99 Cents Only Stores goes Lite

99 Cents Only Stores operates a chain of over 300 “extreme value retail stores” in California, Texas, Arizona and Nevada.The company was founded in 1982, and in January 2012 it was taken private by Los Angeles private equity firm Ares Management and the Canada Pension Plan Investment Board.  The new capital structure was typical of LBOs done at that time: Size (millions) % of Capitalization EBITDA Multiple(b) Revolver(a) $10 Term Loan $525 Total 1st lien debt $535 38% 3.4x Senior Notes $250 18% 1.6x Total Debt $785 55% 5.0x New Equity $536 Rollover Equity $100 Total Equity $636 45% 4.0x Total Capitalization $1,421 100% 9.0x (a) The Revolver commitment was $175 million, of which only $10 was borrowed at the time of the transaction (b) Using fiscal year 2012 pro-forma adjusted EBITDA, a reported by the company The company’s choice of loan products shows that one of its objectives was to maintain as much operating and financial flexibility as possible: The revolver is an Asset Based Lending (“ABL”) facility.  Compared to most secured “cash flow” revolvers, ABL facilities typically have fewer and less restrictive covenants.  In fact, it is common for ABL facilities to have no financial covenants, or to have financial covenants that are only measured if the company borrows most of what is available under the borrowing base.  This additional flexibility is a key advantage for ABL borrowers. The term facility is a Term Loan B (“TLB”).  This provides the company with significant cash flow flexibility.  It has amortization of only $5.25 million per year (i.e. 1% of the original principal) and a final maturity of 7...

How Much Can I Borrow on My Revolver?

We often tell our clients that a company does not file for bankruptcy on a particular day because it has too much leverage, or because it has a bad management team, or because it has a competitive disadvantage.  All of these factors may eventually drive a company out of business, but the reason a company files for bankruptcy on a particular day is liquidity: they run out of cash.  Therefore, it is important to measure a company’s liquidity as part of any comprehensive financial analysis (one of our favorite tools is the liquidity position). For many companies, availability under a committed, revolving line of credit is a key source of liquidity. Here’s an example: In 2010, Sears Canada entered into a five-year $800 million senior secured revolving credit facility.  As of January 28, 2012, they had borrowed $101 million under that facility.  How much additional can they borrow using that revolver? a) $699 million b) zero c) Something between $699 and zero The answer is … you don’t have enough information to give an answer.  According to Sears, they have $415 million available. Here are the factors that determine how much you can borrow on a revolver: How much you have already borrowed.  In the Sears example, it would reduce availability to $699 million Letter of Credit usage.  Many revolvers can also be used for letters of credit.  This allows companies to issue letters of credit without getting credit approval for each one individually.  However, letters of credit issued under a revolver reduce borrowing availability under that revolver.  In the Sears example, they had approximately $284 million of letters...

Why Isn’t Ford Bankrupt?

The Terrible Auto Market With the success of the GM IPO, we may be tempted to forget the terrible decade the U.S. auto industry has just completed.  Car sales steadily declined from 2000 through 2007, then collapsed in 2008 and 2009 to a level not seen since 1951.  Truck sales, which saw dramatic growth in the 1990s and finally eclipsed car sales in 1999, saw some growth in the early 2000s, but also dramatically retreated in the 2007-09 recession. The “big 3” U.S. auto makers also suffered market share declines in this period, from a combined 65% of the U.S. market in 2000, to 53% in 2006, to 44% in 2009.  It should be no surprise that GM and Chrysler filed for bankruptcy in 2009.  The real question is: Why didn’t Ford go bankrupt? Why Didn’t Ford Go Bankrupt? By 2006, it was clear to the big 3 auto makers that there was a problem.  Ford’s sales and net income had been flat for many years.  Ford, like the other auto makers, began a major restructuring to reduce capacity, cut costs, and accelerate product development.  The key to Ford’s success, however, was in aligning its business and financial strategies. How did the Ford finance team respond to declining sales and the company’s new operational restructuring?  By borrowing over $12 billion, increasing the company’s auto sector debt (excluding the financial services business) by 66% from $17.9 billion to $30.0 billion.  Ford borrowed this money at the peak of the credit bubble, right before the recession hit and vehicle sales dropped by over 1/3.  Why isn’t Ford bankrupt? Why the New...

Hovnanian’s Muddled Refinancing

The last time we looked, Hovnanian Enterprises was trying for lower financial leverage. We saw signs of progress along those lines, but we were concerned about the company’s financial flexibility. Let’s see if they made any progress in the last six months. Using cash reserves, the company brought debt down from $2.5 billion in 2008 to $1.8 billion in 2009. But debt was stuck at $1.7 billion in the second quarter of 2010. Cash flow wasn’t strong enough to let Hovnanian pay down more debt, and the company was reluctant use any of its $459 million in cash reserves. Hovnanian also made big changes in its debt maturity structure between 2008 and 2009, as the chart shows. It cut $1.1 billion of the debt maturing between 2012 and 2015 by targeting prepayments on debt maturing in those years and by refinancing $785 million of old debt with new, senior secured notes due in 2016. But the company was able to prepay only $100 million of its 2012-2015 maturities in the first half of 2010 — again because of weak cash flow and the need for large cash reserves. Ironically, one reason Hovnanian needed so much cash is that it had no revolving credit to help with liquidity needs. The company was forced to cancel its $300 million revolver to do the $785 million debt issue in 2009. The lesson is that financial risk can be hard to manage. It involves complex trade-offs among leverage, flexibility, and liquidity. Hovnanian was able to reduce leverage and improve flexibility in 2009, but only by compromising liquidity. And it still has a $1.1 billion...

The Refinancing Cliff Is Coming

The problems of the last leveraged buyout  bubble are still with us.  From 2004 through 2007, the U.S. experienced an unprecedented level of LBO activity.  That all ended with the collapse of the debt markets in the summer of 2007 (and the disappearance of the debt markets after the Lehman bankruptcy). LBOs are funded primarily with debt – somewhere between 60% and 80% of the capital structure.  These are the debt products used: Institutional Term Loans (also know as “Term Loan B” or “TLB”) – often the single biggest tranche of debt, these loans are sold to institutional investors, such as collateralized debt obligations (CDOs) and prime rate funds.  They have very little principal amortization and a final maturity of 6-7 years. Pro-rata Loans (comprised of a revolving credit facility and a Term Loan A) – these loans are sold to banks and typically make up a smaller part of the capital structure than the TLB.  Standard terms for a Term Loan A include significant principal amortization and a final maturity of 5 years. High Yield Bonds – are sold to institutional investors.  They have a bullet maturity (i.e. no principal amortization) and a final maturity longer than the Institutional Term Loans, typically 7-10 years. The Debt is Coming Due! Starting in 2012, we will see significant amounts of LBO debt coming due.  Knowing the typical maturities of the debt products and counting forward from the boom years of 2006 and 2007, first we’ll see large amounts of pro-rata loans come due, then institutional term loans, then high yield bonds, as this chart shows: What is the solution? Highly...