Raising Capital
Franchise wont work because it is too late and wont raise enough money fast enough
-so therefore we need survivorship money
-raise capital from equity
-probably need 25-40 million
-this will give them 50% interest
-It will be very hard to borrow coming out of bankruptcy
-This is a large risk on them because they are a low claimant
-new money will require 20-30% IRR
Raising Survivorship Capital
Capital Funding Decision:
1. Convertible Bonds-Convertible into preferred stock in 5 years with a 11.59% coupon
2. Cumulative Preferred Stock-Issue 10 million shares, which is the equivalent to 50% ownership. It will be offered with an 8% dividend rate. Would be convertible to stock in five years
Recommendation
-Cumulative Preferred Stock-
Pros:
-It gives a large tax incentive to any potential investors
-Dividends Received Deduction -allows the investor to deduct an additional 80% of their dividend tax liability to avoid "triple-taxation"
-The tax break is certain, and NCS can use it to offer a lower dividend rate
Recommendation
-Cumulative Preferred Stock -
Cons:
-Lose all of the NOLs (approximately $27 million)
-Change in ownership and control
Equity Offering
-10 million of cumulative preferred shares issued
-$4/share
-50% ownership of the company
-8% dividend rate, dividends accumulate in arrears annually, even if a dividend is not declared in the current year.
Conclusion
•Van Horn may not be the best person to run NCS
•Convenience stores don't have rapid growth re its small incremental change
•If NCSis to continue operations it should use a cumulative preferred share issuance to raise capital
•NCS's TEV coming out bankruptcy is approximately$213,282 million
National Convenience Stores
The debtor filed for Chapter 11 in December 1991. The debtor's initial Plan assumed an enterprise value for the company of over $300 million. Creditors' claims would be largely reinstated, and common and preferred stockholders would retain their full equity interest. Creditors strenuously objected to this Plan, because they felt it burdened the company with excessive debt, and within a few months the debtor proposed a second Plan. The modified Plan assumed an enterprise value of only $210 million, the firm's debt would be substantially reduced, and preferred and common stockholders would be wiped out. The Plan would also severely restrict trading in the company's common stock to preserve its NOL carryforwards. The Unsecured Creditors' Committee refused to endorse the Plan, because it believed these restrictions would depress the company's value by 25-35%. The company's largest common stockholder, who held 18% of the stock, argued that enterprise value was in excess of $300 million, and therefore the debtor's plan was unconfirmable because it provided no recovery for common stockholders. With the modified Plan lacking sufficient creditor support, the debtor proposed a third Plan. This Plan also assumed an enterprise value of $210 million, but contained fewer trading restrictions on the stock, and less generous stock option grants for senior management. The Plan was confirmed in February 1992. Post-bankruptcy enterprise value: $240 million.
Senior Management Turnover
Senior managers' incentives to support higher estimates of firm value could also increase with the length of their current position at the firm. Hotchkiss (1995) finds that managers of bankrupt firms typically produce overly optimistic cash flow (EBITDA) forecasts, but the positive bias is greatest for firms run by "incumbent" CEOs (those who were in office before the firm filed for bankruptcy). Relative to replacement CEOs, incumbent CEOs have a stronger incentive to portray their firms in a favorable light because more of their human and reputational capital is firm-specific. In the National Convenience Stores case (Appendix), incumbent senior management effectively entrenched themselves by proposing an enterprise value that was fully 50% higher than the value incorporated in the final reorganization plan. Management's plan also significantly restricted trading in the firm's stock after bankruptcy, making it more difficult to replace managers. For 41.3% of sample firms the pre-bankruptcy CEO is still in office when the reorganization plan is proposed (Table I); we expect these cases to be associated with higher estimated values.
What this really tells investors is how much debt a company has in its capital structure. It also gives us an idea of what it would cost a buyer to acquire the company. Further, once we have a company's TEV we can use it to run a number of calculations that provide a more accurate picture of a company's valuation, financial health, and returns.
Attachment:- national convenience stores.xlsx