Revising Equity

Financing
Strategies in
Difficult times
Nikhil Atale

July 27, 2009

Outline

Alternative financing

Applicable regulations

Shareholders right

Implications on accounting system

Today’s landscape

Global economies in crisis mode
since 2008

Money generating economies are

virtually to standstill

High imbalance in funds flow

Emerging markets at the mercy of

G8

Financials institutions in Thailand are

very healthy. But…
Credit markets freeze

Banks unwilling to sell impaired assets

Banks unwilling to substitute for shadow

financial system
− Worries about borrower credit risk.
− Worries about own liquidity if lenders want
money back.
− Worries about likely fire sales pushing securities
prices further down – common discount rate for
risky assets

Banks unwilling to raise enough equity

Stability is not the major focus of the private

sector in the midst of a crisis!

Institutional overhang not a major problem

right now because demand for credit low. But
will hamper recovery.
 Declining credit asset prices
pull equity prices downwards
ABX.07-1
ABX.07-1 AAA
AAA versus
versus BKX*
BKX* index
index prices
prices
Global IPO

1Q 2007 2Q 2007 3Q 2007 4Q 2007 1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009

No. Deals 100 169 113 172 27 67 20 6 2

Total
Proceeds $32.1 $83.1 $47.2 $94.3 $34.8 $35.0 $9.3 $1.6 $0.9
(billions)

Average Deal
Size (millions) $321.2 $491.7 $418.1 $548.2 $1,289.3 $522.2 $464.4 $268.5

Global IPOs include all with deal size greater than US$100mm.

- Global IPO value dips 95% at $1.6 bn in 2009

Xinyi Glass placement upsized to $127 million
The company raises $67 million of fresh capital at a 7.6% discount, while the controlling
shareholder takes the opportunity to secure some profit after this year's strong run-up in the
share price.
By Anette Jönsson | 27 May 2009

NAB raises $2.02 billion from upsized follow-on

The fully underwritten deal, which was launched at a fixed
9.7% discount to the latest market price, drew significant
demand and was increased by 50%.
By Anette Jönsson | 11 November 2008

Cash is king in Thailand

International banks are set to benefit as cash-rich Thai companies look to expand operations
overseas, but the continued dominance of paper-based transactions proves a challenge.

China Metal Recycling prices IPO at the top

The scrap metal recycling company raises $200 million to become the second-largest Hong Kong
IPO year-to-date. Strong retail demand triggers a clawback that boosts the retail tranche to 30%.
By Anette Jönsson | 18 June 2009

Italian-Thai convertible upsized to $150 million

The deal, which is only the third CB from Thailand since
2002, is completed without stock borrow or credit
protection, making it something of a rarity.
Equity Financing Choices

Warrants Conver-
tibles

Equity

ADRs Common
Private Equity
Large source of Capital

The US private equity market exceeded $300b in the US market for 1H 2007 – the last time the markets

had ample liquidity.

In the transportation sector, particularly aviation, private equity has been a large participant through the
funding of equity and the purchase of secured/unsecured debt. Since 2001, it has been a significant

player in the restructuring and mergers of several legacy airlines.

Model Strategic Investor Control Financial Rights Offering Multiple Private

Investor Equity Investors
With Private Equity
Example Continental II 1 US Airways I Air Canada US Airways II 2

Amount $140 million $240 million US$854 million $866 million

Raised
Pros  Benefit to underlying  Simplified negotiations  More attractive to  Less need for deep
business bondholders pocketed investor
 Provides endorsement of
 Possible improved board/management POR  Price validation by private  Likely higher valuation
valuation due to investor than single investor
reciprocal benefits to  Plan sponsor serves as
investor forcing function in
process

Cons  Possible antitrust or  Difficult to find deep
regulatory issues pocketed investor
 Possible strategic  Likely to require lower
investor conflicts on initial valuation
business plan
 Size likely requires
greater depth of due
diligence by prospects
 Complicated if majority of  Negotiation process can
claims are held by non- be complicated
public bond holders and/or
estimation of substantial  Will still entail a “private
portion of claims can’t be equity” discount, albeit
completed prior to equity less than single investor
raise
 May require cash
component option for non-
traditional investors (e.g.,
labor, trade creditors, etc.)
US Airways
US Airways’ equity raise was also a unique challenge – raising substantial equity
capital to acquire a publicly traded company
Publicly pursued “standalone plan” for $250-350mm Private Equity, while privately
Feb-Mar ‘05 secured preliminary merger agreement and quietly sought equity to fund merger

Merger with AWA used to build new business plan upon which equity was raised

May ‘05 $375mm Private Equity raised (merger announced 5/17/05)

Increased view of capital needs because of Southwest competition at PHL

and dramatic spike in oil prices (Hurricane Katrina hit just weeks before closing),

June ‘05 $565mm Private Equity, potential Rights Offering considered Stock Price of LCC 12 Months Pre-
and discarded and 10 Months Post Emergence 1

$6 0
Overcame Katrina, oil price shock and built investor demand $50
May 17, 2005 merger announcement
September 27, 2005 emergence from Ch. 11 and
acquisition of AWA

$4 0
Final Structure $3 0
Sept ‘05 $678mm Private Equity $2 0
$188mm Public Equity $10

$144mm Public Convertible Bond $0

Sep - N o v- Jan- M ar- M ay- Jul - Sep - N o v- Jan- M ar- M ay- Jul -
04 04 05 05 05 05 05 05 06 06 06 06
Note:
1. LCC stock pre-emergence represents equivalent AWA stock price.
Structured Finance

Asset-backed securitization

Corporate financial
restructuring

Structured financing
techniques
 Why Use a Hybrid?

Motivations for Hybrids

Linked to business
Driven by investor needs
risk

Linked to Company
hedges Company does
market risk
not hedge

Cannot hedge Debt or

with derivatives equity are
Not good enough
When Debt and Equity are
Not Enough

Assets Liabilities
Debt
Contractual
Contractualint.
int.&&principal
principal
Value
Value No
Noupside
upside
of
offuture
future Senior
Seniorclaims
claims
Control
Controlvia
viarestrictions
restrictions
cash
cashflows
flows
Equity
Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
Residualclaims
claims
Voting
Votingcontrol
controlrights
rights
 When Debt and Equity are
Not Enough

Alternatives
Assets Liabilities
Collateralized
Debt Asset-securitized
Project financing
Contractual
Contractualint.
int.&&principal
principal
Value
Value No
Noupside
upside
of
offuture
future Senior
Seniorclaims
claims
Control
Controlvia
viarestrictions
restrictions
cash
cashflows
flows Preferred
Equity Warrants
Convertible
Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
Residualclaims
claims
Voting
Votingcontrol
controlrights
rights
 Equity-Linked Bonds

Bonds with warrants

Convertible Bonds

Index-linked Bonds

These are all example of hybrid

bonds and should be priced by
decomposition
 Stock-Purchase Warrants

Warrants are usually detachable and trade on the

securities exchanges

Warrants are often added to a large debt issue as

“sweeteners” to enhance the marketability of the issue

Exercise price

Warrants usually have a limited life of about 10 years

or less

Warrants differ from rights and convertibles

 Convertible Bonds

Bond may be converted into stock

The Conversion Ratio is the number of shares of

common stock that can be received in exchange
for each convertible security

The Conversion Price is the per share common

stock price at which the exchange effectively
takes place
 Financing With Convertibles

Motives for using convertibles include:

− It is a deferred sale of common stock that decreases
the dilution of both ownership and earnings
− They can be used as a “sweetener” for financing
− They can be sold at a lower interest rate than
nonconvertibles
− They have far fewer restrictive covenants than
nonconvertibles
− It provides a temporarily cheap source of funds
(assuming bonds) for financing projects

Most convertibles have a call feature that enables the

issuer to force conversion when the price of the common

stock rises above the conversion price

 Determining the Value of a
Convertible Bond

There are three values associated with a convertible bond:

− Straight Bond Value is the price at which the bond
would sell in the market without the conversion feature
− The Conversion Value is the product of the current
market price of stock times the conversion ratio of the
bond
− The Market Value is the straight or conversion value
plus a market premium based upon future (expected)
stock price movements that will enhance the value of
the conversion feature
Motivations for Issuing
Hybrid Bonds

Company has a view

There are constraints on what the

company can issue

The company can arbitrage to save

money

Always ask: given my goal, is there

an alternative way of achieving the
same effect (e.g., using
derivatives?)
 Accounting for Hybrid
Bonds
Bonds which can be converted into other corporate
securities are called convertible bonds.

Benefit of a Bond (guaranteed interest)

+
Privilege of Exchanging it for Stock
(at the holder’s option)
 Accounting for Hybrid
Bonds
At Time of Issuance

Convertible bonds recorded as straight debt issue, with any

discount or premium amortized over the term of the debt.

At Time of Conversion

Companies use the book value method when converting

bonds.

When the debt holder converts the debt to equity, the issuing
company recognizes no gain or loss upon conversion.
Induced Conversion
Issuer wishes to encourage prompt conversion.

Issuer offers additional consideration, called a

“sweetener.”

Sweetener is an expense of the period.

Retirement of Convertible Debt

Recognized same as retiring debt that is not

convertible.

Difference between the acquisition price and

carrying amount should be reported as gain or loss
in the income statement.
 Accounting for CPS
Convertible preferred stock includes an option for the
holder to convert preferred shares into a fixed number
of common shares.

Convertible preferred stock is considered part of

stockholders’ equity.

No gain or loss recognized when converted.

Use book value method.

 EPS in Simple Capital
Structure

 Simple Structure--Only common stock; no potentially

dilutive securities.

 Complex Structure--Potentially dilutive securities are

present.

 “Dilutive” means the ability to influence the EPS in a

downward direction.
Preferred Stock Dividends

Subtracts the current year preferred stock dividend from

net income to arrive at income available to common
stockholders.

Preferred dividends are subtracted on cumulative

preferred stock, whether declared or not.
 EPS in Complex Capital
Structure

Complex Capital Structure exists when a business has

convertible securities,
options, warrants, or other rights
that upon conversion or exercise could dilute earnings
per share.

Company reports both basic and diluted earnings per

share.
Diluted EPS includes the effect of all potential dilutive
common shares that were outstanding during the period.

Companies will not report diluted EPS if the securities in their

capital structure are antidilutive.
Diluted EPS – Convertible Securities

Measure the dilutive effects of potential conversion on

EPS using the if-converted method.

This method for a convertible bond assumes:

(1) the conversion at the beginning of the period (or at
the time of issuance of the security, if issued during
the period), and
(2) the elimination of related interest, net of tax.
EPS Presentation and Disclosure

A company should show per share amounts for:

income from continuing operations,
income before extraordinary items, and
net income.

Per share amounts for a discontinued operation or an

extraordinary item should be presented on the face of the
income statement or in the notes.
Shareholders rights

All issuance needs shareholders
approval

A situation of 1997 crisis and

present crisis is exception

Banks/creditors virtually take over

the companies and decide the faith
in their “shareholders” interest

Current crisis is classic example:

Minority shareholders are burned in
AIG, Citi, where US Govt. stepped in
Shareholders rights

Exceptions in case of Govt. bailouts

Cases of issuing “not genuine” offers

from “unknown” based in “unknown”
locations

Above actions led to high speculation in

stock price, eventually, major
shareholders found to have exited at
peak

Be watchful incase all of a sudden some

company issues these instruments!
Shareholders rights

In Theory, shareholders take equal risks
as that of promoters of the company

In normal course, passing resolutions

regarding these issues is “purely a
number game”

Funds acting in concert tend to

block/raise voices against “unfair”
practices

Government intervention in special

situation can be unfair to minority
shareholders
Understanding Crisis

No two crisis are alike

Banks and capital markets are ultimate

victims of crisis

Extensive deleveraging follows after

crisis, thus, companies tend to issue
equity to lower their D/E ratios

Its desperate situation and loose loose

proposition for all
Equity Funding in Crisis

Study the timing issue carefully

If its for solid business expansion, or

exciting acquisition (distress assets),
investors would love it

Debt tend to be cheap during crisis, so,

if permits, tend to gear your balance
sheets

Thai banks are flooded with ample

liquidity, what is lacking is good
corporate story

If you feel concerned with debt, then

use hybrids and grab the opportunity
Equity Funding in Crisis

For normal business expansion…..here
are my thoughts…

− Study in-depth, do you really need to

expand with demand is virtually out
− Secondly, as commodities are tend to be
cheap, crisis is the best time to build
capacities at cheap cost
− Use debt, internal cash to expand
− “distress” mentality persists during crisis
mode, so don’t do a private equity deal
for normal expansion
− Unlock your value once, economic cycles
turns upwards (e.g. IPO, etc.)
 THANK YOU!
T