Essay About Mixture Of Debt And Set Repayment Schedule

Finance: Case Study – Tango Vs. Victor
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Tango vs. Victor
A group of financial investors (the Tango group) is considering whether or
not they should invest in a Leveraged Buy-Out. The target of the Buy-Out
would be Victor, a company in the soft drinks industry. The soft drinks
industry is considered a mature business with steady cash flows, and this
makes Victor an attractive candidate for a LBO. The directors of Tango
believe that Victors shares are currently undervalued in the market, and
that there is room for realizing a substantial value by way of stand-alone
improvements and divestiture of a non-strategic division. Moreover, the
top 20 managers at Victor will invest in the Buy-Out and they will commit
themselves to remain with the company for the next five years.
Exhibit 1 shows the estimate of the Income Statement of Victor for the year
ending 31st December 2003.
The share price of Victor in the market is currently € 14 per share and,
according to Tangos investment bankers, a tender offer at € 16.50 per share
will be accepted by Victors shareholders. There are 20,000,000 (twentymillion)
shares outstanding.
Tango plans to take over Victor through a leveraged vehicle (“New
Victor”). “New Victor” will be financed through a mixture of debt and
equity. The debt will be composed of Senior Debt and Mezzanine
(Subordinated Debt). The Senior Debt is provided by a group of banks: it will
amount to € 210 million and it will carry an interest rate of 10%. The
repayment of the principal (Senior Debt) will be linear over three years (in
other words “New Victor” will have to repay the principal of the Senior
Debt from year 1 onwards in three equal installments). The Subordinated
Debt will be provided by a group of financial institutions: it will amount to
€ 80 million and it will carry an interest rate of 12.50%. The principal of the
Subordinated Debt will be repaid with the free cash flow generated by Victor,
after the repayment of the annual installments of the Senior Debt (i.e. there
is no pre-set repayment schedule for the Subordinated Debt). The Equity will
be provided by the Tango group and by the management. The management
team will buy € 10 million worth of shares in “New Victor”: they will
actually invest € 5 million and they will borrow an additional € 5 million
from the Tango group at an interest rate of 11.50% per annum. The principal
on this loan will be repayable when New Victor will be sold. The Tango
group will then invest in the equity of “New Victor” the balance required
for the acquisition of Victor. Once the acquisition is completed, “New
Victor” will be merged with Victor. Due to the covenants imposed by the
lenders, it will not be possible to pay any dividend until both the Senior
Debt and the Subordinated Debt will have been repaid completely.
The analysts at Tango estimate that:
– Victor has excess cash of € 35 million that can be used to finance
the Buy-Out;
– the Senior Debt which is on Victors Balance Sheet prior to the
Buy-out (as we will see here below) has to be repaid in order to
complete the acquisition: this Debt amounts to € 40 million;
– the transaction cost (investment banking and legal fees) will be € 5
million to be paid out at the time of the Buy-Out;
– at the end of year 5 (2008) it will be possible to sell (the shares of)
New Victor for 6 times the Free Cash Flow to Equity in that year
(that is the cash flow earmarked for the Equity holders).
The analysts at Tango have made a number of estimates and projections for
the next 5 years (2004/2008). If Victor stays independent (Scenario 1) Sales are
expected to grow at 6% in 2004, and then: 5% in 2005 and 2006; 4.5% in 2007
and 4% in 2008. EBITDA Margin (which is estimated at 20% in 2003) is
expected to stay at 20% in 2004, but then to slide to 17% in 2005 and 2006; and
further to 15% in 2007 and 2008. Working Capital should stay at 15% of
Sales, as in 2003. Victor has recently completed an investment program to
renew the plant and equipment, and, therefore, estimated Capital
Expenditures will be limited: € 5 million in 2004 and in 2005, € 8 million in
2006, and € 10 million in 2007 and 2008. Total Depreciation charges
(inclusive of old and new equipment) will be: € 15 million in 2004, 2005 and
2006; € 20 million in 2007 and 2008. At 31st December 2003, Victor will have €
40 million of Senior Debt on the Balance Sheet, carrying an interest rate of
9%: the repayment of the principal will be linear over four years.
On the other hand,