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Acquisition Finance Products Expanded Debt Capacity Structuring The Deal

Acquisition Finance Products Expanded Debt Capacity Structuring The Deal. Joseph V. Rizzi Amsterdam Institute of Finance 10-12 October, 2016. Login to our free WIFI Login: AIFGUEST Password: welcome@aif. Share your AIF experience @ AIFknowledge #AIF.

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Acquisition Finance Products Expanded Debt Capacity Structuring The Deal

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  1. Acquisition FinanceProducts Expanded Debt CapacityStructuring The Deal Joseph V. Rizzi Amsterdam Institute of Finance 10-12 October, 2016 Login to our free WIFILogin: AIFGUEST Password: welcome@aif Share your AIF experience @AIFknowledge #AIF

  2. Amsterdam Institute of Finance Joseph V. Rizzi October, 2016 PRODUCTS: EXPANDED DEBT CAPACITY(Affordability Products)

  3. Expanding Debt Capacity Rising purchase price multiples and ROE concerns drive acquirers to seek ways to expand their debt capacity. Some of the most common techniques are: • Adjusted (Increased) EBITDA - Operating improvements - Normalization • Asset Sales - Bridges to asset sales - Liquidity is key in case bridge cannot be taken out • Innovative Securities - Defer interest - Push out amortization - Increase flexibility 3 3 Amsterdam Institute of Finance October, 2016

  4. Debt Options 1L The above table shows the features of different debt options available to issuers The availability of the different options is subject to market conditions 4 Amsterdam Institute of Finance October, 2016

  5. Tranches in the LBO Structure Amsterdam Institute of Finance October, 2016

  6. Tranches in the LBO Structure Amsterdam Institute of Finance October, 2016

  7. Buyout Financing Scenarios Expected Best Case Future Cash Flows Base Case Downside Worst Case Bank Debt T/LB HYB Other R/C + T/LA ------------------ Biblical Bad 5 – 7 yrs 8 yrs 10 yrs Amsterdam Institute of Finance October, 2016

  8. Sponsor Based Debt Financing Allocations and Capital Providers Institutional Investors Private Equity Funds and Co-Investors Providers of Capital Banks, Commercial Banks, Securities Firms Hedge, Mutual, Pension Funds CLOs Insurance Companies Others (e.g., Financing Companies) (BDO) Private Debt Funds Equity 1L 2L Other Debt Capital Structure Facilities Revolving Credit Facility Term A Loan (Tla) Special Purpose Facilities (e.g., Acquisition Line Term B Loan (TLb) Second Lien High Yield Bonds (incl) PIK Mezzanine Unitranche Warrants Preferred Equity Common Equity Leveraged Loans- Institutional Tranche Leveraged Loans – Pro Rata Tranche ----------------------------- Asset Backed Loans Leveraged Loans – Pro Rata Tranche -------------------------------------------------- Junior Debt Equity Senior (Including Cov – Lite) Based on amended HBS case exhibit Amsterdam Institute of Finance October, 2016

  9. Complex Corporate Structure Equity #1 Equity #2 Equity European Holding Company #1 European Holding Company #2 Preferred Stock NEWCO High Yield/Sub Notes Collapsed After Closing Bank Deal with Upstream Guarantee Local Target Guarantee Due to the structural nature of Subordination in Europe, bank Debt would be placed at the Operating subsidiary level. Domestic Operating Subsidiary Domestic Operating Subsidiary Foreign Operating Subsidiary* Domestic Operating Subsidiary * Tax limitations surrounding guarantees from foreign subs. Amsterdam Institute of Finance October, 2016

  10. Innovative Securities and Relative Value Considerations • Innovative securities allow for the expansion of debt capacity by one or more of the following mechanisms: • Reduce Annual Debt Service - Reducing cash interest expense - Lengthen duration (Reduce/Delay amortization) • Increasing Flexibility - Covenants - Public Disclosure - Cash flow control - Call Premium - Bridging - Partial/fully Unsecured • Tranching (sequential ordering of payment or priorities) – A/S - Holding Company instruments - Restricted Subsidiaries - Second lien/bifurcated collateral-crossing liens - Senior/Subordinated • Cost – Second Lien vs Mez 10 10 Amsterdam Institute of Finance October, 2016

  11. LBO Transaction Structures 2007 2010 2012 2015 1H16 Bank Debt 53.3% 41.6% 48.8% 52.1% 48.9% Unsecured Debt 1.7% 1.3% 0.6% 0.3% 0.8% Sr. Unsec’d Debt 5.1% 5.8% 6.9% 2.9% 2.4% Public/144a High Yield 3.5% 0.7% 0.4% 0.0% 0.0% Bridge Loan 0.3% 0.3% 0.0% 0.3% 0.0% Mezzanine 1.8% 5.1% 2.9% 0.6% 1.0% HoldCo Debt/Seller Note 0.3% 0.5% 0.3% 0.0% 0.0% Preferred Equity 0.1% 0.9% 0.3% 0.2% 0.9% Common Equity 30.4% 30.0% 37.4% 40.3% 42.1% Rollover Equity 2.0% 2.4% 1.6% 1.9% 2.9% Other 1.3% 1.4% 0.6% 1.3% 0.6% Total Senior Debt 60.1% 48.7% 56.3% 55.4% 52.2% Total Sub Debt 5.7% 6.1% 3.3% 0.9% 1.0% Total Equity 32.9% 43.8% 39.7% 42.4% 45.9% FD/EBITDA 6.1x 4.2x 4.5x 5x 4.68 SD/EBIITDA 5.4x 3.9x 4.1x 5x 4.68 PPX 7 9x 9x 9x 10x Source: S&P Capital IQ Amsterdam Institute of Finance October, 2016

  12. Country Financing StylesAverage Sources of Proceeds of Buyouts – By CountryLTM 6/16 EuropeWestern EuropeU.K. FranceGermany Bank Debt 46% 47% 48% 48% 46% 2nd-Lien Debt 2% 3% 2% 2% 4% Secured HY 1% 1% 0% 2% 2% SrUnsec HY 2% 2% 3% 1% 2% Mezzanine 0% 0% 0% 0% 0% Bridge Loan/Public High Yield 0% 0% 0% 0% 0% Vendor Note 2% 2% 0% 0% 0% Total Debt 54% 55% 52% 53% 55% Source: S&P Global Amsterdam Institute of Finance October, 2016

  13. Non Investment Grade Loan Market Bank Oriented Revolver T/LA Institutional Investor T/LB 2L Regulatory Leverage “Test”: <6X EBITDA Amsterdam Institute of Finance October, 2016

  14. Second Lien Loans – 1H16 • Senior Secured, but with Junior or Second Lien-Lower recovery • Competing with EURO Mezzanine • Investors – hedge funds and CLO • Spread differential between Second Lien and First Lien currently around 325 BP 1H16 (Depressed) • Volume: U.S. $5.4B EUR $1.9B • Issues: - Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout bought at discount - CLO Rating Impact % limit on 2L paper Amsterdam Institute of Finance October, 2016 14 14

  15. Unitranche Hybrid Senior/Mezzanine/2L Combination • Separate Revolver: Usually Banks with an Inter-Creditor Agreement • Unitranche Term Position: Alternative Nonbank Providers Middle Market Oriented • Bank Risk Appetite Supplement • Size: Usually <€150 mln First Appeared in 2005. Increased Popularity Following Crisis When 2L and CLO Stalled Blended Rate: Target Returns Around 7% • PIK Portion Amsterdam Institute of Finance October, 2016

  16. Covenant Lite • Covenant Issues • Creditor – preserve deal; recovery value • Debtor – flexibility • Covenant Lite – liquidity vs. structure • Similar to Investment Grade • One or No Financial Covenants • Rating Agency impact on CLO • Volume • US – Now dominant form >90% • Europe – 30% (€8B) • Almost no incremental yield over first lien loans with financial covenants 16 16 Amsterdam Institute of Finance October, 2016

  17. ‘OpCo \ PropCo’ Financing (1) By structuring the financing of a pool of assets with a credit quality stronger than the corporate credit as a whole, ‘OpCo’ \ ‘PropCo’ financing can provide a cost effective source of (acquisition) financing. • Example:- • Target company de-merged into ‘PropCo’, which owns the real estate assets, and ‘OpCo’, the operating company. • Banks finance ‘PropCo’ acquisition of properties at agreed Loan to Value ratio. • ‘PropCo’ leases the real estate assets to ‘OpCo’. • ‘PropCo’ debt refinanced by traditional Property Lenders or via Commercial Mortgage Backed Securities (CMBS) market. • ‘OpCo’ required to service the acquisition debt not assumed by ‘PropCo’. • REIT 17 17 Amsterdam Institute of Finance October, 2016

  18. ‘OpCo \ PropCo’ Financing (2) BidCo Notes Financing Approx. 100% Approx. 100% PropCo OpCo Rental Payments 18 Amsterdam Institute of Finance October, 2016

  19. High Yield Bonds • Longer Term Bonds • 7-10 years and longer • 4/5 NC • Public or Private • Usually issued in private form with exchange rights • Pricing would step up if bonds not public within short period (say 180 days of close) • HYB New Issue (€ B) – YTD End of August 2016 v 2015 • 2015 2016 • Issuance €55B €30B • Market Size 480B 470 B 19 19 Amsterdam Institute of Finance October, 2016

  20. Key High Yield Terms • Registration rights • Issuer • Status • Degree of subordination • Limitations on liens • Limitations on indebtedness • Restricted payments • Asset sales • Change in control • Minimal financial maintenance covenants 20 20 Amsterdam Institute of Finance October, 2016

  21. European Mezzanine Terms(Currently dead due to HYB, 2L and Unitranche loan competition) Covenants * Extensive (bank type) * Maintenance basis (tested quarterly) Security * Second secured Call Provisions * Generally callable immediately (103,102,101) Maturity * Ten year Pricing * LIBOR + * Warrants for total return * TBD Liquidity * Low Disclosure * Limited Marketing * No research coverage, no roadshow Rating Requirements * None 21 21 Amsterdam Institute of Finance October, 2016

  22. PIK • Pay if you can toggle • Ratings – NR or CCC • Eats up equity • Holding Company Issuer • Characteristics • End of August 2016: 500 mln (all toggle) 2 deals 22 22 Amsterdam Institute of Finance October, 2016

  23. Stapled Financing Amsterdam Institute of Finance October, 2016 Staple financing term sheet to deal book Be prepared to fund Establishes ceiling Conflicts of interest 23 23

  24. ACCORDIAN LOAN • Incremental Loan Facilities • Option allowing increase in principal under existing terms subject to • certain conditions • Existing lenders can participate or new lenders can be sought • Dilution of Lender Interest • Uncommitted – access requires lenders willing to provide • Suffer dilution if you elect not to participate and facility approved Amsterdam Institute of Finance October, 2016

  25. Bridge Loans • Equity • Bank provides equity • Find other equity investors later or keep • Reduce PE equity • Lowers need for club or larger deals • Rationale – pay to play • Bonds 25 Amsterdam Institute of Finance October, 2016

  26. Changing Nature of Leveraged FinanceCapital Structures • Pre-Crisis • Common equity < 35% • Hybrid preferred (0.5x) • PIK notes (0.5x) • Unsecured/mezzanine (1x) • Carve-out collateral (1x) • - OPCO/PROPCO • Second lien loans (1x) • Senior secured bank loan (4x) • - Amortizing T/LA – 20% • - B tranches – 80% • Post Crisis • Common equity > 35% • Unsecured/mezzanine (1x) • Senior secured bank loan (4x) • - Amortizing T/LA – 40% • - B tranches – 60% FDX – 5x + PPX – 9x + FDX – 6x + PPX – 9 + • Increasing layers of debt • Directed at different investors • Intercreditors conflicts 26 26 Amsterdam Institute of Finance October, 2016

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