debt valuations for pe and bdcs
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©2016 RSM US LLP. All Rights Reserved. ©2016 RSM US LLP. All Rights Reserved.
©2016 RSM US LLP. All Rights Reserved. ©2016 RSM US LLP. All Rights Reserved.
LATEST ON DEBT VALUATIONS FOR THE PRIVATE EQUITY AND BDC INDUSTRY
November 10, 2016
American Society of Appraisers
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Melissa Brady- Director- RSM US LLP- Financial Advisory Services- Valuation Services- New York, NY- [email protected] 212-372-1296
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Middle Market Loan Overview
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Definition of middle market
Lower Middle Market: Under $50MM in EBITDA
Upper Middle Market: $50MM - $100MM in EBITDA
Deals are private; relationship driven; club deals
Less liquidity
More robust covenant packages
Simpler capital structures
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Key Trends
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• Increase in unitranche loans• Supply demand imbalances
• More competition in middle market investing• Increase in private credit fundraising• Decline in refinancing and M&A
• Traditional bank lending declining• Increase in co-investment positions• Purchase multiples have increased with debt
financing availability
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Middle Market New Issue Volume
5Source: S&P Global Market Intelligence. www.lcdcomps.com
$0B
$20B
$40B
$60B
$80B
$100B
$120B
$140B
Middle Market New Issue Loan Volume
$200M or Less $201M - $350M $351M - $500M
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Middle Market New Issuance Volume 3Q16
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28.3%
24.6%
18.8%
16.1%
10.3%
1.8%
0.1%
0% 10% 20% 30% 40% 50%
Retail
Healthcare
Computers &Electronics
Printing & Publishing
Aerospace &Defense
Restaurants
Oil & Gas
Issuers with EBITDA of $50MM or less ($1.4B). Source: S&P Capital Market Intelligence
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Middle Market: 3Q 2016
7Source: S&P Global Market Intelligence. www.lcdcomps.com
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Issuers with $50MM EBITDA or Less
8Source: S&P Global Market Intelligence. www.lcdcomps.com
Period Debt/EBITDASenior
Debt/EBITDAEBITDA/Cash
InterestEBITDA - Maint
Capex/Cash InterestEBITDA - Capex/
Cash Interest
1997 4.82 3.69 2.37 1.88 1.641998 4.55 3.49 2.75 2.30 1.841999 4.11 3.32 3.03 1.80 1.772000 4.01 3.14 3.10 1.94 1.702001 3.56 2.65 3.22 2.47 2.232002 3.75 2.81 3.64 2.50 2.372003 3.86 3.02 3.67 2.87 2.712004 4.11 3.51 3.92 3.34 3.122005 4.31 3.97 3.34 2.91 2.802006 4.40 4.03 2.82 2.24 2.142007 4.76 4.52 2.79 2.50 2.352008 4.25 3.61 3.17 2.74 2.722009 3.41 2.90 3.37 2.40 2.402010 3.66 3.16 3.92 3.43 3.232011 4.23 3.91 3.43 3.08 2.912012 4.34 3.98 3.43 2.90 2.732013 4.81 4.68 3.53 2.91 2.822014 4.97 4.88 3.67 2.84 2.692015 4.92 4.72 3.72 3.06 2.83
1Q-3Q16 5.11 4.67 2.98 2.42 2.313Q16 5.31 5.31 3.06 NA NA
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Methodology Overview
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Credit Analysis
High Probability for Credit Event/ Default
Liquidation Approach:No longer expected to be a
going concern
Net Recovery Approach:
Expected to remain a going concern
Low Probability for Credit Event/ Default
Income Approach
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Calibration Analysis – Capital Structure
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Pricing 10/30/2015 xEBITDA 06/30/2016 xEBITDA 09/30/2016 xEBITDARevolver L+175 23.6$ 0.7x 6.6$ 0.2x 9.0$ 0.3xFirst Lien Term Loan L+575 100 3.8x 100 3.3x 100 3.7xTotal Senior Debt 123.6 3.8x 106.6 3.3x 109 3.7xSecond Lien Term Loan L+1000 55 5.5x 55 5.0x 55 5.6xOther Debt 4 5.6x 3.9 5.1x 3.7 5.7xTotal Debt 182.6 5.6x 165.5 5.1x 167.7 5.7xLess: Cash 4.4 4.2 3.2Total Net Debt 178.2$ 5.5x 161.3$ 5.0x 164.5$ 5.6x
EBITDA 32.6$ 32.5$ 29.2$
At Investment Previous Valuation Current Valuation
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Calibration Analysis – Credit Ratios
Investment Date vs. Valuation Date
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EBIT interest coverage (x)EBITDA interest coverage (x)Free oper. cash flow/total debt (%)FFO/total debt (%)Return on capital (%)Operating income/sales (%)Total debt/capital (incl. STD) (%)Discretionary cash flow/total debt (%)Total debt/EBITDA (x)
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Lower Middle Market Stats By EBITDA
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Debt Pricing
Primary loan issuances
Secondary pricing
Comparable bond pricing
Loan Indices By credit rating By industry By size (EBITDA) By leverage / type Other
Data providers that focus on middle market debt pricing
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3 Month Average New Issue Yields
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MM6.40%
LC
5.14%
4%
5%
6%
7%
8%
Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16
3 Month Average New-Issue Yields($50M of EBITDA or Less)
Source: LCD, an offering of S&P Global Market
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Yield Calibration
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Market Indices Change in Yield CalculationsIssuance Date Valuation Date Change in Yields Implied Yield
Credit Quality Related IndicesLCD All Loans Index 5.18% 5.14% -0.03% 10.97%LCD MM Single B Loan Index 6.74% 7.23% 0.49% 11.49%LCD Second Lien Loan Index 10.11% 11.93% 1.82% 12.82%LCD Middle Market Index 7.14% 8.19% 1.04% 12.04%
Interest Rate Related IndicesBloomberg HY Corporate Bond Index 1-5 Year 6.97% 6.62% -0.35% 10.65%Bloomberg HY Corporate Bond Index 5-10 Year 6.26% 6.03% -0.23% 10.77%
Industry Related IndicesLCD Financial Intermediaries Index 4.21% 3.94% -0.26% 10.74%Barclays High Yield Other Finance 7.69% 8.12% 0.42% 11.42%Middle Market Services ($20M to $50M EBITDA) 9.53% 9.90% 0.38% 11.38%
Yield at Investment Date: 11%
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Credit Analysis
Leverage - Seniority in the capital structure
Senior Lender – Terms/Type
Collateral coverage Capital expenditure needs
Industry trends – favorable / unfavorable
Sponsor – reputation, relationship with creditors, etc.
Structural subordination (holding company vs. operating company)
Debt semantics
Not all Bs created equally16
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Credit Analysis: Other Factors
Adequacy of liquidity Regulatory issues Operational disturbances Diversification (Product/Geographic/etc.) Customer concentration Failures in risk management Misguided management decisions Other issues
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Some Tips if Credit Risk Deteriorates
If you have a deterioration in credit quality:
- Assess the spreads between different credit rating indices
- Assess spreads between first lien and second lien
- Assess new issuances and secondary trades of loans with similar credit profile
- Assess qualitative factors
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Credit Rating Table
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Moody's S&P FitchLong-Term Short-Term Long-Term Short-Term Long-Term Short-Term
Aaa P-1 AAA A-1+ AAA A1+Aa1 AA+ AA+Aa2 AA AAAa3 AA- AA-A1 A+ A-1 A+ A1A2 A AA3 P-2 A- A-2 A- A2
Investment Baa1 BBB+ BBB+Grade Baa2 P-3 BBB A-3 BBB A3
Baa3 BBB- BBB-Ba1 Not Prime BB+ B BB+ B
Non-Investment Ba2 BB BBGrade or Junk Ba3 BB- BB-
B1 B+ B+B2 B BB3 B- B-Caa1 CCC+ C CCC CCaa2 CCC
D DDDDD
Caa3 CCC-
Ca CC
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Credit Ratings
Risk comparison between public debt and private debt can be difficult
Accuracy of rating agencies may be questionable
Credit ratings are backward looking
Credit ratio analysis does not capture all credit risk factors. Qualitative factors are just as important.
Market prices and yields could be volatile and affected by liquidity and market volatility
Key credit ratios will differ by industry
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Broker Quotes
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Challenges associated with broker quotes:
• Does a broker quote represent fair value?
• What are the typical nuances of assessing trading activity?
• Does fair value differentiate between retail trades and institutional trades?
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Recovery methods for non-performing loans
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Recovery Rates for Balance Sheet Assets
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Example:• Cash – 100% recoverable
• Accounts Receivable – 75% to 85% recoverable
• Inventory – 50% to 80% recoverable
• Fixed assets – 50% recoverable
• Intangible assets – 0%
• Prepaid assets – 0%
• Other assets – 0%
The rates above are for illustrative purposes only. Recovery rates vary by industry and by company.
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Example 1 – Plant Nursery Business
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Balance Low High Low HighCurrent Assets:
Cash & Cash Equivalents 3,040$ 0% 0% -$ -$ Accounts Receivable 2,973 70% 80% 2,081 2,378 Prepaids 5,225 0% 0% - - Inventory 250,257 15% 25% 37,539 62,564 Other Current Assets - 0% 0% - -
Total Current Assets 261,495$ 39,620$ 64,943$
Net Fixed Assets 18,368 40% 60% 7,347 11,021
Intangible Assets 12,667 0% 0% - - Total Other Assets 12,667$ -$ -$
Total Assets Supporting Debt 292,530$ 46,967$ 75,963$
Less: Revolver 31,035 31,035 31,035
Collateral Supporting First Lien 261,495 15,932 44,928
First Lien Term Loan A 75,000$ 75,000$ 75,000$ First Lien Coverage 21.2% 59.9%
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Example 2: Sun Block Retail (Part I of II)
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($ in thousands) Low Range High RangeValuation Valuation
Balance Adjustments Adjustments Low HighCurrent Assets:
Cash 80$ 100% 100% 80$ 80$ Accounts Receivable 6,990 75% 85% 5,243 5,942 Inventories 6,018 90% 90% 5,416 5,416 Other Current Assets 2,065 0% 0% - -
Total Current Assets 15,153$ 10,739$ 11,438$
Net Fixed Assets 1,445$ 45% 55% 650$ 795$
Intangible Assets 16,564 0% 0% - - Brands - N/A N/A 12,496 14,995 Other Assets 964 0% 0% - -
Total Other Assets 17,528$ 12,496$ 14,995$
Total Assets 34,126$ 23,885$ 27,228$
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Example 2: Sun Block Retail (Part II of II)
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($ in thousands)Low -- High
Available for Paydown 23,885$ 27,228$ Less: Senior Debt 13,322 13,322 Residual Coverage 10,563$ 13,906$ Less: Subordinated Debt 17,854 17,854 Residual Value to Common -$ -$
Subordinated Debt Coverage 59.2% 77.9%
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Considerations
• Factors behind market approach limitations.
- Choosing only distressed firms may be problematic if there is few available.
- Adjust multiple for distress (highly challenging)
• Factors behind income approach limitations.
- Using distressed discount rates of 30% or higher may overestimate value.
• Use multiple methods, if possible.
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Example 3: Market Approach – Service Co.
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Low -- HighAdjusted EBITDA 5,355$ 5,355$ EBITDA Multiple 6.5x 7.0xImplied Enterprise Value 34,808$ 37,485$ Plus: Sponsor Committed Equity Infusion 2,500 5,000 Plus: Cash 248 248 Available for Paydown 37,556$ 42,733$ Less: Senior Debt 25,249 25,249 Residual Value For Subordinated Debt 12,307 17,485 Less: Subordinated Debt 29,045 29,045
Subordinated Debt Coverage 42% 60%
Valuation Range
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Exploration and Production / Oil & Gas
• Proved Reserves, 90% Certainty of Commercial Extraction
• Probable Reserves, 50% Certainty of Commercial Extraction
• Possible Reserves, 10% Certainty of Commercial Extraction
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©2016 RSM US LLP. All Rights Reserved.
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