FIN500Y White Paper - AXA Private Equity: The Diana Investment
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FIN500Y
December 02, 2022
White Paper - AXA Private Equity: The Diana Investment
I: Background
AXA Private Equity:
A PE group has a $25 billion pool, founded in 1996, and has grown rapidly, mainly focusing on Funds of Fund, infrastructure and private equity direct investing, which include Diana’s investment deal.
Diana Company:
Diana was originally an animal food production company, but later focused on exacting ingredients to produce food, drink, and more. It was sold to Cognetas for 271 million Euros in 2004, and then built the company had 280 million Euros in revenue.
European PE industry:
The European PE industry was on rapid growth in 2007, from 35 billion in 2005 to 216 billion business. Deals are usually financed with 70% debt, and the Enterprise Value EBITDA multiple is between 9.5 and 11.5x.
The Acquisition:
Valued at 710 million with 11.5 multiple on 2007 expected EBITDA. AXA PE invested 218 million in Diana to hold 52% of the equity, with Diana holding 33% of the company and Congnets holding 15%.
AXA had 415 million in debt with an increased combined effective interest rate of 2.67% since the economic condition changed from May to July due to the crisis that happened in mid-2007
The Problems:
The financial crisis has already started to infect the company. The increase in raw material price reduced orders from major customers, and a production issue cost them 400 thousand per month. They start being tight on cash.
Banks are unhappy with Diana’s performance and tell the company to sell itself to secure a bank loan.
AXA was also upset with Diana’s performance and decided to run an independent valuation, the share prices have fallen by 30%, and the EBITDA multiples have fallen from 6.5 to 8x,
II: Proposal
i: Direct Buyback
The first option is a direct buyback, in which sponsors could buy and retire 121.6 million of UKFC debt without SCF, but there will be a write-down of the loan by 42% for SCF if auditors viewed the transactions as the market benchmark, forcing SCF to mark the loan to market.
In this case, we use multiple valuations, summing the senior debt and junior debt (from Exhibit 10) to get the book value of the debt and multiplying with a market value of debt converter, resulting market value of debt in 171.9 million. Then we get a firm value of 521 million by multiplying the EV/EBITDA (from Exhibit 8) with EBITDA in 2009 (from Exhibit 9).
In addition, we use DCF to get enterprise value by summing the present value of FCFF, which is around 538 million. And we use enterprise value minus debt value to get our equity value of 366 million. Therefore, only 70 additional equity injection is needed to decrease the average marginal rate of 2.54% (the lowest average margin rate), as shown in Exhibit 10 in the article.
ii: Indirect Buyback
The second option is indirect buyback which sponsors first inject €50 million to repay B and C tranches and convert some of the B and C tranches to PIK and buy it back at a 50% discount while increasing the yield to lenders by 2.56%, and then inject a further € 30 million to buy back € 60 million of this new PIK also at a 50% discount. This would align the structure with the expected market and prevent them from writing down loans.
In option 2, the valuation method is quite similar to option 1. By using multiple valuations, we used above for option 1, the book value is 308 million, which is the sum of the senior debt of 184 million and the junior debt of 124 million. The equity value is 212.7 million in EBITDA multiple valuations, which is firm value minus the value of debt. For DCF valuation, as we can see in the chart below, the equity value increased to 247.3 million, and the firm value increased to 555.3 million. After calculation, the second option requires 80 million equity injections, and the average marginal rate increases to 5.24%.
iii: Straight Equity Cure
The third option is a straight equity cure, an injection of € 75 million of equity which would reduce the A, B, and C tranches and reduce the revolver. SCF would welcome this method because part of the debt bought back would be converted into equity, making their remaining debt more highly valued, while the company balance sheet would be structured with lower leverage. It's important to reach an agreement with banks quickly, so Diana will have the flexibility to make acquisitions, grow, and reach its potential. When using the multiple valuations, the book value of debt became 343 million, and the equity value was 177.7 million. For DCF valuation, the equity value increased to 198.7 million, and the firm value increased to 541.7 million. The new average marginal rate is 2.74%.
III: Valuation
We use multiples and discounted cash flow (DCF) methods to yield market relative value and intrinsic value. In multiples valuation, an EV/EBITDA of 9.8x is used based on the average multiples in Exhibit 8 in Excel. In DCF valuation, the unlevered beta is 0.9, the risk-free rate is 4.25%, and the equity risk premium is 6% from Exhibit 8 in Excel. the Tax rate is 23% which is about the average corporate tax rate of OECD countries. Then we calculated the new Ru and different WACCs based on the leverage Diana took under each scenario. Then we calculated the enterprise value for each option. All valuation details can be found in Excel.
IV: Conclusion
To conclude, we recommend the third option: a straight equity cure. This method can not only reach an agreement faster but also make the remaining debt more highly valued and lower leverage on the balance sheet. Most importantly, this method is preferred by the SCF, they have a strong position, and we would like to maintain a close relationship with them during the financial crisis.
2022-12-15