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1.
Situation of Company Pre-LBO
EMAS (which originally
stood for
Malaysia Armed
Service Enterprise) was started to provide the Malaysia Armed Forces
with
consumer goods at affordable prices. EMAS has a well-known brand name
in
Malaysia, a reputation for giving value for money, and a low default
rate
(about 0.8% of Sales in 1998, and 1.1% in 1999) on its
customer-financing
business. HP financing rates are: 8% on PCs, 12% on other goods.
EMAS was profitable, and had come through the economic crisis well --
it
had made profits every year despite the poor retail market conditions
in
Malaysia during the late 1990s. It had five retail outlets and a
warehouse
in Klang, Malaysia, prior to its LBO. Its biggest market is the lower
and
middle-income families who live in the Klang Valley area.
EMAS was wholly owned by a State Company, which decided to divest the
enterprise
because it was not considered a core business.However, the State
Company
was aware of EMAS's initial public offering (IPO) potential, and so
negotiated
to have an option to re-invest in EMAS, prior to its IPO, at a discount
to its IPO price.
2.The
LBO Investors
The Investors are a group of financial investors of good reputation,
and
who have a track record in hotel development and investment. Some of
them
are based in the US where they had migrated from Malaysia and Indonesia
over 10 years ago. They do not have any retail experience.The Investors
had been looking for a well-managed and profitable company with listing
potential to buy into. EMAS fit those requirements.
For
the LBO, the Investors acquired a Malaysia-incorporated shell company ("Hope"),
which was used to buy over the assets, liabilities, business
undertakings
and the "EMAS" trademark leaving the post-acquisition EMAS as a cash
shell
with the vendor. The acquisition was financed partly by equity and bank
loans to Hope. Hope is also intended to be the IPO listing vehicle.
3. Financing the LBO
Hope was incorporated
in mid-1999 to buy EMAS’s existing assets,
liabilities
and business at 10.5 times prospective PER i.e. equivalent to 2 times
book
value, subject to a minimum of RM52m and a maximum of RM63m. The RM52
million
was paid at the date of sale, while the remainder if any would depend
on
Hope’s earnings performance in the first two years. The vendors have an
option to subscribe up to 20% of Hope’s issued shares prior to IPO at
an
8% discount from the IPO price.
The
leveraged buyout was financed primarily by bank borrowings (RM42m
senior
debt at Libor + 2%) provided by a prominent Malaysian bank) and partly
by equity (RM10.25m).
4.
Changes Following the LBO
Post-LBO changes have
been minimised. The Investors rely on EMAS's
operational
management, and had acquired EMAS's business on the condition that
EMAS's
management would remain in place. Hence, there has been no change in
operational
management.
To
retain and motivate them, key management staff are provided with
share
ownership opportunities under the LBO arrangements. The Investors
intend
to extend share ownership opportunities to all staff so as to inculcate
a dynamic and team culture.
The
US-based Investors have also mentioned that there were some retail
ideas
that they could introduce to Hope, and one of their ideas was to
introduce
an extended 3-year warranty to their goods.
Hope has also started a
web site to
retail its
goods electronically. However, the investment into
e-commerce
has not swung into full gear yet. The company intends to expand into
geographical
areas where they are currently under-represented, starting from the
Klang
Valley to the rest of peninsular Malaysia. Since the LBO, the 6th
retail
outlet has been opened, and the launch of another outlet is planned.
The
emphasis is on brick-and-mortar expansion initially to achieve greater
economies of scale.
For this expansion,
the company needs approximately RM6 million. The
Investors
are not willing to provide additional capital themselves; instead they
aim to raise funds through an IPO. Although the company’s financials
may
not yet be strong enough to meet the requirements of the Kuala Lumpur
Stock
Exchange, such as having positive net tangible assets, the Investors
have
stated their intention to launch the IPO before the end of the year.
They
aim to issue at a price of approximately 15 times earnings and to
retain
at least 51% of the shares. They would like to get the interest costs
down
in order to improve earnings and hence get a better price for the
shares.
Some of the proceeds of the IPO will be used to reduce Hope’s senior
debt
to more acceptable levels.
Questions:
- How much debt should this kind of company
have?
- What will it take to ready the company
for a public
offering?
- How will the debt be brought down level
if the IPO is
delayed or cancelled?
- How is LBO debt usually repaid or
refinanced?
The company may require additional funding prior
to its IPO. The
Investors
have been considering a convertible note, or finding an equity investor
– a financial investor, a venture capital fund or a strategic partner –
to take up to 20% of the post-IPO equity value. What form of funding,
and
at what terms, would you recommend?
Prepared by Ian H. Giddy with the assistance
of Lynn Goh.
Appendix
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