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...

5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...

Risk Culture in Action

Risk culture is the way people behave about risk. But people, organizations, and risk are all complex and dynamic. It’s important to have a formal concept of risk culture, but perhaps the best way to explain it is through examples. Dan Sparks at Goldman Sachs In 2006, Dan Sparks was the partner in charge of mortgage trading at Goldman Sachs, and by mid-year he was troubled by growing risks in the mortgage markets. For the next six months he tried to escalate his concerns. In Sparks’ words: ”It was tough…and I mean tough…the rigor that Goldman Sachs puts on people is unbelievable…especially when there’s a concern…I went up there to the 30th floor…five times…’We’ve got a problem…Here’s what’s going on. Here’s what I don’t understand. Here’s what I’m worried about.’ As soon as you do that…they get the risk controllers and all kinds of people involved…I mean they’re all over it.” In December David Viniar, Chief Financial Officer, convened a meeting to discuss Sparks’ views. The decision was to “get smaller, reduce risks, and get closer to home.” As a result, Goldman ultimately gained $4 billion from hedging its mortgage exposures. For more on risk management at Goldman read Money and Power by William D. Cohan. Madelyn Antoncic at Lehman Brothers Madelyn Antoncic was Chief Risk Officer at Lehman Brothers from 2005 to 2007. Before joining Lehman, she’d been a mortgage trader at Goldman Sachs, head of market risk at Goldman Sachs, and head of market risk at Barclays. In 2005 she was Risk Magazine’s risk manager of the year, and in 2006 she was named one of the...

Master of the world?

Jean Marie Messier became Chairman of Compagnie General des Eaux in 1996 at the age of 38. He was a graduate of elite French universities. At age 29, he held a senior post in the French Ministry of Economy and Finance. At age 32, he joined Lazard Frères, where he became the French investment bank’s youngest general partner. He renamed the company Vivendi in 1999. And under Messier, Vivendi’s deal flow was staggering: the company sold 39 businesses and bought control of or stakes in 65 others. The capstone deal was a merger with Seagram-Universal and Canal Plus in 2000. The share price climbed to a record high, and Messier became a darling of the financial press. Time magazine named Messier the 12th most influential businessperson in the world, and the French Government awarded him the Legion of Honor. Articles in Business Week and Fortune compared him to Jack Welch, the legendary CEO of General Electric. The French press called him Jean “Magic” Messier. But Messier preferred J6M, which stood for Jean Marie Messier, moi-meme maitre du monde (“Jean Marie Messier, myself, master of the world”). Massive impairment charges hurt the company’s credit ratings in 2001, which led to problems rolling over short-term debt, which put pressure on liquidity, which hurt the share price. Messier fought back in 2002 with a massive increase in share buybacks, a special dividend, and a request for a big increase in his compensation. Directors began resigning in packs, and Messier lost his job that July. He paid over $2 million in civil fines for misleading investors in France and the United States. Now...

Lehman’s Worst Offense: Risk Management

Last post, we argued that Lehman’s Repo 105 balance-sheet-management tactic was not the worst thing Lehman Brothers did on its way to extinction. Volume 8 of Anton Vakulas’s Bankruptcy Examiner’s report details a bunch of blunders with far more serious consequences. Here are a few of our favorites: Although management was aware of the growing problems in the mortgage markets as early as 2006, Lehman decided to take on more risk “to pick up ground and improve its competitive position.” It chose to do that by “making ‘principal’ investments – committing its own capital in commercial real estate, leveraged lending, and private equity investments.” And it sacrificed liquidity along the way, so that “less liquid assets more than doubled during the same time from $86.9 billion at the end of the fourth quarter of 2006 to $174.6 billion at the end of the first quarter of 2008.” But in our view, Lehman’s biggest missteps were in risk management. Lehman’s opportunistic push for growth changed into an aggressive push to offset declines in its commercial mortgage business late in 2007 and early in 2008, and that led the company to ignore its own risk controls. This chart from the Examiner’s Report shows how Lehman’s risk appetite grew through 2007 and into 2008. Risk appetite was Lehman’s estimate of the amount it could lose without jeopardizing employee compensation or shareholder returns. The chart also shows how in the last two quarters of 2007 the firm exceeded its own risk appetite limit with hardly any restraint, and then in the first quarter of 2008 solved the problem not by reducing risk but...