Case Studies

Case Study I

  1. CEO asks us to sell his public company
  2. Listening we learn that:
    1. He loves what he does and doesn’t want to retire as he’s in his 40’s
    2. He’s brought this company from bankruptcy to #2 in the US—but wants to ensure his financial security
    3. He’s going to add on 3 additional plants in the next several years, which will boost earnings significantly
    4. The industry is a worldwide oligopoly and a foreign firm couldn’t afford to start from scratch in the US
  3. Our response is not to sell the company, but propose to take it private, which
    1. Lets him monetize 80% of his personal value and achieve financial security
    2. Lets him continue to work and to enjoy what he does
    3. Lets him continue to build value by growing the company and participating in the value accretion.
  4. He agrees, but then the high yield market evaporates.
  5. We then propose a “deferred sale”
    1. Sell the bottom 20% of the debt to one of the potential strategic acquirers and make it convertible into equity. This way that purchaser will pay the least for 20% of the company, which would give it a huge advantage when the rest of the company is put up for sale in several years
    2. The strategic purchaser of the debt would implicitly guarantee the capital structure, since it can’t afford to let this asset go bankrupt and be taken over by a competitor, which makes the marketing of the balance of the debt straightforward
  6. The transaction was done on these terms
    1. The CEO achieved financial security on the going private transaction, continued to build the company and made more on the residual 20% than he did on the original 80%
    2. We not only made the initial $15 million M&A fee that we would have received for simply selling the company, but also much more in financing fees and also had an equity stake in the recapitalized company.
    3. The strategic purchaser of the debt was the ultimate buyer of the company.

Case Study II

  1. Problem: A public company, A, holds a significant equity stake in another public company, B, as the result of an acquisition. A wants to divest itself of this position in B, since it’s not a core asset. It also wishes to lock in the profit, but not to recognize the profit until a subsequent year.
  2. Solution: Suggest to company A that it offer “deep in the money warrants” (i.e. warrants with an exercise price that is significantly below B’s current stock price) that will ensure that the warrants will be exercised. However, the profit would not be recognized until the warrants were exercised (resulting in the purchase of the underlying stock of B from the current owner, A). Therefore, the profit would be locked in, but deferred.
  3. Problem: Company B’s management team did such an excellent job in investor presentations that the price of B’s stock spiked up. Investors were leery about investing in the warrants, which even though they were currently in the money, could be “out of the money”, should B’s stock subsequently decline steeply. Therefore, there was insufficient demand for the offering.
  4. Solution: Created an alternative pricing mechanism for the warrants. The exercise price would be the lower of:
    1. The exercise price established at the time of the public sale of the warrants.
    2. The same percentage discount to market of the exercise price to the market price as at the time of the initial offering of the warrants, based on the average market price for B’s stock for the thirty days prior to exercise of the warrants.
  5. This revitalized investor demand and the offering was a success. Although A couldn’t be sure of locking in the entire amount of its current profit in B’s stock, it also felt confident enough of B’s future performance that it was comfortable with this solution.

Case Study III

  1. Situation: A start-up private company with an experienced management team has acquired all of the intellectual property (i.e., brand name, formulas, and trade secrets) for an “orphan” consumer product from a Fortune 100 Company. The new company needs $10 to $15 million to re-launch the brand and already has significant orders from retailers. Management estimates that the business should produce revenues of $35 to $45 million in the first year, with potential pre-tax earnings of $40 to $45 million in year five.
  2. Problem: How to arrive at an appropriate pre-money valuation?
  3. Solution: The institutional investor invests in a convertible preferred whose conversion price will be set based on the actual financial performance of the company during the first year. Namely, the valuation is a pre-determined multiple of audited EBITDA and is then discounted back by a pre-determined discount rate (e.g., 30%) to give the investor a defined rate of return of 30% in the first year.
    1. Until the conversion price is established, the investor also has a lien on all of the intellectual property.
    2. This avoids the interminable and typically unproductive haggling over what is an appropriate pre-money valuation based on speculative and unproved data.

Case Study IV

  1. Situation: A large US company was considering establishing a subsidiary in a very attractive emerging market.
  2. Problem: The host country’s government required that 60% of the ownership be held by citizens of the host country. The US company had never and would never consider owning less than 51%.
  3. Solution: I divided the US company’s 40% of the projected profits by 100% of the projected revenues. This produced better operating margins than in any other subsidiary of the US company, despite the fact that it owned 100% of nearly all of its foreign subsidiaries. The board readily approved the investment in the new subsidiary.

Case Study V

  1. Situation: A real estate investment and development firm, Acorn, had successfully completed the conversion of one type of property, Silver, to another higher value use, Gold. The firm had attempted to approach other owners of this type of property to purchase and subsequently convert it, but none had been interested in selling. Therefore, Acorn identified a public company, Oak, that had a number of Silver type of properties in its portfolio. Acorn approached us to explore taking Oak private in a management buyout.
  2. Analysis: Acorn’s management introduced us to the CFO of a company, Pine, whom Acorn’s management knew well. Pine is in a similar business to Oak. The CFO explained that Pine had ample liquidity, would be interested in diversifying into related businesses and thought that Acorn’s idea of converting Silver properties to Gold was very attractive. However, he also noted that Oak’s stock price had risen substantially, so that the economics of a going private would probably be unattractive. Furthermore, he observed that Oak’s CEO was young, smart and aggressive and would not want his company to be “put into play” and, therefore, most likely be unreceptive to a going private approach.
  3. Solution:
    1. Meeting with Acorn’s management before we met with Pine’s CFO, I suggested that, instead of attempting to purchase Silver type properties from the various current owners, who weren’t interested in selling, Acorn should ask them if they would consider contributing those properties to a joint venture, in which Acorn would use its experience and talent to convert Silver to Gold. This would let owners of Silver type properties share in the upside of the conversion, so that they could jointly profit rather than just sell, since they probably realized that Acorn, in making its purchase offer to them, must have had a plan in mind to make better economic use of those properties.
    2. Suggested to Pine’s CFO that Pine become Acorn’s joint venture partner, since (i) he knew and liked Acorn’s management, (ii) Pine had excess liquidity and the ability to raise additional capital, and (iii) Pine’s cost of capital would be lower than that of a hedge fund or private equity partner. Pine’s CFO responded favorably, but cautioned that for tax reasons, Pine would have to hold the converted properties for several years rather than to sell them outright, as Acorn would prefer. I responded that we could do a “deferred sale” in which the price and the terms of the sale X years hence would be established at the outset and that a “lease with the payments applied against the purchase price” could be set for the interim period. Pine’s CFO liked this and is reviewing this with Pine’s tax advisor. As an alternative, I suggested that Pine could invest as a lender with participating debt that would have the same economics, but potentially eliminate the holding period requirement.
    3. Suggested to Acorn and Pine that:
      1. Acorn should first do several additional conversions of independent properties from Silver to Gold that it would joint venture with the current owners of those respective properties.
      2. Acorn then approach Oak with Pine as its partner and suggest that Acorn joint venture with Oak to convert Silver properties in Oak’s portfolio to Gold.
      3. The independent properties that Acorn had previously converted (3.a) would demonstrate “proof of concept”.
      4. Acorn had a skill set that Oak lacked in Acorn’s ability to convert these properties.