferred Stock increasingly
causing significant earnings dilution for common shareholders and
could precipitate a Company-sponsored exchange offer or
bankruptcy
Overall leverage is too high
1. Lack of financial flexibility to mitigate potential shortfall in earnings
performance
2. High risk/low probability of execution of Companys five year
business pan and forecast without a de-leveraging event
30
Background and Situation Assessment
Balance Sheet and the reported financial statement losses continued
to affect Companys business and relationships with the Companys
suppliers, vendors and other constituencies
Management stock option plan is not able to provide incentive to
management in a way to benefit common shareholders
The impact of the downturn in the economy and the Companys
industry
Companys revenues and EBITDA were highly dependent upon performance of
international operations and global travel industry
Current geopolitical and economic climate puts downward pressure on tourism
and travel related industries, and adds uncertainty to the Companys business
model and operating forecast going forward
US war with Iraq
Terrorism concerns and is effect on international travel
Spread of SARS virus
Continued global economic softness
31
Objectives of the Recapitalization Transaction
32
Summary of the Recapitalization Transaction
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Summary of the Recapitalization Transaction
34
Alternates to Recapitalization
Issues with status quo with new senior credit facility
Management issues
Capital structure issues
Refinancing difficulties of new facility
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V. Financial Model
36
IS, BS and Old Capital Structure
Let us model the historical income statement and balance sheet for
year ended January 31, 2001, 2002 and 2003
Information is available in Samsonite 10K for January 31, 2002
and 2003
Make sure we check our data after we complete the income
statement
Net Income ties in to the NI from Income Statement barring any
unusual or non-recurring items we took out
Assets = Liabilities + Shareholders Equity
Income Statement
Observe the drop in revenues and EBITDA in 2002 vs. 2001
See how the Preferred Stock dividends (37.5 mm dividend in 2002
are impacting the Companys Net Loss every year
Balance Sheet
Observe how the redeemable preferred is increasing from $240.0
mm to $320.3 mm from 2001 to 2003 as it is PIK interest (paid in
kind a type of bond that pays interest in additional bonds or
interest is added to the principal, as opposed to cash payouts )
37
Sources and Uses
Let us prepare sources and uses for the recapitalization
transaction
Pay down old term loan and revolver
Fees paid to bankers, lawyers and miscellaneous expenses
is $20mm
$106 mm of new preferred equity is being put in by private
equity investors
Use the January 31, 2003 numbers
Keep the cash balance the same as before at $22.7mm
Sources equal uses and the balance will be the new
revolver balance
38
Pro Forma Balance Sheet and Capitalization
Let us make a pro forma balance sheet for January 31, 2003
incorporating the sources and uses for the recapitalization
Capitalize $5 mm of the $20 mm of fees and the other $15 mm
get expensed
Uses the sources and uses table to make the adjustments
In the pro forma capitalization see how the following ratios
change as a result of the recapitalization look at these ratios
before the recap and after the recap
Total Debt to EBITDA
(Total Debt + Preferred Stock) / EBITDA
39
Pro Forma Ownership
What % of the Company do the Existing Common Shareholders
and the Preferred Stockholders get after the recapitalization?
Conversion price of preferred shares to common stock is $0.42 per
share
Find the current common shares outstanding for Samsonite from
the most recent 10K or 10Q (January 31, 2003)
Find out how many shares and % of the Company the common and
preferred shareholders get (Old preferred and new preferred
shareholders)
The private equity investors end up owning more than 50% of the
Company after the recapitalization for the $106 mm equity
investment they made as they owned some of the old Preferred
also (41.7% as the result of the $106 mm investment and over 10%
from the Old Preferred shares)
40
Valuation Analysis
We did a valuation analysis to see how much would Samsonite
common shareholders and preferred shareholders get in the
current company without the recapitalization
Comparable Company looked at other brands challenging to
find appropriate comps to Samsonite Comps included apparel
companies like Nike, Ralph Lauren as one group and luxury
groups like Coach, Gucci and Waterford
Comparable Transaction challenging to find appropriate
comparable transactions also Antler was sold to an investor
group etc
Discounted Cash Flow Analysis - forecast free cash flow for 5
years, terminal multiple of 7.0x-8.0x and discount rate of
approx 10%-14%
We see that common shareholders get zero in most of the
scenarios
41
Implied Enterprise Value
42