Mezzanine Financing E-Book

Luc Nijs

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Series
• Sprache: Englisch

Seitenzahl: 1203

Veröffentlichungsjahr: 2013

Beschreibung

An in-depth explanation of mezzanine finance

Mezzanine finance products, which have grown increasingly popular in recent years, involve a unique and complex form of analysis because of their hybrid nature. Because mezzanine finance involves no collateral, it accentuates legal terms, term sheets, and contracts, in addition to depicting dynamics of both debt and equity. Experienced chairman, lecturer, and professor of investment banking Luc Nijs presents readers with a thorough description of product groups, structuring and pricing, and cultural discrepancies in terms of regulation and application in Mezzanine Financing: Tools, Applications and Total Performance. Nijs analyzes common triumphs and failures encountered in mezzanine financing, and he discusses techniques for risk analysis and risk mitigation. A final study of international capital markets, their products' relevance, attractiveness, and liquidity, and the effects on pure equity/fixed-income risk concludes the book.

• Conveys a professional's advice through case studies of various regions, industries and contexts
• Provides the only complete analysis of mezzanine finance as no other books take on the topic as their only subject
• Details an increasingly popular and globally relevant subject in finance

Those seeking a detailed explanation of the complexities within mezzanine financing will encounter a professional account in Nijs's book.

Leseprobe

Contents

Cover Page

Series

Title Page

Copyright

Dedication

Preface

1 Introduction

1.1 THE BI-POLAR WORLD OF FINANCE

1.2 DEMARCATION OF THE PRODUCT GROUP

1.3 POSITIONING AND USE OF MEZZANINE FINANCE

1.4 THE RISK–RETURN CONUNDRUM

1.5 PROVIDERS OF MEZZANINE FINANCE

1.6 THE MARKET FOR MEZZANINE PRODUCTS

2 The Mezzanine Product Group

2.1 CATEGORIZATION OF THE MEZZANINE PRODUCT GROUP

2.2 CASE STUDY: THE KRATOS COMPANY – MERGER FINANCE

3 The Implicit Cost of Mezzanine Products

3.1 MEASURING RISK

3.2 TYPES OF RISK

3.3 EQUITY RISK VERSUS THE RISK OF BORROWING: DEFAULT RISK AND THE COST OF DEBT

3.4 PUTTING IT ALL TOGETHER

3.5 HOW MUCH RISK IS THERE IN A MEZZANINE PRODUCT?

3.6 COST VERSUS RETURN DYNAMICS FOR MEZZANINE PRODUCTS

4 The ‘Pricing’ Question and Further Financial Dynamics of Convertible Loans and Preferred Convertible Shares

4.1 PRICING GRID FOR MEZZANINE PRODUCTS

4.2 FINANCIAL DYNAMICS OF CONVERTIBILITY IN CONVERTIBLE LOANS AND PREFERRED CONVERTIBLE SHARES

4.3 CASE STUDY: JJ BARS & RESTAURANTS – MEZZANINE FOR EXPANSION

5 The Mezzanine Product Group and the Financial Industry

5.1 THE BASEL COMMITTEE AND FRAMEWORK

5.2 THE EVOLUTION OF THE BASEL RULES (BASEL I AND II)

5.3 OBJECTIVES OF BASEL III AND THE CENTRAL THEMES

5.4 IMPACT ON THE USE OF MEZZANINE PRODUCTS IN THE FINANCIAL SECTOR

5.5 REGULATION IN THE INSURANCE SECTOR IMPACTING THE USE OF MEZZANINE PRODUCTS

5.6 COCO BONDS – CONTINGENT CONVERTIBLE BONDS

5.7 ANNEX I – SUMMARY BASEL III

5.8 ANNEX II – BASEL III – SPECIFIC FEATURES

5.9 CASE STUDY POSITIONS: MEZZANINE FINANCING FOR FINANCIAL INSTITUTIONS

5.10 CASE STUDY 1: FINANCING THE FUTURE OF BANK ALHANBRA

5.11 CASE STUDY 2: GROWING THE BRAZILIAN MARKET

5.12 CASE STUDY 3: FINANCING A SOUTH AFRICAN FI WHICH IS PART OF A LARGER CONGLOMERATE PRIOR TO AN IPO

6 Mezzanine and Project Finance

6.1 TYPES OF PROJECTS

6.2 FINANCING ASPECTS

6.3 SECURITIZING PROJECT LOANS

6.4 CASE STUDY 1: DEVELOPING A TOLL ROAD IN POLAND (A2)

6.5 CASE STUDY 2: BUILDING AND OPERATING A WIND PARK

7 Real Estate Projects and Mezzanine Finance

7.1 WIDER APPLICATION

7.2 OTHER APPLICATIONS AND RETURN ISSUES

7.3 CASE STUDY: FINANCING A REAL ESTATE COMPANY IN THE CEE REGION

8 Mezzanine and the Private Equity Space

8.1 DRIVERS OF RETURN

8.2 LBO STRUCTURE

8.3 TAX IMPLICATIONS

8.4 ALTERNATIVE TRANSACTIONS USING SIMILAR FINANCING STRUCTURES

8.5 SUMMARY OF DIFFERENT COMPARTMENTS IN THE LBO STRUCTURE17

8.6 SUMMARY OF TYPES OF SECURITIES IN THE LEVERAGE STRUCTURE OF AN LBO

8.7 CASE STUDY: BUYING ORANGINA – A TYPICAL LBO WITH SOME INTERESTING QUESTIONS AHEAD!

9 Mezzanine Products and the World of the Rating Agencies and Accountancy Boards

9.1 RATING AGENCIES AND THE DEBT–EQUITY CONTINUUM

9.2 CASE STUDY: FITCH’S APPROACH TO RATING HYBRID FOR CORPORATES5

9.3 MEZZANINE DEBT, RATING AGENCIES, THE REGULATOR AND FINANCIAL INSTITUTIONS AFTER 200811

9.4 APPENDIX 1:18 EQUITY–CONTENT MAXIMIZATION AND STRUCTURING CRITERIA AT MOODY’S

9.5 APPENDIX 2: S&P’S AND MOODY’s KEY STRUCTURING CONSIDERATIONS19

9.6 THE INTRICACIES OF THE ACCOUNTING WORLD

9.7 DEMARCATION LINES AND PRODUCT MODELING

10 Term Sheets, Inter-creditor Agreements and Debt Restructuring

10.1 GROUPS OF COVENANTS

10.2 REVIEW OF KEY COVENANTS FOR MEZZANINE PRODUCTS2

10.3 OTHER COVENANTS

10.4 CASE STUDIES: THE GOOD, THE BAD AND THE UGLY3

10.5 A COMPARISON OF DEBT ASSET CLASSES4

10.6 CASE STUDY: LYONDELLBASELL AND LYONDELL CHEMICAL COMPANY15

11 Outlook

11.1 INTRODUCTION

11.2 THE NOT-TOO-DISTANT PAST

11.3 NEW KIDS ON THE BLOCK

11.4 THE UNITRANCHE PRODUCT

11.5 REORGANIZATION OF INSOLVENCY LAWS IN EUROPE

11.6 ISLAMIC FINANCE: SUKUKS AND NON-RISK-FREE BOND LOOK-ALIKES

11.7 ORIGINATION SOURCES FOR MEZZANINE

11.8 THE ROLE OF GOVERNMENTAL ORGANIZATIONS

11.9 THE REFINANCING WALL: OPPORTUNITIES AND CHALLENGES

11.10 PERFORMANCE OF MEZZANINE PRODUCTS

Appendix 1: Overview of Term Sheets and/or Model Contracts for the Mezzanine Product Group

APPENDIX 1.A TERM SHEET FOR A SENIOR SECURED LOAN

APPENDIX 1.B TERM SHEET FOR A SUBORDINATED LOAN/BOND

APPENDIX 1.C TERM SHEET FOR MEZZANINE DEBT

APPENDIX 1.D WARRANT PURCHASE AGREEMENT

APPENDIX 1.E CONVERTIBLE BOND TERM SHEET

APPENDIX 1.F CONVERTIBLE PREFERRED SHARES

APPENDIX 1.G TERM SHEET FOR SENIOR SECURED FINANCING

Appendix 2: First Lien/Second Lien Inter-creditor Agreement

PREAMBLE

AGREEMENT

1 LIEN PRIORITIES3

2 MODIFICATION OF OBLIGATIONS23

3 ENFORCEMENT30

4 PAYMENTS

5 PURCHASE OF FIRST LIEN OBLIGATIONS BY SECOND LIEN CLAIMHOLDERS45

6 INSOLVENCY PROCEEDINGS52

7 MISCELLANEOUS

8 DEFINITIONS93

Glossary

Case Guidance/Solutions

KRATOS ACQUISITION FINANCE

JJ BARS & RESTAURANTS

POLAND A2

BUILDING AND OPERATING A WIND PARK

FINANCING A REAL ESTATE COMPANY IN THE CEE REGION

BUYING ORANGINA – A TYPICAL LBO WITH SOME INTERESTING QUESTIONS AHEAD!

LYONDELL CHEMICAL COMPANY

Index

For other titles in the Wiley Finance series please see www.wiley.com/finance

© 2014 Luc Nijs

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Library of Congress Cataloging-in-Publication Data

Nijs, Luc.    Mezzanine financing : tools, applications and total performance / Luc Nijs.          pages cm. — (The Wiley finance series)    Includes index.       ISBN 978-1-119-94181-1 (hbk)   1. Finance—Management.   2. Risk management.   3. Finance–Law and legislation.   I. Title.    HG173.N54 2013    658.15’224–dc23

2013034153

A catalogue record for this book is available from the British Library.

ISBN 978-1-119-94181-1 (hbk) ISBN 978-1-118-76522-7 (ebk) ISBN 978-1-118-76520-3 (ebk)

Cover images reproduced by permission of Shutterstock.com

To my parents.

For their relentless support in pretty much everything I do.

That they may continue to thrive in good health.

Preface

For years now, for one and a half decades in fact, I have been engaged in the mezzanine world as an academic, trainer, consultant and as an entrepreneur/investor. Although nothing can replace practice and experience, it is the many students and practitioners I have met in my programs and courses, as well as the many business situations which triggered open-ended questions, that ultimately motivated me to write the book you now have in front of you.

During all those years the mezzanine finance world has changed a lot; it has grown significantly, boundaries have become blurred and financial innovations have made the spectrum more fragmented than before. Not surprisingly, many students and young professionals have wondered if they really understood what was going on, and when it was appropriate to use these products in a variety of situations thrown at them in their professional careers. They wondered which type of product to use and when, what the short and long-term impact would be for their firm, how to legally construct these products and, most importantly, how much risk there would be in each of these products, and therefore what a realistic and meaningful return would be given the risks involved. Some of them ended up in a vicious circle of self-repeating and self-reinforcing questions.

In my students’ battle to embrace the dynamics of the product group and assess the adequateness of each product, their eagerness and uncertainty forced me to be clearer and more transparent in the way I communicated about the theme. That clarity is even more important in emerging markets where most of my business engagements are (and also my heart and passion) and where the banking sector has often not yet (fully) commercialized the product group. Sometimes this was because there was no need for the product group, sometimes because overall financial development has not been ongoing at a pace that would justify their introduction, and finally the contractual structure which can, at times, be difficult to understand, and/or difficult to produce, and the position the creditor ends up in when things go wrong, obstructed the introduction of the product group in some of those emerging markets.

This book is written around my experiences during sessions, and is based on years of implementing the product group in many countries, structures and industries while supporting different corporate or entrepreneurial objectives. The book, therefore, has content that can be described as a mix of academic analysis and practical applications for selecting and structuring deals. It is also characterized by a multidisciplinary approach, where economic, legal and financial aspects are intertwined where needed and as deemed appropriate.

I have also included the necessary examples and case studies, as the picture they provide can say more than a thousand words, and will further stimulate those who decide to use the book primarily as a study handbook or guide.

The book’s content falls into four major divisions. After an introduction that allows us to look at the mezzanine market and the demarcation of the product group (Chapter 1), the second part of the book will include extensive coverage of the individual products, and contains a list of dos and don’ts for each of them (Chapter 2), the implicit cost of mezzanine products (Chapter 3) and the technicalities with respect to embedded optionalities (Chapter 4) as well as the overall pricing and valuation question. The third part of the book will look at the peculiarities of the product group when applied within certain industries and the implications of highly regulated environments. The banking sector, project finance applications, the real estate sector and private equity settings all pose specific questions and raise individual problems that we need to tackle (Chapters 5–8).

The fourth part of the book will look at the issues of structuring the products, accounting and legal issues, the struggle of rating agencies (Chapter 9) dealing with the product group, cash flow waterfall concerns and, most importantly, the question of an adequate risk–return trade-off for the product group, in particular in distressed situations or issues related to work-outs or (outside) courtroom restructuring programs (Chapter 10). I end in Chapter 11 with an outlook for the product group and what innovation has delivered in this field in recent years. The aforementioned case studies and the necessary appendices which primarily contain legal and contractual support documents complete the book.

The book is therefore appropriate for both scholarly and professional purposes. For the academic or student wishing to delve deeper into the specifics of the product group, as well as the practitioner who might be looking for specific answers to the challenges that come with the application of the product group, this book provides the necessary answers and food for thought. The references made in the footnotes facilitate further reading.

The market is continuously in action and financial innovation will, at some point, force this work to be revised. Where possible, I have tried to use foresight to shape the content without leaning towards speculation about certain aspects of the product group’s future and its place in the financing spectrum. Where adequate and properly identifiable, I also refer to regional differences in application or pricing levels of the product group. Finally I have tried to anticipate some of the most pressing questions facing the product group, both from a regulatory and a market point of view. No doubt, the future mezzanine market will be shaped in part by how the lending market and the need for credit will evolve into what will still qualify as significantly unstable markets, as well as the impact of Basel III and the wider regulatory reforms on the banking industry, and the further development of the shadow banking system and the regulation it will face. Each of these aspects will have distinct implications that can currently only be vaguely assessed.

Many times during the writing of this book I have had to use discretionary judgment about what to include and in how much detail. Statistically that must mean that, while exercising my discretionary judgment, I have been wrong on a number of occasions when making those decisions, for which I hope you will forgive me.

The mezzanine product group deserves increased attention and I hope this book contributes to that well-justified longevity. Happy reading!

Luc Nijs February 2013

1

Introduction

For as long as some sort of trade-centered economy and society has existed for mankind, people have been financing those activities, either directly or through the sort of intermediaries that we now know as banks or financial institutions. Historically, there have always been two types of financing available for businesses which are trying to raise capital to fund their activities.

That sounds somewhat simplistic but ‘debt’ and ‘equity’ have always been the fundamental financing classes tapped into by businesses, despite the many investment vehicles most businesses have access to.

We begin this section by looking at the characteristics of debt and equity and then conclude by defining the scope of the mezzanine product group.

1.1 THE BI-POLAR WORLD OF FINANCE

There are many different ways in which businesses can raise money, the primary ones being ‘debt’ and ‘equity.’ As I mentioned above, that sounds somewhat basic, and I guess it is, looking at the many product choices firms have these days. However, the two groups point at a fundamental difference as we know it in corporate finance. Let’s first look at the characteristics of both groups and then at the individual products that are included in these groups. After that, we will look more closely at the hybrid or mezzanine product group.

Although debt and equity are often characterized by referring to the products that feature their characteristics, i.e., stocks and bonds, the true nature of the difference lies much deeper; in the nature of the cash flow claims of each product.

The first big distinction has to do with the debt claim, which entitles the holder to a contractual set of cash flows to finance the repayment of the principal amount as well as the interests on a period-to-period basis. An equity claim, on the other hand, only holds a residual claim on the cash flows of the firm, i.e., after all expenses and other commitments are honored.

This is the fundamental difference, although the tax code and legal qualifications have contributed to the creation of further distinctive characteristics between both groups.

The second distinction, which can be seen as a direct consequence of the first distinction, is a logical result of the contractual claim that debt holders have versus the residual cash flow claim of equity holders. Debt claims have priority over equity claims, hence the qualification of equity owners as residual cash flow owners. That is true for both the principal amount and interest payments, and is valid until the instrument reaches maturity, even in the case of a bankruptcy or liquidation of the firm (claim by the debt holders on the firm’s assets).

The tax laws in most countries make a distinction between the tax treatment of interest versus dividends. Interests paid are tax deductible when paid by the borrowing firm and are therefore cheaper on a net (after tax) basis. Dividends, however, are not tax deductible, as they are considered to be paid out of net cash flows.

Additionally, debt instruments have a fixed maturity, i.e., the principal amount becomes due at a certain point in time, together with the interests which have not yet been paid. (We will ignore, for the time being, perpetual bonds, which are, in essence, 99/100 year renewable instruments). Equity instruments are perpetual or infinite, i.e., they continue to exist until the firm decides to buy them back and retire them, or to liquidate the firm completely.

Lastly, because equity owners are the residual cash flow owners, they are given control over the assets of the firm and its operational direction. Debt investors usually have a more passive role, often with no power of veto over major decisions in the firm. However, in recent years debt owners have done a pretty good job of getting their foot in the door, by using positive and negative covenants in their loan agreements to have (some level of) control over major transactions that would impact their position in the firm, often by making their investment more risky (i.e., due to increased leverage) or by damaging their chances of being repaid.

In short, debt is characterized by a contractual claim on the firm, benefiting from tax-deductible interest payments, with a finite lifetime and a priority claim on cash flows in both going concern situations and bankruptcy or liquidations. Equity, on the other hand, has a residual cash flow claim on the firm, is an infinite security, where dividend payments do not come with tax deductibility, has no priority, but provides control over the management and assets of the firm (in theory). Securities that have characteristics of both are termed hybrid or mezzanine capital, a definition which we will refine later in this chapter.

Figure 1.1a brings the categories and characteristics together but requires some explanation. Starting from the debt and equity positions we have already discussed (which make up boxes 1 and 3), the figure substantiates those two financing classes by indicating which types of instruments can be classified as being either debt or equity and further introduces the hybrid capital category (box 2) with an indicative set of products included.

Figure 1.1a The financial spectrum

For the sake of completeness, and to provide a level playing field, I will review most of the products mentioned at this stage. Additionally, all terms are explained in the glossary, which can be found at the end of this book, and which includes a review of all technical terms used in this book, regardless of whether they have already been explained in the core text.

Box 1, which reflects the debt products, includes the following instruments:

(1) Bank debt or loans which are fixed-income instruments with a fixed or floating interest rate and a pre-determined maturity. Often these loans are secured and therefore repayment is secured by collateral.