Analysis of an LBO: The How

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Analysis of an LBOThe Hows and Whys of Japan
Telecom
Master of International Finance International
Finance Final Project Prof. MH Bouchet Ceram
Sophia Antipolis European School of Management

• Jeffery Davanzo
• jeff_at_davanzo.net
• Omar el Houri
• omarhouri_at_hotmail.com
• Dung Xuan Vu
• vxdung53_at_yahoo.com
• Tarek Hussein
• tarekegypt78_at_hotmail.com

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Contents

• Theory
• Why Japan Telecom?
• Leveraged Buyout of JT
• Risk Analysis / Conclusion

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Theory

• Explanation of an LBO
• Historical placement
• Examples of LBOs
• Objectives of different LBOs
• Incentive of LBO

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Explanation of an LBO

• What is LBO?
• LBO is a leverage buyout in which a takeover of a
  company or controlling interest in a company
  using a significant amount of borrowed money
  usually up to 70 or more of total purchase
  price.
• The term leverage Buyout refers to a system of
  company self-financing that has its origins in
  America.
• It is mainly used in so-called Mergers and
  Acquisitions operations, through which one
  company is bought( the so-called target company )
  by a second company.
• The buying company is usually a company set up
  for that purpose and which obtains financing
  through third parties (usually institutional
  investors ) and using the assets of the target
  company as collateral.

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Explanation of an LBO (contd)

• Its is when a group of investors decide to buy a
  public owned company.
• The LBO goes private and its shares no longer
  trade in the market.
• When the companys management buys the shares it
  becomes MBO.
• Large fraction of purchase price is debt
  financed.
• Some of this debt is junk,that is below
  investment grade.
• LBOs are aggressive because they depend highly on
  debt.

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Explanation of an LBO (contd)

• Investors takeover the company to build
  shareholder value through capital structure and
  sell it to the public again.
• The debt is serviced with funds generated by the
  aquired companys operations and,often, by sale
  of some of its assets.
• Bondholders lose in an LBO because the debt they
  thought was well secured may turn into junk when
  borrowers goes through an LBO.

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Explanation of an LBO (contd)

• A leverage buy out makes it possible to buy a
  company with the minimum use of risk capital by
  acquiring company by using the ability of the
  company that is to be required to take of debt,
  or alternatively its cash flow to pay back the
  capital borrowed.

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History Of LBOs

• The leverage buyout market rose to prominence in
  the late 1980s.
• This happened when private equity firms such as
  Kohlbers Kravis and Roberts (KKR) and Fortsmann
  little were consistently making headlines with
  large buyouts including the largest leverage
  buyout ever, KKRs 25 billion buyout of RJR
  Nabisco in 1988.
• The success of these financial sponsors (i.e.
  private equity firms) and others in completing
  transactions and earning favorable returns,
  attracted many other parties to the industry.
• There are currently hundreds of financial
  sponsors focused on buying companies of all sizes
  across many industries.

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Examples

• Acquirer Target Industry Year Price
• KKR RJR Nabisco Food,tobacco 1989 24,720
• KKR Beatrice Food 1986 6,250
• KKR Safeway Supermarkets 1986 4,240
• Thompson Co Southland Convenience
  stores 1987 4,000
• Wings Holdings NWA,Inc Airlines 1989 3,690
• KKR Owens-illinois Glass 1987 3,690
• TF Investments Hospital Corp Hospitals 1989 3,6
  90
• Macy Acquisitions R.H. Macy Co Department
  stores 1986 3,500
• Bain Capital Sealy Corp. Mattresses 1997 811
• Cyprus Group WESCO Distribution Data
  communications 1998 1,100
• Clayton,Dubilier North America Lines Trucking 199
  8 200
• Berkshire Partner William Carter Co Childrens
  clothing 2001 450
• Heartland Industrial Springs Industries Household
  textiles 2001 846

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RJR Nabisco Case

• A good example of an LBO is KKRs buyout of RJR
  Nabisco. RJR, a leading producer of tobacco and
  food products.
• On October 28,1988,the board of directors of RJR
  Nabisco revealed that Ross Johnson, the companys
  chief executive officer, had formed a group of
  investors that was prepared to buy all RJRs
  stock for 75 per share in cash and take the
  company private.
• RJRs share price immediately moved to about
  75,handling shareholders a 36 percent gain over
  the previous days price of 56.
• At same time RJRs bonds fell, since it was clear
  that existing bondholders would soon have a lot
  more company.
• Johnsons offer lifted RJR onto the auction block.

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RJR Nabisco Case (contd)

• Once the company was in play ,its board of
  directors was obliged to consider other offers,
  which were not long in coming.
• Four days later KKR bid 90 per share,79 in cash
  plus PIK preferred valued at 11.
• The resulting bidding contest had many surprises,
  but in the end it was Johnson group against KKR.
• KKR offered 109 per share, after adding 1 per
  share in the last hour.
• The KKR bid was 81 in cash, convertible
  subordinated debentures valued at about 10,and
  PIK preferred shares valued at 18.Johnson group
  bid 112 in cash and securities.
• RJR board chose KKR although Johnsons group had
  offered 3 per share more, its security
  valuations were viewed as softer and perhaps
  overstated.

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Types of LBOs

• LBO When a company is bought by another company
  made just for this purpose. Stocks of the
  acquired company are hold by a partnership of
  investors (usually institutional).
• MBO It occurs when the operation is set up by
  the managers of the company and the objective
  being to take control of the company. It is the
  company management buying back its shares,
  Management buyout.
• Family buyout it occurs when the shares of the
  company are held by a family group which retains
  control of the company as a result without
  actually having the financial means to make the
  purchase.

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Objective of the LBO

• Investors takeover a company when they see it
  undervalued or its assets are not being used
  properly.
• Investors takeover the company,improve it causing
  its value to increase then sell it back to the
  market at a higher price share.
• Sometimes they sell parts of it which could give
  back a big amounts of money.
• A clear tax saving.

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Objective of the LBO (cont)

• Generally,the aquirning group plans to run the
  acquired company for a number of years,boost its
  sales and profits,and then take it public again
  as a stronger company.
• In other instances,the LBO firm plans to sell off
  divisions to other firms that can gain
  synergies,but the inherent risks are great due to
  the heavy use of financial leverage.
• Saving a lot of taxes because they are borrowing
  a lot of money.

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Incentive of LBO

• It gives managers and employees the incentive to
  work harder often smarter because they have to
  generate cash to service the debt.
• Managers personal fortunes are riding on the
  LBOs success.
• They become owners rather then organization men
  and women.

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Why Japan Telecom

• Introduction to JT
• Qualitative analysis of industry
• Discussion of risks in acquisition
• Financial analysis
• Income statements
• Cash flows
• Balance sheets

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General Overview in Japan

• Big Bang deregulation in banking sector
• Corporate Restructuring
• - Write off the bad debt (popular)
• - Huge Distressed Debt Business Opportunities
  for Investment Bankers
• MA unpopular, LBO really unpopular
• Private Equity Players entering into Japan
• Current Player Ripplewood, Advantage Partners,
  Schroder Ventures etc.

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Who is Japan Telecom?
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Japan Telecom
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Japan Telecom
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J-Phone Co., Ltd.
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Japan Telecom vs. J-Phone
Year 2002 Japan Telecom J-Phone
Revenue 457,4 1351
Employees 3300 3138
Total asset 1501,8 1219,2
Net Income -64,5 _
Efficiency (Asset turnover) 0,30 1,11
Productivity (Y bil Revenue per employee) 0,14 0,43
Profitability (NI/Revenue) -0,14 _
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Japan Telecom holdings debt
  FY2002 31 March 2003 FY2001 31 March 2002
Assets    
Current assets 315,159 314,963
Investments and advances 86,915 89,168
Fixed assets for telecommunications services 1,429,155 1,420,722
Fixed assets for other services 8,590 31,297
Deferred charges - 183
Total assets 1,839,821 1,856,335
Liabilities    
Current liabilities 1,006,914 1,067,650
Long-term liabilities 260,437 365,244
Total liabilities 1,267,352 1,432,894
Minority interest 106,432 32,043
Shareholders' equity 466,036 391,397
Total liabilities and shareholders' equity 1,839,821 1,856,335
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Vodafone willingness to offload Japan Telecom

• Analysts generally agree it is a good time for
  Vodafone to exit the fixed-line market in Japan,
  as the industry has remained moribund and is
  struggling with price cuts and intense
  competition against larger rivals NTT DoCoMo Inc
  and KDDI Corp.
• The large user migration to mobile phones and the
  growing use of cut-rate Internet Protocol phones
  are also causing headaches. Sales at Japan
  Telecom fell 2.2 to JPY340bn (2.89bn) in its
  last fiscal year, with net income of JPY15.7bn
  (130m).
• Vodafone huge capital demand to focus on its core
  mobile business

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Who is Ripplewood?

• US based Private Equity Firm 4 funds
• Ripplewood Interim Partners, L.P.,
• Ripplewood Partners, L.P.,
• Ripplewood Japan, Inc.,
• New LTCB Partners C.V.
• Investment Focus
• Education publishing and training,
• Selected technology market segments
• Automotive retail, specialty chemicals
• Consumer products food manufacturing
• Industrial products
• Timothy C. Collins (Founder, 1995)
• Senior MD and CEO of Ripplewood Holdings L.L.C.

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• Former Long Term Credit Bank (LTCB)
• Fully integrated Bank
• 1. Commercial Banking
• 2. Retail banking
• 3. Investment Banking
• All-Star Management team
• 1. CEO Masamoto Yashiro - President of
  Citibank Japan
• 2. Senior MD David M. Fite Group Executive of
  Austrian Bank
• 3. Executive Director 5 people from outside
  (including Kei Imai Chairman of Japan's
  Federation Economic Organization )
• ? American-style, untouchable bank among
  conveying Japanese bank
• Recent Performance
• 1. Highest Self-Owned Capital Ratio among
  Japanese large banks
• 2. 2nd highest ROE among Japanese large banks
• 3. 2nd highest ratio of bad debt reserve account
  among Japanese large bank

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SEAGAIA Resort

• 153 ha
• Bubble Resort,
• Owned by Local Government etc.
• Star Manager
• Michael F. Glennie
• - Former CEO of Boca Raton
• Resort and Club

753 Rooms
296 Rooms
27 hole - Phoenix Country Club 18 hole - Tom
Watson Golf Course 36 hole - Phoenix Kogen
Country Club 18 hole - Kitago Phoenix Country
Club
Tokyo
SEAGAIA Resort
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Niles Parts

• Former Nissans Vendor
• Business Focus (Sales 2001 300M)
• switches, sensors, actuators and control units
• Star Board Member from outside
• Richard Donery
• Former Vice President of GM
• - Former President of GM Europe

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Nippon Columbia

• Former Hitachi Group
• Business Focus
• Music Entertainment, Media Equipment
• Star Board Member from outside
• CEO Strauss Zelnick(44)
• Former CEO of Fox
• - Former CEO of BMG Entertainment
• Katsumi Matsumura
• - Former Director of BMG Japan Entertainment

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Ripplewoods Japan strategy

• Opportunistically invest in different industries
  to restructure the companies with the objective
  of turning the company around.
• Combine Western management style with local
  Japanese expertise in managing the restructured
  companies.
• Leverage human networks, personal connection
  with Industry partners.
• Invest with longer time horizon that fits with
  the Japanese business culture.
• Form alliance with Mitsubishi Corporation to
  gain local market intelligence and business
  connections.

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Performance Improvement in Japan Telecom
Y\billions Fiscal 2003(forecasted) Fiscal 2002 Change
Mobile business 1,460 1,348 8.4
Fixed-line business 385 410 (6.2)
Other 16 30 (46.3)
Elimination -65 -84 -
Operating revenue 1797 1704 5.5
Operating expense      
Mobile business 1217 1353 -10
Fixed-line business 340 475 -37
Interest expense 32  29
Net income   -70
Mobile business 243 -5
Fixed-line business 35 -65
Other 12  
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Future prospect
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Future prospect

• JAPAN declined by 3.7 from TELECOM reviewed its
  cost structure through a series of steps that are
  part of Project V, Operational costs, including
  sales costs as well as general administrative and
  selling expenses, the interim results in the
  previous fiscal year.
• Interconnection charges for NTT, meanwhile,
  increased by 5.8 to \43.8 billion due to a rise
  in charges and post-fact adjustments, despite
  reduced traffic volumes.

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Local cable fabric network
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International connection
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JT undervaluation?

• Asset-Based Methods
• The deal - JPY261.3bn lt Book value of equity
  shares JPY486.1bn
• Free Cash Flows Methods Just slightly over 7
  times (261.3/35 7.4) of FCF forecasted in 2003

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Ripplewood desire to buy Japan Telecom

• Risks are shared with other banks (LBO with 80
  leverage)
• Foreign deals on Japanese assets
• Compliant with Ripplewood strategy
• JT is problematic company which can be turned
  around
• Bring American management to fixed line
  business in Japan
• Expand Ripplewood empire in Japan and set
  foundation for telecommunication business

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Leveraged buyout of Japan Telecom

• JT Before the Acquisition
• Presentation of offer to JTH
• Strategy adopted by Ripplewood
• Analysis of offer
• Corporate structure
• Equity preferred stock
• Debt structure
• Shareholder value

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Presentation of JTH

• JT is Japans 3rd biggest fixed-line operator
• JT has a clear strategy, good management a good
  position in the emerging technologies in fixed
  line telecommunications
• JT fixed-line had sales of more than 3bn in FY
  2002 took in profits of more than 160 million
  for the same year

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Presentation of JTH

• Improved key performance in 2002
• Revenue increase 5.5
• Ordinary income increase 267
• Net income increase Y145bn
• EBITDA margin improvement to 30.3
• Debt reduction of Y158bn

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Revenue Improvements in FY02
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Operating Profit Improvements in FY02
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Strategy adopted by R.W.

• Turn Japans Telecom fixed line operators into a
  tougher competitor
• Achieve new revenue sources build up the
  business
• Generate billions in additional cash from
  interest tax shields.
• Cut labour costs changing labour group seeking
  for idea about better growth

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Strategy adopted by R.W.

• Believes that it can turn around sell for a
  profit.
• Reduced capital expenditure, sales of assets
  improve operating profits.
• Ripplewood would sell a large part of the equity
  portion to some of International banks.
• Support of important decision makers
• in Japan

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Analysis of the offer
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Analysis of the offer

• R.W. has bought Japan Telecoms fixed-line in a
  2.22bn (Y261.3) transaction
• Based on the terms of the deal, JT will receive
  1.94bn (Y228.8) in cash 280 million (Y32.5bn)
  in the form of redeemable preferred equity
• 80 debt to equity has been financed this
  operation
• R.W. has secured 1.7bn (Y200bn) of loan
  financing from a consortium of 11 international
  bank (e.g. Citibank, JP Morgan)

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Analysis of the offer

• The cash received will be used to reduce JTH
  consolidated debt
• Banks have been eager to finance the deal with
  lucrative fees of 150-180 basis point above
  interbank rates
• JT intending to effect a legal transfer from its
  capital reserve A/C to a distributable A/C to
  service future dividends redeemable preferred
  equity

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Analysis of the offer
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Risk Analysis - Conclusion

• Goals
• Set by Ripplewood Holdings
• Increase share value
• Risk assessment
• Economic
• Interest rate risk
• Currency risk
• Telecom market risk
• Conclusion

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Goals set by Ripplewood Holding

• Increase share value
• Increase profitability and cash flows by cutting
  operating costs and changing marketing strategies
• Reorganize production facilities
• Improve inventory control, product quality,
  customer service, and pricing,
• Trim employment
• Return public within 5 years as a more
  profitable, leaner and meaner company

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Goals Increase Share value
The Goal Increase the share price of the firm
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Risk assessment Economic

• Japan is living a recent acceleration of growth
  following a pitiful decade with less than 1
  growth in GDP
• Driving trade surplus through China
• However, strucutral problems still reamin to be
  resolved
• Revitalizing business sector activites
• Restore the banking sector
• Improve on monetary policy before deflation ends

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Risk assessment Interest rate risk

• Of particular importance is the adjustment when
  deflation will end
• A long-term inflation target must be set not to
  fall back into delfation
• On the other hand, the banking sector must be
  address by reducing non-performing loans by half
  (4 of total lending) by 2005
• Stabilizing the banking sector will help reduce
  the public debt which is now 150 of GDP
• Low levels of interest rates have maintained
  interest paymetns low on govt bonds
• Transition to positive inflation will increase
  real interest rates and interest payments

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Risk assessment Currency

• The outlook in the medium to long-term is weak
  due to
• Weak banking sector
• High unemployment (5.2)
• Decreasing consumption
• Decreasing productivity
• Weak capital spending

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Risk assessment Telecom Market

• Slow economoy, but very rapid growth of telecom
  market on average 8.1 in the last 20 years
• Major players are NTT and KDD (the two original
  monopolies), DDI, and JT
• In March 2000, 36 of people are connected
  through bb cables.
• By 2010 100 will be connected.
• Within 3 years, 60 of people will be connected
  to Internet

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Conclusion

• The fixed line business is booming in Japan
• The risks lie mainly with a non-performing
  economic revival currency issues exist only in
  terms of exporting the currency to the US
• RH has other investments such as banks and
  manufacturing to recycle yen
• We will see Japan Telecom turning public within 3
  years as a more competitive and profitable player

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