M&A transaction and Capitalising Interco loans

I have some questions about M&A for minority stakes and intercompany loans. Posting in the IB forum as it draws the most views and it's a M&A tropic.

Overview: A company is selling a minority stake (up to 49%) of itself (EV of 500m). EBITDA of 50m and FCF of 40m. However, this company has an interco loan of 300m from it's Holdco and has the option of capitalising the loan from Debt to Equity.

I think the main questions are:

  • If the Debt of 300m is capitalised, does the equity investment amount that the new investor will have to put up for a 20% stake change? (I.e. change from 40m to 100m)
  • Or do most transactions ask the potential investors to invest on a "EV basis" and apportion debt i.e. buy equity stake of 20% but on the basis of a 500 EV, with the minority "taking on" a pro-rata amount of the interco loan (investors inject 100m, but 60m goes to their share of "clearing" interco debt and 40m goes to buying equity)
  • If the company does not apportion debt to the minority shareholder, and if all cash is upstreamed to shareholders as dividend and debt is not repaid, wouldn't the minority shareholder receive an much higher % return on their capital?
  • Best practices of handling interco debt between company and holdco during a M&A minority transaction?

Tried to post a picture of some calculations for guidance but can't seem to post it.

Thank you all for your help.

Comments (9)

 
Most Helpful
Mar 12, 2020 - 9:07am

EV 500m
Debt: 300m
Equity: 200m

49% stake = 98m to holding company to acquire 49% shares in opco.

Now the question is if the debt is worth $300 or more. Basically you are valueing an option here. I would say value is $300 (given that EV is well in excess of 300) + value of the option which depends on strike price etc.

As a buyer, I would tell the seller to forfeit the option /exercise before transaction, or I will lower my offer for the minority stake.

In addition: minority stakes are almost always acquired at a discount to actual EV as the seller maintains control in this case.

 
Mar 12, 2020 - 10:27pm

Thank you for the reply. Not sure where is the option in the transaction nor how you arrived at value being 300m? Or are you referring to the option to convert the debt into equity? By calculations below, won't it be advantageous for the buyer (of 20%) to go in before the change of debt to equity occurs?

EV: 500m
Debt: 300m
Equity: 200m

Purchase price of 20% stake = 40m.

Or

EV: 500m
Debt: 0m
Equity: 500m

Purchase price of 20% stake = 100m.

Array
 
Mar 13, 2020 - 12:02pm

First of all lets be clear about your question: there is a holdco loan that is structured as a convertible or is it just that the holdco/seller has to decide on whether to label this money as debt or equity?

Regarding your question: makes a lot of sense to pay more for shares of a company without debt than for one that has debt right :) If you look at option 2, you could attract 300 of debt afer transaction and pay that out as a dividend and you end up with same net equity investment (100-(20% of 300) = 40)

 
Mar 14, 2020 - 6:40am

Thank you for your response.

It is not structured as a convertible. The seller is just deciding whether they should label it as equity and the impact of doing so for the buyer.

To your second part: Yes, in fact, some buyers require the seller to capitalise the loan to not have any debt above them in the capital structure since they can come before dividends.

*"If you look at option 2, you could attract 300 of debt afer transaction and pay that out as a dividend and you end up with same net equity investment (100-(20% of 300) = 40)"
*
And yes, this is what i meant when i said the loan is allocated "pro-rata" to the buyer (300m * 20% = 60m). Would you happen to know if this is a common industry practice?

Array
 
Mar 17, 2020 - 6:46am

Thanks for your response. Just musing: do companies pay their % of the EV, even if they investing on a minority stake basis? this lets some of their consideration go to eliminating interco debt.

Lets assume the below:

  • EV of 500m
  • intercompany debt of 300m
  • Equity of 200m
  • EBITDA of 100m
  • company get dividend of 100m for next FY

I.e. if the loan is not capitalised, and investor only pays for his % of equity value. i.e. he pays 40m for 20% stake and gets 20m dividend.

vs

If the loan is capitalised, investor pays 100m for 20% stake and gets 20m dividend.

Seems to me that Companies transact on a EV basis even when on a minority basis?

Array
 
Mar 17, 2020 - 10:01am

Dividend will not be the same because the entity has to pay interest over the 300m of debt. You always only pay for the equity value if you buy a company. Debt can remain with the seller (in which case equity = enterprise).

I think you mean convert into equity intead of capitalise btw. You can only capitalise P&L items into balance sheet items, not between balance sheet items.

Finally, let me rephrase my example above: Transaction goes through with 0 debt (loan converted into equity before transaction). Buyer than pays 100m for a 20% stake. After the transaction the target could raise 300m and pay it out as a dividend to both shareholders pro-rata so buyer receives 20% of 300 = 60m. In that case it paid 100-60=40m net for the stake, which is the same as leaving the 300m holdco loan (20% of remaining 200m equity value = 40m).

As a Buyer I would rather have the 300 come from a third party (bank) than from my co-owner as it will give the co-owner (seller) much more power in distressed situation for example + you ensure everything goes at arms length.

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