Debt Case Studies
Client: A well-known for-profit vocational school that has been in business for over 60 years and has 27 school campuses, located all over the United States. The company owns the underlying real estate on five of the 27 campuses and the remainder are subject to long-term leases.
Scenario: The company has been generating approximately $320MM per year in revenue and $18-$20MM per year in EBITDA. The primary reason for the low EBITDA margins is because six of the 27 schools were losing money and the company couldn’t close them because of the long-term lease liability. Additionally, the company had very little free cash flow because it had significant capital expenditures each year to ensure that all of the schools were as modernized as possible from both an equipment and curriculum standpoint to stay competitive. The lack of free cash flow and overall liquidity put the company on probation with the federal regulators and put the company in jeopardy of losing its federal funding, which would effectively put it out of business.
The company had been trying for close to a year to refinance its existing bank loan to increase the amount to the needed $50MM to no avail. It also engaged a very large real estate finance intermediary to arrange a refinancing of the loan collateralized by the parcels of owned real estate. The problem with the real estate refinance was that the recent appraisals that were done came in relatively low given the single-use nature of the property and would not support a $50MM loan.
Solution: The company subsequently retained us last year to structure and arrange a new $50MM loan after the above-described failures. After analyzing the company’s business, we ascertained that there was significant value in at least three of the company’s automotive schools, both because of their reputation and the fact that they were the only schools of that type in their geographical area.
We had the company engage an appraiser who specialized in valuing for-profit vocational schools, and the schools described above appraised out in the aggregate of approximately $80MM (there was some overlap with the real estate values as one of the three school’s appraisals included $20MM of the company’s owned real estate on that campus).
After unlocking the intrinsic value of a few of the schools, the next challenge was to find a private debt fund that would loan $50MM against both the real estate and the schools, notwithstanding the fact that there would be very little cash flow to service the debt because of necessary capital expenditures going forward and because many real estate lenders do not lend against other types of collateral.
We were able to find a relatively new private debt fund that was able to make a three-year, interest only loan of $50MM, collateralized by the value of the three schools and the real estate, which enabled the company to regain financial compliance with the federal regulators and have enough additional cash to negotiate lease buyouts and school closures on its three most unprofitable schools, which boosted the company’s EBITDA and free cash flow on a going-forward basis.
Client: One of the largest custom ski boot manufacturers in North America had both a rapidly growing wholesale and retail business and is owned in large part by a private equity sponsor. The company is well-known for its custom orthotics technology and believed that such technology would transfer well into the retail running shoe industry.
Scenario: The company sought to purchase two retail running shoe store chains concurrently and have both sales close simultaneously. One of the chains was located in Los Angeles and the other was located in New York City. Neither chain was affiliated with the other and both were lower middle market companies. The aggregate purchase price for the two chains was approximately $50MM, which was a weighted average purchase price multiple of approximately 5.5X, on $9MM of trailing 12-month EBITDA. The ski boot manufacturer who was acquiring the running shoe store chains had about $10MM in trade accounts receivable but almost zero EBITDA because it was growing very rapidly.
The equity sponsor was prepared to contribute $18MM toward the $50MM purchase price and was seeking $32MM of debt against an aggregate of $9MM of aggregate trailing 12-month EBITDA. The sponsor’s in-house debt placement personnel were able to secure several term sheets from BDCs with all-in pricing on the $32MM loan of between 10% and 12% per annum (including closing fees, annual audit fees, etc.). The sponsor was not able to obtain lower pricing because of the amount of leverage involved and also because its then current lender, Bank of America, did not make cash-flow based term loans to companies with less than $25MM of EBITDA. The sponsor was being forced to either pay a high debt service cost or infuse significant additional equity, which would have reduced its projected ROI.
Solution: The equity sponsor was referred to us by an investment bank in New York who characterized Reedland as debt specialists who might be able to provide a better solution. We advised the sponsor that there are certain aggressive regional banks around the country who make cash flow-based term loans for companies with EBITDA as little as $8MM. The problem here was that with two acquisitions occurring concurrently, there were a lot of moving parts, and these regional lenders generally will not lend on a EBITDA multiple higher than 3X, which would have left them approximately $5MM short on a $32MM Loan.
We were able to structure the loan by having a regional bank, who had a geographical footprint in both New York and Los Angeles, provide a five-year senior credit facility consisting of a $27MM cash flow-based term loan against the $9MM of trailing 12-month EBITDA, and a $10MM revolver against the ski boot manufacturer’s trade accounts receivable, which provided another $8MM in total loan availability. Generally, commercial banks will not permit the cash proceeds from working capital revolvers to fund long-term assets such as company acquisitions. We convinced the lender to allow $5MM of the revolver proceeds to be used towards the purchase price because we argued that the adjusted pro forma trailing 12-month EBITDA was actually $11MM, once you net out the selling shareholders’ salaries and certain one-time non-recurring expenses. Consequently, Reedland was able to arrange the $32MM revolver/term loan at a weighted average blended all-in rate of LIBOR+3.75%, which at the time translated to 3.92%. As the term loan was only partially amortized, this will save the company approximately $10MM in interest expense during the life of the loan.