WEBVTT 1 00:00:01.700 --> 00:00:05.660 The first step of the process consisted in making the financial analysis of the 2 00:00:05.700 --> 00:00:09.200 target. The second step was about the evaluation of the 3 00:00:09.240 --> 00:00:13.200 company. Now we can move to the third and last step of the financial 4 00:00:13.240 --> 00:00:15.700 engineering, which consists in structuring the 5 00:00:15.740 --> 00:00:17.800 financing. 6 00:00:18.840 --> 00:00:22.680 We are looking at an acquisition where the transaction price has been 7 00:00:22.760 --> 00:00:25.599 fully justified by the fundamental value 8 00:00:25.720 --> 00:00:29.220 analysis. Discounting the free cash flow at the cost of 9 00:00:29.260 --> 00:00:33.080 capital was the proof that it was a quite good deal, because we used 10 00:00:33.140 --> 00:00:35.580 quite conservative assumptions. 11 00:00:35.660 --> 00:00:39.240 Now, the target company is growing, is growing within 12 00:00:39.320 --> 00:00:43.040 profitability, and what is very important is that the performance is 13 00:00:43.160 --> 00:00:46.860 quite stable and predictable. The company is a 14 00:00:46.920 --> 00:00:50.820 cash generator, generating approximately nine hundred million 15 00:00:51.000 --> 00:00:54.540 in excess cash flow over the next ten years. 16 00:00:54.560 --> 00:00:58.520 Then there is a capacity to raise debt at the level of the holding company, which 17 00:00:58.560 --> 00:01:01.960 is going to make the acquisition, but not only raise debt, 18 00:01:02.040 --> 00:01:05.600 remunerate the debt through financial expenses, through 19 00:01:05.640 --> 00:01:07.980 coupons, and then obviously repay 20 00:01:07.990 --> 00:01:09.900 it. 21 00:01:11.020 --> 00:01:13.160 I propose you the following agenda. 22 00:01:13.220 --> 00:01:17.130 First, I'm going to give you a general description of all the financial resources 23 00:01:17.160 --> 00:01:19.630 contributing to the financing of the acquisition. 24 00:01:20.640 --> 00:01:23.890 Then I'm going to deep dive into each and every source of financing. 25 00:01:23.900 --> 00:01:27.770 It's going to start with the senior debt, then junior debt, mezzanine 26 00:01:27.880 --> 00:01:31.740 financing, which consists in high yields subordinate debt, 27 00:01:31.800 --> 00:01:33.920 and a bond redeemable into shares. 28 00:01:33.980 --> 00:01:37.060 Last but not least, straight equity ordinary 29 00:01:37.080 --> 00:01:40.800 shares. But it's not enough to raise the financial 30 00:01:40.880 --> 00:01:44.440 resources. You have to convince the investors that the cash, which is going to be 31 00:01:44.560 --> 00:01:48.100 received by the financing company, is going to be 32 00:01:48.160 --> 00:01:51.560 enough to remunerate the investors and to repay the 33 00:01:51.600 --> 00:01:55.220 loan. This is why we are going to make a forecast of the 34 00:01:55.300 --> 00:01:58.440 financial statement of the holding company. 35 00:01:58.480 --> 00:02:02.440 This analysis will suggest me some observations and 36 00:02:02.500 --> 00:02:05.000 comments to conclude this module. 37 00:02:07.040 --> 00:02:09.940 First, let's have a look at the financial environment. 38 00:02:09.980 --> 00:02:13.140 You remember, interest rates, inflation. 39 00:02:13.180 --> 00:02:17.140 We are in nineteen ninety when the transaction takes place, and at that time, the 40 00:02:17.200 --> 00:02:19.860 inflation rate is about three percent. 41 00:02:19.900 --> 00:02:23.880 The risk-free rate, the government bond rate, is ten percent, which 42 00:02:23.960 --> 00:02:27.940 is going to be extremely important in order to assess the risk 43 00:02:27.950 --> 00:02:31.240 premium, which is going to be generated for the investors. 44 00:02:32.780 --> 00:02:36.170 The transaction price was seven hundred and seventy 45 00:02:36.240 --> 00:02:38.920 million. Now, how was it financed? 46 00:02:39.020 --> 00:02:43.000 First, with the shareholders, the owners of the company, straight equity 47 00:02:43.080 --> 00:02:47.040 ordinary shares contributed to one hundred and sixty million. 48 00:02:47.060 --> 00:02:51.000 But the main item in the financing, representing sixty percent of 49 00:02:51.040 --> 00:02:54.790 the financing, is a senior debt with four hundred and fifty 50 00:02:54.860 --> 00:02:58.680 million. There will be some junior debt, some mezzanine financing, 51 00:02:58.740 --> 00:03:02.380 ninety million, decomposed into a high yield subordinate 52 00:03:02.500 --> 00:03:06.220 debt for sixty-seven million on a bond redeemable 53 00:03:06.280 --> 00:03:09.380 into shares, which is twenty-three million. 54 00:03:09.440 --> 00:03:13.130 Now, Secap is very cash rich, and some 55 00:03:13.300 --> 00:03:17.250 part of this cash is going to be used, seventy million, in order 56 00:03:17.280 --> 00:03:20.840 to contribute to the acquisition of the company 57 00:03:20.880 --> 00:03:22.280 itself. 58 00:03:24.240 --> 00:03:27.560 Now, when we analyze this financing, we have to adopt two 59 00:03:27.600 --> 00:03:31.500 perspectives. First, the investors are attracted 60 00:03:31.540 --> 00:03:34.880 by a combination of risk, return, and value 61 00:03:35.000 --> 00:03:38.120 creation. This is a financial performance. 62 00:03:38.200 --> 00:03:41.500 They have to be remunerated for the risk they have taken. 63 00:03:41.540 --> 00:03:45.100 So we are going to have a look at each and every financing item, 64 00:03:45.200 --> 00:03:49.170 understanding what the rate of return is going to be and 65 00:03:49.220 --> 00:03:51.960 trying to assess if it's high enough. 66 00:03:51.980 --> 00:03:55.690 But this is about performance. There is also a perspective which is 67 00:03:55.780 --> 00:03:59.480 about liquidity. The financial equilibrium of the 68 00:03:59.540 --> 00:04:02.960 acquisition must be reached for the holding 69 00:04:03.040 --> 00:04:05.950 company, so we are going to have a look at cash flows and 70 00:04:06.040 --> 00:04:09.620 liquidity. Interestingly, we finance people, we are 71 00:04:09.740 --> 00:04:12.840 always interested in these two perspectives. 72 00:04:12.850 --> 00:04:16.709 We are in charge of performance, and we are in charge of liquidity. 73 00:04:16.760 --> 00:04:20.360 This is exactly the same for this LBO acquisition. 74 00:04:23.020 --> 00:04:26.800 The first financing item is going to be the senior debt, which is 75 00:04:26.840 --> 00:04:30.500 again sixty percent of the total financing of the acquisition. 76 00:04:30.540 --> 00:04:33.010 The amount is four hundred and fifty million. 77 00:04:33.020 --> 00:04:36.520 You remember that the government bond rate is ten percent? 78 00:04:36.580 --> 00:04:40.160 Now, the contractual interest rate of the senior debt is going to be 79 00:04:40.240 --> 00:04:43.800 twelve percent, which demonstrates that the default risk 80 00:04:43.900 --> 00:04:47.210 premium is two percent. Is it enough? 81 00:04:47.240 --> 00:04:51.080 Very likely, because the cash flows are quite stable for 82 00:04:51.120 --> 00:04:54.940 this company, and so it's reasonable to consider that two 83 00:04:55.040 --> 00:04:58.080 percent pays for the probability of default. 84 00:04:58.140 --> 00:05:00.460 Is it going to be repaid bullet in fine? 85 00:05:00.500 --> 00:05:02.840 Is it going to be staggered repayment? 86 00:05:02.850 --> 00:05:06.720 The second solution is adopted, and so the debt is 87 00:05:06.740 --> 00:05:10.630 going to be repaid little by little, consistent with 88 00:05:10.660 --> 00:05:14.260 the financial equilibrium of the holding company. 89 00:05:14.300 --> 00:05:18.080 So we are going to repay the senior debt when we have enough cash to 90 00:05:18.200 --> 00:05:19.740 do it. 91 00:05:21.400 --> 00:05:24.980 The first layer of the mezzanine financing of the junior debt is a 92 00:05:25.020 --> 00:05:28.710 subordinated bond. What does it mean, subordinated? 93 00:05:28.720 --> 00:05:32.660 It means that contractually, you cannot remunerate, you 94 00:05:32.680 --> 00:05:36.400 cannot pay the coupon of the bond, you cannot repay the bond 95 00:05:36.420 --> 00:05:39.560 before the contractual repayment and 96 00:05:39.600 --> 00:05:43.590 remuneration of the senior debt is completed, is 97 00:05:43.620 --> 00:05:47.320 achieved. It is subordinated to. How many 98 00:05:47.400 --> 00:05:51.160 bonds? Six hundred and seventy subordinated bonds, and the nominal 99 00:05:51.260 --> 00:05:54.600 value is going to be one hundred thousand per bond. 100 00:05:54.610 --> 00:05:57.140 The coupon is not going to be stable. 101 00:05:57.180 --> 00:06:00.600 It's going to start at thirteen point one during a few years 102 00:06:01.080 --> 00:06:04.420 and fifteen point eight during the last years.... 103 00:06:04.430 --> 00:06:08.280 and you understand that the first coupon is not that high compared with the 104 00:06:08.340 --> 00:06:12.089 senior debt. The second coupon is significantly 105 00:06:12.100 --> 00:06:15.480 higher, and you increase the coupon when you have enough 106 00:06:15.600 --> 00:06:19.220 money to remunerate the loan. Now, there is an 107 00:06:19.280 --> 00:06:23.140 additional layer in the remuneration, which is the redemption is going to be 108 00:06:23.260 --> 00:06:27.120 one hundred and forty-three thousand at maturity at the end of the 109 00:06:27.180 --> 00:06:30.840 process, which is significantly more than the one hundred 110 00:06:30.850 --> 00:06:34.780 thousand initial nominal value. So the yield for 111 00:06:34.900 --> 00:06:38.880 the subordinated bondholder is going to be a combination of 112 00:06:38.940 --> 00:06:42.500 the coupons, which are going to be paid by the debt, plus the 113 00:06:42.520 --> 00:06:46.470 redemption premium, the forty-three thousand above the 114 00:06:46.620 --> 00:06:50.500 nominal value, which is going to be paid at maturity. 115 00:06:52.360 --> 00:06:56.040 Calculating the rate of return, which is anticipated by the investors, is quite 116 00:06:56.120 --> 00:06:59.040 straightforward. It's a simple actuarial 117 00:06:59.080 --> 00:07:02.760 calculation: cash out, cash in. Cash 118 00:07:02.920 --> 00:07:06.420 out is a capital flow. First, you pay one hundred 119 00:07:06.580 --> 00:07:10.340 thousand to buy the bond, then you receive some coupons 120 00:07:10.400 --> 00:07:13.980 during three years, thirteen point one percent, and 121 00:07:14.000 --> 00:07:17.440 during the remaining six years, fifteen point eight 122 00:07:17.540 --> 00:07:21.500 percent. Then at the end of the process, you receive the last 123 00:07:21.560 --> 00:07:25.120 coupon, and you're repaid one hundred and forty-three thousand, 124 00:07:25.860 --> 00:07:27.940 and then you combine all these cash flows. 125 00:07:27.960 --> 00:07:30.920 You calculate an internal rate of return. 126 00:07:30.940 --> 00:07:34.720 The internal rate of return is sixteen point eighty-three percent. 127 00:07:34.760 --> 00:07:38.340 So you understand that the first coupon is just one percent 128 00:07:38.420 --> 00:07:41.600 above the senior debt, but at the end of the day, the 129 00:07:41.700 --> 00:07:45.380 subordinated debt, uh, subordinated bond is going to 130 00:07:45.440 --> 00:07:48.660 generate an actuarial rate of return, which is 131 00:07:49.140 --> 00:07:52.960 about seven percent more than the government bond rate 132 00:07:53.180 --> 00:07:56.340 and about five percent more than the debt, the senior 133 00:07:56.380 --> 00:07:57.480 debt. 134 00:07:59.360 --> 00:08:03.150 The calculations for the high-yield subordinated bond were 135 00:08:03.220 --> 00:08:06.760 quite easy. It's a bond with interest, 136 00:08:06.860 --> 00:08:09.220 second rank against the senior debt. 137 00:08:09.260 --> 00:08:12.580 It's a high-yield debt, and because it's subordinated, so it's more 138 00:08:12.600 --> 00:08:16.580 risky. Now, it's going to be a completely different story for the bond, 139 00:08:16.640 --> 00:08:20.580 which is redeemable in shares. Redeemable is a little 140 00:08:20.600 --> 00:08:24.540 bit confusing. In fact, it's actually redeemed into 141 00:08:24.580 --> 00:08:27.420 shares. It's a kind of deferred capital increase. 142 00:08:27.460 --> 00:08:31.220 You have absolutely no choice. You have absolutely no 143 00:08:31.320 --> 00:08:34.000 option, such as in a convertible bond. 144 00:08:34.020 --> 00:08:37.800 In a convertible bond, you decide at maturity if you get your 145 00:08:37.860 --> 00:08:40.691 cash back or if you convert into shares. 146 00:08:40.720 --> 00:08:44.540 Here, there is no choice, no alternative, so it's a deferred capital 147 00:08:44.600 --> 00:08:48.340 increase, and it very much looks like equity. 148 00:08:48.380 --> 00:08:51.980 So the subordinated bond looks very much like debt with a high 149 00:08:52.140 --> 00:08:55.910 yield. The bond redeemable in shares is definitely 150 00:08:55.980 --> 00:08:59.700 equity-like. What are the 151 00:08:59.760 --> 00:09:02.880 financial characteristics of this bond redeemable in 152 00:09:02.900 --> 00:09:06.440 shares? First, the amount which is going to be collected by the 153 00:09:06.480 --> 00:09:09.480 company is twenty-three million. 154 00:09:09.520 --> 00:09:12.520 The nominal of each and every bond is twenty-six 155 00:09:12.620 --> 00:09:16.540 thousand. Number of bonds issued, eight hundred and 156 00:09:16.600 --> 00:09:20.560 eighty-five. Now, the question is, which conversion rate? 157 00:09:20.660 --> 00:09:23.780 How many shares are you going to get at maturity 158 00:09:24.400 --> 00:09:28.180 out of the conversion of each and every bond? 159 00:09:28.240 --> 00:09:31.320 It's one hundred and eighty-five new shares per 160 00:09:31.360 --> 00:09:35.320 bond, and then it is a bond. Which coupon you're going to receive 161 00:09:35.580 --> 00:09:38.960 from the issuance to the maturity? It's negligible. 162 00:09:39.000 --> 00:09:41.800 It's almost zero. It's one percent. 163 00:09:41.820 --> 00:09:45.760 You remember that for the senior debt, the interest rate was twelve percent, 164 00:09:45.840 --> 00:09:49.400 government bond, ten percent. Here, the coupon is absolutely 165 00:09:49.800 --> 00:09:53.400 negligible. So the rate of return is going to be generated 166 00:09:53.420 --> 00:09:56.290 by the conversion of the bond into 167 00:09:56.300 --> 00:09:59.740 shares. In order to 168 00:09:59.760 --> 00:10:03.520 predict the rate of return, which is going to be generated by the bond 169 00:10:03.760 --> 00:10:07.600 to the investor, we need to identify the cash flows generated 170 00:10:07.720 --> 00:10:10.420 by the bond. First, there will be the coupons. 171 00:10:10.440 --> 00:10:14.080 Each and every year, the bond is going to pay a coupon, which is one percent of the 172 00:10:14.120 --> 00:10:17.910 nominal value. One percent of twenty-six thousand is two hundred and 173 00:10:18.060 --> 00:10:20.980 sixty French franc each and every year. 174 00:10:20.999 --> 00:10:24.080 But the second set of cash flow is, in fact, a 175 00:10:24.140 --> 00:10:28.080 conversion, the value of the one hundred and eighty-five shares at the time 176 00:10:28.100 --> 00:10:32.000 of the redemption. Time of redemption is exactly the moment where 177 00:10:32.060 --> 00:10:34.800 we calculate the terminal value of the company. 178 00:10:34.840 --> 00:10:37.080 You remember, there are three cases. 179 00:10:37.120 --> 00:10:41.020 The median case is the terminal value is about one point three 180 00:10:41.380 --> 00:10:41.940 billion. 181 00:10:42.780 --> 00:10:45.620 Then what will be the number of shares once the conversion is 182 00:10:45.660 --> 00:10:49.600 exercised? One point six million shares for the ordinary shares, 183 00:10:49.640 --> 00:10:53.200 plus eight hundred and eighty-five bonds times the 184 00:10:53.240 --> 00:10:57.140 conversion rate of one hundred and eighty-five shares per 185 00:10:57.200 --> 00:11:00.740 bond. So the total number of shares is going to be one million 186 00:11:01.080 --> 00:11:04.780 seven hundred and sixty-three thousand seven hundred and twenty-five 187 00:11:04.920 --> 00:11:08.440 shares. The value of one share is a terminal value 188 00:11:08.880 --> 00:11:11.730 divided by the number of shares at that time. 189 00:11:12.120 --> 00:11:15.920 Again, once the conversion is exercised, which is seven hundred 190 00:11:16.240 --> 00:11:18.400 and sixteen per share. 191 00:11:19.960 --> 00:11:23.680 Then we can use these series of cash flows in order to calculate the 192 00:11:23.740 --> 00:11:26.300 internal rate of return for the investor. 193 00:11:26.380 --> 00:11:29.700 Cash out, the day the transaction takes place, twenty-six 194 00:11:29.800 --> 00:11:33.440 thousand. Cash in, ten coupons, two hundred and 195 00:11:33.540 --> 00:11:37.460 sixty, plus the value of the one hundred and eighty-five shares at 196 00:11:37.500 --> 00:11:41.460 the time of the redemption. Case one, two, and three, depending on 197 00:11:41.500 --> 00:11:45.480 the beta, depending on the cost of capital, and then we add to the 198 00:11:45.540 --> 00:11:48.980 last coupon the value of the one hundred and eighty-five shares. 199 00:11:48.990 --> 00:11:52.620 We calculate the internal rate of return, and we understand that 200 00:11:53.020 --> 00:11:56.940 when the WACC is higher, the terminal value is lower, and the 201 00:11:57.060 --> 00:12:00.040 internal rate of return is nineteen percent. 202 00:12:00.060 --> 00:12:03.920 With a lower WACC, case two, twenty point four percent. 203 00:12:03.960 --> 00:12:07.410 Case one, almost twenty-two percent internal rate of 204 00:12:07.440 --> 00:12:11.404 return for the investor.... 205 00:12:11.424 --> 00:12:14.404 The last stage of the rocket is equity, the ordinary 206 00:12:14.464 --> 00:12:17.864 shares. Initially, we have one hundred and sixty million 207 00:12:17.984 --> 00:12:21.344 franc, and we have one point six million ordinary 208 00:12:21.354 --> 00:12:25.264 shares. They are issued at a unit price of one hundred currency 209 00:12:25.384 --> 00:12:29.184 units. Now, the holding company will pay no dividend during the 210 00:12:29.244 --> 00:12:32.034 next ten years. It's very likely in the 211 00:12:32.124 --> 00:12:36.084 contract. You have to commit yourself contractually not to pay any dividend 212 00:12:36.124 --> 00:12:39.574 to the shareholders up to the moment the debt is entirely 213 00:12:39.964 --> 00:12:43.843 repaid. It's probably also a necessity, because we are going to 214 00:12:44.024 --> 00:12:47.784 need any French franc generated by SECAP to the 215 00:12:48.004 --> 00:12:51.924 holding company in order to be able to remunerate the investors, in order 216 00:12:51.984 --> 00:12:55.884 to be able to repay the debt. So the only cash flow for the shareholders 217 00:12:55.924 --> 00:12:59.744 will be the value of the share in year ten. 218 00:12:59.784 --> 00:13:02.274 There will be dividends, but later on. 219 00:13:02.304 --> 00:13:06.044 We calculate an internal rate of return for holding the ordinary 220 00:13:06.064 --> 00:13:08.634 shares during ten years. 221 00:13:10.744 --> 00:13:13.004 So the calculation is quite straightforward. 222 00:13:13.044 --> 00:13:16.603 You buy a share when it is issued, and you pay one hundred. 223 00:13:16.704 --> 00:13:20.624 No dividend during ten years, and the cash inflow is 224 00:13:20.644 --> 00:13:24.344 only the value of this share at the end of year 225 00:13:24.644 --> 00:13:28.064 ten. It is a terminal value per share. 226 00:13:28.084 --> 00:13:32.004 You remember seven hundred and sixteen for the median case, a bit less for 227 00:13:32.104 --> 00:13:35.024 case three, a bit more for case one. 228 00:13:35.044 --> 00:13:38.124 And then you understand that the internal rate of return for the investor is going 229 00:13:38.164 --> 00:13:41.624 to be ranging from twenty-three to twenty-six 230 00:13:41.824 --> 00:13:43.604 percent. 231 00:13:45.304 --> 00:13:49.184 Now we are going to put all these figures together and understand that 232 00:13:49.244 --> 00:13:53.144 the risk-return hierarchy is respected within the 233 00:13:53.184 --> 00:13:56.924 set of the financial instruments, and that's the strongest 234 00:13:57.064 --> 00:14:01.044 point of this case. You remember that capital markets are driven by an 235 00:14:01.064 --> 00:14:04.664 extremely strong principle: risk aversion. 236 00:14:04.764 --> 00:14:08.264 I accept to take a risk because I anticipate a return. 237 00:14:08.344 --> 00:14:12.264 I will accept to take a higher risk if there is a higher risk premium, 238 00:14:12.344 --> 00:14:16.104 a higher remuneration, which is going to remunerate the incremental 239 00:14:16.124 --> 00:14:19.893 risk. Now, if you take the risk-free rate, which is government bond rate, it's 240 00:14:19.923 --> 00:14:23.844 ten percent. Senior debt, even though it represents sixty 241 00:14:23.944 --> 00:14:27.744 percent of the financing, is not subordinated to anything. 242 00:14:27.764 --> 00:14:31.534 It's a contractual debt, and it's about predictable cash flows. 243 00:14:31.544 --> 00:14:34.814 This is why the risk premium is two percent, which is quite fair and 244 00:14:34.844 --> 00:14:38.124 realistic. Senior debt, twelve percent. 245 00:14:38.144 --> 00:14:41.784 There is another debt with a contractual interest, a 246 00:14:41.824 --> 00:14:44.864 subordinated bond, but it's riskier because it's 247 00:14:44.874 --> 00:14:48.794 subordinated, and then the internal rate of return we anticipate out 248 00:14:48.844 --> 00:14:52.534 of this subordinated debt is sixteen point eight 249 00:14:52.624 --> 00:14:56.564 percent, a higher risk premium. Then we move from debt to 250 00:14:56.684 --> 00:15:00.524 equity. We have equity, which is straightforward equity 251 00:15:00.884 --> 00:15:03.904 issued today, and we have deferred equity. 252 00:15:03.944 --> 00:15:07.604 The deferred equity is going to receive a coupon, so there's a 253 00:15:07.744 --> 00:15:11.464 little bit of a bond inside the bond redeemable in 254 00:15:11.544 --> 00:15:15.384 shares. This is why it's a bit less risky than the ordinary 255 00:15:15.404 --> 00:15:19.053 shares. And if you look at the range of internal rate of 256 00:15:19.104 --> 00:15:21.824 return, it's nineteen to twenty-two. 257 00:15:21.884 --> 00:15:25.584 Ordinary shares, twenty-three to twenty-six percent. 258 00:15:25.604 --> 00:15:29.544 It's a bit more risky. This is why it deserves a higher internal 259 00:15:29.784 --> 00:15:33.504 rate of return. So you have a perfect hierarchy, 260 00:15:33.684 --> 00:15:35.224 risk/return. 261 00:15:37.444 --> 00:15:41.344 But now we have to get back to the calculation, understanding that there 262 00:15:41.404 --> 00:15:45.284 was a fundamental assumption. We have calculated the 263 00:15:45.324 --> 00:15:49.284 return investment for the ordinary shares and the bonds redeemable 264 00:15:49.344 --> 00:15:53.284 in shares, but we have said that the terminal value 265 00:15:53.404 --> 00:15:56.204 is the value which is attributable to the shareholders. 266 00:15:56.264 --> 00:15:59.064 The underlying assumption is that there is no debt. 267 00:15:59.104 --> 00:16:02.664 So we have to make sure that the financial holding debt 268 00:16:02.804 --> 00:16:06.164 is fully repaid at the end of this period of ten 269 00:16:06.224 --> 00:16:09.833 years. Otherwise, we are going to be forced to take the terminal value 270 00:16:10.304 --> 00:16:14.004 minus the debt at maturity. It's not the calculation we 271 00:16:14.024 --> 00:16:17.904 made. Now we have to check about liquidity and the repayment and the 272 00:16:17.924 --> 00:16:20.944 redemption of the senior debt and the 273 00:16:21.364 --> 00:16:23.384 subordinated bond. 274 00:16:25.084 --> 00:16:27.824 Now we are going to make the financial forecast. 275 00:16:27.844 --> 00:16:31.664 We are going to forecast the financial statements of the holding company. 276 00:16:31.674 --> 00:16:35.274 The holding company is Financière SECAP, and it's financed by 277 00:16:35.344 --> 00:16:39.004 equity and by debt. The cash inflows 278 00:16:39.044 --> 00:16:42.944 received by La Financière SECAP is about dividends paid 279 00:16:42.964 --> 00:16:46.584 by SECAP, but also excess cash, which is going to be 280 00:16:46.684 --> 00:16:50.424 returned from SECAP to the mother company because the company 281 00:16:50.784 --> 00:16:54.004 is generating more cash than its net income. 282 00:16:54.064 --> 00:16:58.024 Cash outflows, interest expense to the debt, and repayment 283 00:16:58.124 --> 00:17:02.104 of at least part of the debt, because some debt is going to be redeemed 284 00:17:02.244 --> 00:17:05.984 into shares. The objective is clearly a balance between 285 00:17:06.065 --> 00:17:09.634 cash in and cash outflows during these 286 00:17:09.634 --> 00:17:13.134 next ten years, so that the holding company can 287 00:17:13.164 --> 00:17:16.644 merge with its investment with SECAP at the end of the 288 00:17:16.664 --> 00:17:20.384 period. But the constraint is no additional 289 00:17:20.644 --> 00:17:24.585 debt at the level of the financial holding, and then it's going to be a success 290 00:17:24.664 --> 00:17:28.545 because there will be no debt at the level of SECAP and no debt at the 291 00:17:28.584 --> 00:17:30.724 level of the Financière SECAP. 292 00:17:32.964 --> 00:17:36.444 Now we can start forecasting the financial statements of Financière 293 00:17:36.484 --> 00:17:40.184 SECAP. We're going to start with the P&L and the cash flow statement 294 00:17:40.464 --> 00:17:43.004 and then move to the balance sheet. 295 00:17:43.044 --> 00:17:46.964 The question will be, when we look at an item, is it a P&L item 296 00:17:47.484 --> 00:17:51.384 and/or is it a cash item? Let's start with the dividends, which 297 00:17:51.404 --> 00:17:53.624 are received by Financière SECAP from SECAP. 298 00:17:53.644 --> 00:17:56.484 It's one hundred percent of the net income of SECAP. 299 00:17:56.564 --> 00:17:58.874 It's an interest, it's a financial income. 300 00:17:58.904 --> 00:18:02.884 It is in the P&L. But SECAP is generating more cash 301 00:18:02.924 --> 00:18:06.804 than its net income and is going to transfer the cash surpluses, the 302 00:18:06.844 --> 00:18:10.504 excess cash, to the financial holding. It's a transfer. 303 00:18:10.544 --> 00:18:14.004 It's a financing. It has absolutely nothing to do with an 304 00:18:14.084 --> 00:18:16.764 income, so it will not be in the P&L. 305 00:18:16.804 --> 00:18:19.062 It will be in the cash flow statement.... 306 00:18:19.072 --> 00:18:22.712 Then, of course, there will be some financial expenses in the P&L 307 00:18:23.112 --> 00:18:27.032 and senior debt repayment in a cash flow statement. 308 00:18:27.112 --> 00:18:30.752 About the mezzanine financing, there will be coupons, which are going to 309 00:18:30.812 --> 00:18:33.912 be in the P&L, and repayment in a cash flow 310 00:18:33.992 --> 00:18:37.952 statement. Coupons paid by the subordinated bond and by 311 00:18:37.972 --> 00:18:41.772 the bond redeemable into shares. But the bond redeemable 312 00:18:41.812 --> 00:18:45.512 into shares is, in fact, redeemed into shares, and it's going to be an 313 00:18:45.612 --> 00:18:48.612 equity issue at the end of the process. 314 00:18:48.692 --> 00:18:51.932 What about the subordinated bond? It's going to be repaid. 315 00:18:51.952 --> 00:18:55.612 It's cash out. Last but not least, there's a tax 316 00:18:56.092 --> 00:18:58.312 question, which is quite interesting. 317 00:18:58.512 --> 00:19:02.272 As Financière Secap holds one hundred percent of Secap, there will be a tax 318 00:19:02.372 --> 00:19:05.132 integration between these two companies. 319 00:19:05.152 --> 00:19:08.672 And so when Financière Secap is paying some interest 320 00:19:08.712 --> 00:19:12.232 expense, financial expense, and coupons, it's going to 321 00:19:12.292 --> 00:19:16.092 generate tax savings because Secap itself 322 00:19:16.212 --> 00:19:20.132 is profitable, and these income tax savings are going to be put at the 323 00:19:20.192 --> 00:19:22.892 credit of the P&L of La Financière 324 00:19:22.911 --> 00:19:24.212 Secap. 325 00:19:25.912 --> 00:19:29.392 Now let's have a look at what is anticipated for Financière Secap, the 326 00:19:29.472 --> 00:19:32.632 financial holding, for the next ten years. 327 00:19:32.672 --> 00:19:36.402 P&L first, financial income, dividends received from 328 00:19:36.492 --> 00:19:40.342 Secap, and then interest expense, financial expense for the 329 00:19:40.412 --> 00:19:44.352 senior debt, for the bond redeemable in shares, and for the subordinated 330 00:19:44.512 --> 00:19:48.122 bonds. These are interest expenses, of course, in the 331 00:19:48.192 --> 00:19:51.792 P&L. But you remember that if you accrue for some 332 00:19:51.872 --> 00:19:55.732 interest expense and Secap is generating profit, 333 00:19:55.742 --> 00:19:59.332 there will be some tax savings because of tax consolidation. 334 00:19:59.352 --> 00:20:03.052 It's going to be put at the credit of the P&L of the financial 335 00:20:03.192 --> 00:20:07.162 holding. So you get to the holding profit, and then it's about 336 00:20:07.292 --> 00:20:11.252 cash out. The redemption of the senior debt, little by 337 00:20:11.332 --> 00:20:14.732 little, year after year. There will be also the 338 00:20:14.752 --> 00:20:18.692 redemption of their subordinated bonds at the end of the process. 339 00:20:18.712 --> 00:20:22.632 There is no redemption for the bonds redeemable into shares because they are 340 00:20:22.652 --> 00:20:26.092 going to be converted into shares. There is no cash out. 341 00:20:26.132 --> 00:20:29.912 There will be a cash inflow, which is a cash returns from Secap. 342 00:20:29.932 --> 00:20:33.892 This cash in excess generated by Secap, which is going to be transferred 343 00:20:33.932 --> 00:20:37.872 to the financial holding as a source of financing. 344 00:20:38.152 --> 00:20:42.052 You calculate all the cash in and cash outflows, and you get to the 345 00:20:42.092 --> 00:20:45.312 change in the holding cash position. 346 00:20:47.272 --> 00:20:50.472 Then we can move to the financial balance sheet of Financière 347 00:20:50.512 --> 00:20:54.332 Secap. The initial balance sheet when the transaction takes place in 348 00:20:54.392 --> 00:20:57.572 nineteen eighty-nine. Asset side, financial fixed 349 00:20:57.652 --> 00:21:01.372 asset, the value which is paid for the transaction, seven 350 00:21:01.472 --> 00:21:04.852 hundred and seventy. No cash initially. 351 00:21:04.892 --> 00:21:08.672 On the equity and liability side, the financing of the deal, one hundred and sixty 352 00:21:08.792 --> 00:21:12.752 million for ordinary shares, twenty-three for the bonds redeemable in 353 00:21:12.792 --> 00:21:16.212 shares, sixty-seven for the subordinated bond. 354 00:21:16.252 --> 00:21:18.992 So shareholders' equity, plus mezzanine, plus 355 00:21:19.032 --> 00:21:22.212 quasi-equity, it's two hundred and fifty. 356 00:21:22.252 --> 00:21:25.972 Senior debt, four hundred and fifty, and the Secap financing, which comes 357 00:21:25.992 --> 00:21:29.232 from the company which you acquired, is seventy. 358 00:21:29.272 --> 00:21:32.832 You have a matching between assets and equity and liabilities, which is quite good 359 00:21:32.872 --> 00:21:36.492 news, and you have initially the deal and its 360 00:21:36.572 --> 00:21:40.432 financing. Then what's going to happen throughout the years? 361 00:21:40.472 --> 00:21:43.532 There are some figures which are going to change, and there are some figures which 362 00:21:43.592 --> 00:21:46.882 are going to be stable. Financial fixed asset is stable. 363 00:21:46.912 --> 00:21:50.652 It's seven hundred and seventy. It's a historical purchasing price you paid for the 364 00:21:50.712 --> 00:21:54.312 transaction. Cash is going to be incremented or 365 00:21:54.352 --> 00:21:57.532 decremented by the increase or decrease in the cash 366 00:21:57.632 --> 00:22:01.012 position, which is a cash flow statement, uh, the previous 367 00:22:01.092 --> 00:22:04.852 slide. Shareholders' equity is going to be incremented by 368 00:22:04.932 --> 00:22:07.812 the profit generated by the financial 369 00:22:07.872 --> 00:22:11.762 holding. Interestingly, at the end of the process, 370 00:22:11.812 --> 00:22:15.412 in nineteen ninety-nine, what's going to happen to the shareholders' 371 00:22:15.552 --> 00:22:19.512 equity is that it's going to receive the profit generated by the 372 00:22:19.552 --> 00:22:23.152 financial holding at the end. It's going to also receive an 373 00:22:23.192 --> 00:22:27.132 equity issue, which is a redemption of the bond redeemable in shares, which is 374 00:22:27.172 --> 00:22:29.572 going to be transformed into equity. 375 00:22:29.581 --> 00:22:33.552 And there will be a kind of a loss because the company is going to repay 376 00:22:33.562 --> 00:22:37.192 the subordinated bond at a price which is more than the 377 00:22:37.312 --> 00:22:41.272 initial nominal value of the bond and is going to decrement the shareholders' 378 00:22:41.432 --> 00:22:45.252 equity. Bond redeemable into shares, twenty-three, up to 379 00:22:45.312 --> 00:22:48.932 the transformation into equity. Subordinated bonds, 380 00:22:48.992 --> 00:22:52.192 sixty-seven, up to the moment it is repaid. 381 00:22:52.272 --> 00:22:55.752 Senior debt is repaid little by little, and the Secap 382 00:22:55.812 --> 00:22:59.752 financing is incremented each and every year by the cash in excess 383 00:22:59.812 --> 00:23:03.532 generated by Secap and transferred to the financial holding. 384 00:23:03.572 --> 00:23:07.212 So what do we observe here? Is that the cash situation is 385 00:23:07.232 --> 00:23:10.732 always positive, not that much, but always 386 00:23:10.812 --> 00:23:14.472 positive, and we don't need to increase the debt at the level of the 387 00:23:14.532 --> 00:23:18.412 financial Secap, which was exactly the constraint which was 388 00:23:18.572 --> 00:23:21.372 imposed by the financing. 389 00:23:23.272 --> 00:23:27.172 Now, we can consolidate ten years of activity of Financière 390 00:23:27.212 --> 00:23:30.472 Secap, of the financial holding, P&L, cash flow 391 00:23:30.592 --> 00:23:34.452 statement, and balance sheet. But when you look at cash in 392 00:23:34.492 --> 00:23:37.862 and cash outlays, it's quite interesting to observe the balance. 393 00:23:38.692 --> 00:23:41.772 In fact, the company is going to cash in a billion 394 00:23:42.332 --> 00:23:45.832 dividends received from Secap, one hundred percent of the net income. 395 00:23:45.852 --> 00:23:49.532 Cash returns to holding because there is cash in excess of the net income, 396 00:23:49.992 --> 00:23:52.812 and the tax savings on the interest expense because of tax 397 00:23:52.892 --> 00:23:55.692 consolidation between the mother company and the 398 00:23:55.732 --> 00:23:59.052 investment. This is cash in. What about cash out? 399 00:23:59.112 --> 00:24:03.012 Interest expense for the senior debt, a bit more than three hundred and fifty 400 00:24:03.112 --> 00:24:07.052 million. The redemption of the senior debt, four hundred and 401 00:24:07.152 --> 00:24:10.892 fifty million. The sum is eight hundred million, so it is a 402 00:24:10.932 --> 00:24:13.432 consumption of cash for the company. 403 00:24:13.442 --> 00:24:17.412 And now there will be some coupons paid for the subordinated bond, for the 404 00:24:17.432 --> 00:24:20.822 bond redeemable to shares, and the redemption of the subordinated 405 00:24:21.092 --> 00:24:24.614 debt, which is almost one billion.... 406 00:24:24.624 --> 00:24:28.524 cash in minus cash out is exactly the nine million which 407 00:24:28.584 --> 00:24:32.044 you observe in the balance sheet, cash at the end of the process 408 00:24:32.584 --> 00:24:36.404 when everything is over at the end of this LBO. 409 00:24:39.004 --> 00:24:42.944 When we look at the initial financing structure of the company and the evolution of 410 00:24:42.984 --> 00:24:46.444 the financial statements of Financière Secap throughout the years, 411 00:24:47.004 --> 00:24:50.704 there are a few observations. First, it's a sophisticated 412 00:24:50.784 --> 00:24:54.584 financial engineering. It's a financial structure with no 413 00:24:54.864 --> 00:24:56.824 options, no optional instruments. 414 00:24:56.833 --> 00:24:59.584 There is no convertible bond, there is no warrant. 415 00:24:59.604 --> 00:25:03.344 It's just about straight subordinated debt, straight 416 00:25:03.484 --> 00:25:07.444 senior debt, and bonds redeemable into shares, but with no 417 00:25:07.544 --> 00:25:11.084 option in sight. You don't need to put options in financial 418 00:25:11.244 --> 00:25:13.884 engineering. Now, what about the leverage? 419 00:25:14.244 --> 00:25:18.024 Equity plus the bond, which is redeemable in shares, which 420 00:25:18.184 --> 00:25:21.584 is deferred equity issue, is one hundred and eighty-three 421 00:25:21.684 --> 00:25:25.624 million. Subordinated and senior debt, it's five 422 00:25:25.704 --> 00:25:29.184 hundred and seventeen. So it's a high leverage. 423 00:25:29.244 --> 00:25:32.994 The original debt is three times the equity and 424 00:25:33.224 --> 00:25:36.764 four times the EBITDA, even though the EBITDA is quite 425 00:25:36.804 --> 00:25:39.944 high. So it's really a leverage, a highly 426 00:25:40.044 --> 00:25:43.484 leveraged buyout. Then we have the financing 427 00:25:43.544 --> 00:25:46.644 instruments, and we have calculated the rate of return, which can be 428 00:25:46.664 --> 00:25:50.264 predicted. The interest rate hierarchy is fully 429 00:25:50.284 --> 00:25:54.004 respected. There is a remuneration for the risk. 430 00:25:54.044 --> 00:25:57.664 Now, is it enough? The answer is yes, because the company found 431 00:25:57.764 --> 00:26:01.284 investors for each and every layer of financing 432 00:26:01.384 --> 00:26:05.364 instrument. Last but not least, it was absolutely fundamental 433 00:26:05.444 --> 00:26:08.324 to demonstrate the holding company's financial 434 00:26:08.384 --> 00:26:12.144 equilibrium. Each and every year, of course, we have the 435 00:26:12.164 --> 00:26:16.124 balance sheet, which is balancing, but cash in and cash out 436 00:26:16.224 --> 00:26:19.884 is absolutely okay each and every year and at the end. 437 00:26:19.944 --> 00:26:23.724 So we have achieved something which is cash inflows are high 438 00:26:23.784 --> 00:26:27.194 enough to meet the financial requirements of the 439 00:26:27.264 --> 00:26:30.344 company, pay the coupon, and repay the loans. 440 00:26:32.744 --> 00:26:35.104 A few comments to conclude this module. 441 00:26:35.184 --> 00:26:38.194 First, we have observed that there is a lot of debt in the financing. 442 00:26:38.244 --> 00:26:42.164 This is really a highly leveraged buyout. 443 00:26:42.184 --> 00:26:45.964 But if you introduce debt in a financing, you introduce financial 444 00:26:46.044 --> 00:26:48.504 risk. Can you afford financial risk? 445 00:26:48.524 --> 00:26:52.364 The answer is yes, if the operating risk is low, which is exactly the 446 00:26:52.424 --> 00:26:54.904 case. The operating risk is quite modest. 447 00:26:54.924 --> 00:26:58.424 Because of the contract, the cash flows are quite stable. 448 00:26:58.504 --> 00:27:01.264 There is visibility in this industry. 449 00:27:01.344 --> 00:27:03.864 As a consequence, the operating risk is low. 450 00:27:03.884 --> 00:27:07.834 But you cannot combine a high operating risk and a high financing 451 00:27:07.904 --> 00:27:11.264 risk. This is absolutely fundamental. 452 00:27:11.324 --> 00:27:15.244 Second thing, there is a lot of debt, and the financial structure is quite 453 00:27:15.364 --> 00:27:19.004 tight. At the end of the day, we need each and every currency 454 00:27:19.144 --> 00:27:22.924 unit coming from Secap to make the balance of the cash flow statement 455 00:27:23.324 --> 00:27:26.884 of the Financière Secap. Imagine that there are some 456 00:27:26.924 --> 00:27:29.844 difficulties for La Financière Secap. 457 00:27:29.864 --> 00:27:33.644 Well, there will be some buffer, some security coming from Secap's balance 458 00:27:33.664 --> 00:27:37.124 sheet, because at the level of the industrial companies, there is no 459 00:27:37.264 --> 00:27:41.124 debt. So you can put a little bit of debt at the level of Secap in 460 00:27:41.164 --> 00:27:44.964 order to make sure that La Financière Secap is going to have enough 461 00:27:45.004 --> 00:27:47.524 financing. Now, these are 462 00:27:47.844 --> 00:27:51.644 predictions. It's about forecasts for the future. 463 00:27:51.724 --> 00:27:55.484 Now you have to transform a forecast into a reality, and 464 00:27:55.524 --> 00:27:59.124 this is why this is true for this LBO and for each and every 465 00:27:59.264 --> 00:28:02.884 LBO, the quality of execution is going to be absolutely 466 00:28:02.944 --> 00:28:06.624 critical. Now you have to generate the revenues, the 467 00:28:06.664 --> 00:28:10.334 EBITDA, the deferred income, the deferred revenues, the 468 00:28:10.424 --> 00:28:14.394 negative working capital requirement, the capital expenditures, the free cash flow, 469 00:28:14.424 --> 00:28:18.204 et cetera. Now you have to transform predictions into reality, and 470 00:28:18.244 --> 00:28:21.344 then it's going to be the success of the transaction. 471 00:28:21.384 --> 00:28:24.924 But quality of execution is absolutely critical. 472 00:28:25.784 --> 00:28:29.624 Last but not least, we have proposed a financial structure 473 00:28:29.644 --> 00:28:33.543 which is quite clever, but it is not the one 474 00:28:33.704 --> 00:28:37.024 unique financial structure which can be considered. 475 00:28:37.084 --> 00:28:40.884 It's relevant, it's coherent in terms of yield, of 476 00:28:40.964 --> 00:28:44.224 cash, of risk, of return, et cetera. 477 00:28:44.244 --> 00:28:46.624 But there is no options, there is no convertibles. 478 00:28:46.644 --> 00:28:49.764 We could imagine other financial structures. 479 00:28:49.784 --> 00:28:53.524 The objective was absolutely not to try to optimize the balance 480 00:28:53.564 --> 00:28:55.484 sheet, but there was a constraint. 481 00:28:55.524 --> 00:28:59.184 The investors are going to be happy, because if the investor 482 00:28:59.264 --> 00:29:03.004 satisfaction is not met by the financial engineering, there will be 483 00:29:03.084 --> 00:29:06.664 simply no investor, and then there will be no 484 00:29:06.904 --> 00:29:10.284 leveraged buyout. Investor satisfaction is the 485 00:29:10.384 --> 00:29:13.064 heart of this issue, is the heart of this 486 00:29:13.164 --> 00:29:15.123 structure.