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Corporate Restructuring Term 4 2013 Due date: July 16, 2013 (Tuesday) Assignment 5
SHINISO COMPANY (Update) Corporate Restructuring Case Financial Crisis Shiniso Company is a local railway company with widely diversified businesses. Until recently, top management believed that the company was managed well because it produced positive operating earnings and free cash flow. The CEO, a fourth-generation member of the founding family, has been reluctant to implement tough restructuring policies. The CEO often says, I am making money and generate positive cash flow. What is wrong with my management? As long as I am making a profit, I will not give up any business that my grandfather developed. Neither will I make severe cost cuts and lay off my employees, which would damage the local economy. The facts spoke in the CEOs favor. The companys 2006 non-consolidated P&L statement recorded $38M in operating income, with $1.3 billion in sales. The companys EBITDA was as large as $160M, and their free cash flow was positive at $49M. Unfortunately, contrary to the CEOs assertion, the true financial situation of the company is quite serious, and Shiniso Company is in a financial crisis. The company carries a huge debt burden of $1.5 billion, the result of its aggressive expansion into railway lines and past investments in leisure and real estate. Most of its past expansion was financed by debt, utilizing its high collateral property value during the bubble economy. After the property market crashed, the company was left with a huge debt burden, and it was forced to take a series of devaluations of the property assets, which resulted in three consecutive years of net loss. The current equity amount is only $60M, and the equity ration is only 3.8%. An analyst estimates that the real equity value may actually be negative if the mark to market accounting evaluation were to be applied to its leisure and construction businesses. He estimates a possible $150M devaluation of their assets. If we apply the mark to market valuation, the real equity value may be a negative $90M. Because of this huge debt burden, Shiniso Company has an annual interest payment obligation of $60M. As a result of this, the positive operating income becomes negative (minus $22M) ordinary income. The positive Free Cash Flow of $49M is far less than the Interest Payment Obligation of $60M. And no bank will provide a loan to Shiniso Company to fill this gap. This cash flow shortage has become serious and real, and there is a bankruptcy risk emerging.
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Divisional Businesses While its main Railway transportation business has a healthy operation, with $600M in sales and $40M in operating earnings, the Bus & Taxi transportation businesses suffer from poor earnings, with a combined total of $200M in sales and only $2M in operating earnings. However, public transportation services are crucial social capital for the regional economy, and the regional government has recently decided to provide $5M annually in governmental aid to Shiniso Companys bus business. The company and most of the banks believe that these services should be run as Shinisos core business, and that performance improvement efforts should be focused on these two businesses. The most divisions in most serious trouble are the Leisure and the Construction businesses. Both have been big loss makers and big capital users. These two were aggressively expanded during the bubble economy, and Shiniso Company invested hundreds of millions of dollars to purchase property at the peak of the real estate market. After the burst of the bubble economy, the leisure market crashed and the business has produced a $10-20M operating loss every year. In addition, because of the decline in property values, the real market value of the divisions property is estimated to be $100M lower than its book value. The construction business has also been damaged by the recent decline in public construction budgets, and its operating earnings show a $10M loss. The construction business also carries a hidden negative asset value of $50M. Since both the leisure and construction businesses are the least attractive and biggest loss-making operations, no strategic investors have shown any interest in acquiring them, aside from a real estate developer that is only interested in buying the land. The developer has offered to pay $50M for the leisure division property and $80M for the land owned by the construction division. The restructuring costs for Shiniso Company after selling the property are estimated to be $20M, including expenses for shutting down the leisure park and terminating the employment contracts. The net cash income from the closure of the two bad divisions, therefore, is $110M. The company also engages in community development business along its railway lines. An example of this is the chain of Supermarkets and Convenience Stores (CV) serving residents along the railway line. Some of the shops are located in the station building. The chain store business generates $150M in sales, and has a 10% operating profit margin. Its EBITDA is $20M, and free cash flow is $10M. Attracted by this performance and growth, a national retail store approached the CEO to acquire the business for $200M. He immediately rejected the offer, saying that the retail and railway businesses had a high degree of business synergy with each other. The other community development business is a Housing sales concern, which is a traditional railway companys business. At one time, as railway companies expanded new
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railway lines, they would develop housing property adjacent to new stations and turn residents into new customer passengers. Shiniso Company shifted its real estate business from housing developer to sales, which minimized their capital needs. Shiniso Company also has two interesting subsidiaries. The first is Hotel Beautiful, one of the most successfully operated hotels in the region. It has $100M in sales, $15M in operating earnings, $25M in EBITDA, and a free cash flow of $20M. Unlike other hotels, Hotel Beautiful has a superb financial structure. It has no debt. With a 70% equity share, the CEO loves the status that comes with being the chairman of this high reputation hotel, and emphasizes its synergy with the transportation business. Two investors have proposed to acquire the hotel. Most recently, the National Hotel Chain Corporation offered $160M for it (8 times their EBITDA multiple). The banks welcome this offer and have asked the CEO to seriously consider selling. The other proposal was made directly to the hotel management. Trust Bank proposes to use an REIT (real estate investment trust) to generate cash and use it for developing another hotel in the region. Trust Bank estimates that the hotel property can be sold to its hotel REIT with a $10M annual rent payment, which may be worth $200M. Hotel Beautiful can act as the hotels operating management company with $5M in operating income. The CFO of Shiniso Company is attracted by the concept of a REIT, and wonders how Shiniso Company can utilize the cash from it to repay Shiniso Companys debt. The other subsidiary is the E-Shopping/Travel Corporation. Shiniso Company was the sponsor of this venture company and owns a two-thirds equity share. The EShopping/Travel Corporation was established and is run by a young entrepreneur and attracts many e-technologists. The company has sales of $180M, which are expected to grow over 15% annually. Its operating profit ratio is as high as 10% ($18M), and its EBITDA is $30M. In order to support the sales growth and technology innovation, the company needs substantial capital expenditure and working capital. As a result, the free cash flow is only $5M and can barely cover the interest payment obligation of $4M. Among all of Shiniso Companys businesses, E-Shopping/Travel Corporation has the highest growth potential. Thus, the CEO would like to maximize the future value of the corporation, either fully consolidated with Shiniso Company or through an IPO in three years. A securities company estimates that the possible IPO value of the company in three years may be as much as $300M, which means that Shiniso Company would generate a $200M capital gain. However, the sub main bank insists on selling the subsidiary now for repayment of the loan. E-Giant company has offered $140M to acquire the share held by Shiniso Company. Banks Under the FSA guidelines, the bank loan to Shiniso Company is categorized as a nonperforming loan, which could force the lending banks to commit significant amounts of capital reserves to write off the loans. As this is a very expensive course of action, the banks
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are under tremendous pressure to clean up this large, non-performing loan. Unless there is significant improvement in the financial situation of Shiniso Company, the banks may be forced to use an additional $300M of write-off reserve. The Bank of Region is Shiniso Companys primary lender, and has loaned $650M to the company. It is the leading regional bank in the area where Shiniso Company is operating, and is a financially healthy company that plans to clean up the largest non-performing loan in the region. The bank takes a conservative approach, and $400M of the outstanding loan has been collateralized, with $180M put aside for write-off reserves. The Bank of Region also understands the need to take care not to damage the local economy during the process of restructuring this public transportation conglomerate. At the same time, based on past negotiations, The Bank of Region believes that replacing the CEO is vital to implement tough restructuring measures. The secondary lender is The Bank of Saisei, which was acquired by a foreign buyout fund after it went bankrupt. The Bank of Saisei is an aggressive, risk-taking bank that has increased its loan share to Shiniso Company by offering non-collateral loans with high margins. The loan outstanding to Shiniso Company is $400M, with only $100M collateralized, and $100M put into write-off reserves. Given the emerging crisis of Shiniso Company, The Bank of Saiseis attitude toward the company has changed and it is eager to minimize its potential losses. The bank has requested early repayment of the loan, even if it requires selling one of its businesses. The Bank of Saisei is located in Tokyo and is less interested in the communitys economy. Two Mega Banks each provided a loan of $100M to Shiniso Company. Their loans are well protected by collateral that is worth $150M in total. The remaining $250M in loans are provided by five Small- and Medium-sized Local Financial Institutions. Mostly they are short-term loans to support the Companys working capital needs, and accordingly this group has only $50M of collateral. They also have only $50M in write-off reserves. Since their capital structure is weak, some of them may not accept any restructuring plan that would require giving up a substantial portion of their loans. They insist that the main bank take full responsibility and shoulder the loss. Shareholders Shiniso Company is a public company whos market value is still $200M, which is 3.3 times its PBR (Price to Book Value Ratio) or unlimited PER (Price Earning Ratio). Its unusually high PBR/PER ratio is due to the small volume of stock traded. The CEO and members of the founders family own 40% of the companys shares, 20% is owned by affiliated companies of the Shiniso Group, 20% by banks, and the remaining 20% is held by regular investors. But, public shareholders have been frustrated because of the substantial decline in shareholder equity value due to the companys continued poor performance. A
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recent report by an investment analyst warns that the current market price of Shiniso Company is over-valued. Rumors of the companys crisis have already leaked out to the community. In fact, the stock price of the company recently dropped 12% in just one week. Devaluation of the current equity share as part of the restructuring process has often been discussed in the past, but the CEO and his family strongly oppose this approach. Privately-Arranged Restructuring Plan Finally, the Bank of Region and the CEO have agreed to make a last-ditch effort to restructure the company. They have decided to accept a privately-arranged restructuring scheme because a legal rehabilitation would create unnecessary confusion in the local community. Q1. Which businesses will you retain and which businesses will you divest yourself of? The two public transportation businesses should be retained as the core business. Leisure business and construction business will be divested. You have the option to either retain or divest yourself of the Supermarket and CV chain store business and the Housing Sales business. You have three options with regard to the two subsidiaries: sell, retain, or fully consolidate. Q2. What would be the likely P/L of the retained business(es) (Good Company) and what would be the proper financial structure (debt and equity)? You can assume the restructuring effort will improve the operating earnings of the retained business by 10% and the free cash flow by 20%. The maximum level of the debt transferable to the new Good Company is 10 times the free cash flow or 4 times the EBITDA. Target equity ratio (Equity /Equity + Debt) is set at 20%.

Q3. How will you raise the necessary capital? How much will you devalue the current equity? Debt Equity Swap (DES) by banks is set at $30M. How much new equity capital should be raised? How are you going to appeal to potential investors?

Q4. How much can you get from the divestiture of the businesses? How much net cash can you get from the closure of the two bad businesses? How much can you get from selling one of the businesses? How much cash can you get from the full consolidation of the subsidiaries, if you
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propose such a strategy? Q5. How much in total should you ask the banks to give up? And how much would you recommend each category of bank to give up? You have to get full consensus. The current outstanding debt is $1.5 billion How much debt can be transferred to the new Good Company? DES is $30M How much cash can you get from the divestiture of some businesses and subsidiaries? How much are you still short? How will you allocate the shortage to each category of banks? Bank of Region, Bank of Saisei, mega-banks, small and medium financial institutions? Q6. How will you structure the current top management? Legal Restructuring Unfortunately, the privately-arranged restructuring trial failed because of disagreements among the parties. The risk of bankruptcy has suddenly increased. The last option for Shiniso Company and the banks is to go to court. The CEO and Bank of Region would like to file for bankruptcy under the Civil Rehabilitation Law (Minji Saiseiho) because the procedure is speedy and simple. Furthermore, it is more attractive to the CEO as he can continue in the top management position during the companys restructuring. The Bank of Region has another motivation for using Minji Saiseiho. Their loan is well protected by collateral, and they believe that giving up the banks control during the restructuring is a smaller loss than if the company were to file under the Corporate Reorganization Law (Kaisha Koseiho). On the other hand, the Bank of Saisei and the railway company that is interested in acquiring Shiniso Company prefer that the company file under Kaisha Koseiho. The Bank of Saisei, whose loan is not well protected by collateral, worries that under Miniji Saiseiho, the Bank of Saisei stands to loose the most. The other railway companys motivation is simple. It believes that filing under Kaisha Koseiho will give it the chance to take 100% control of the company, and to buy it at the lowest investment cost. The banks settlement amount under Minji Saiseiho or Kaisha Koseiho is usually much smaller than under a Privately Arranged Restructuring deal, and the settlement amount is applied equally to all banks. Mega-banks and small and medium financial institutions are very concerned with how much write-off burden will be imposed on them if the legal action is approved.

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Q7. Assuming that the banks are required to give up $700M in total, how much of a write-off is required for each group of banks in the case of Minji Saiseiho? $700M is the total amount the banks are required to give up Target is non-collateral loans Settlement amount is applied equally to all banks concerned

Q8. How much of a write-off is required for each group of banks in the case of Kaisha Koseiho? $700M is the total amount the banks are required to give up Target is all loans, including collateralized portion Settlement amount is applied equally to all banks concerned

Q9. If you were a strategic buyer (another railway company) and were interested to be a sponsor to restructure Shiniso company under Kaisha Koseiho, what kind of rehabilitation plan and financial deals would you request? Q10. Among all possible restructuring alternatives, which restructuring plan would you

prefer if you were a representative of one of the following parties, and how would you negotiate with the other counterparts? CEO Public Shareholder Bank of Region Bank of Saisei Mega-banks Small- & Medium-sized Financial Institutions Strategic Buyer