Prof. Ian Giddy, New York University
The Car Toys Proposed Recapitalization
Car Toys, Inc., is the largest independent retailer of car audio and wireless products in the U.S. The company opened its first store in Seattle in 1987 and now has stores in the Pacific Northwest, Denver, Dallas/Fort Worth and Houston. The company went public in 1997.
In late 2001 the founder and CEO of Car toys was considering options for a change in the company's capital structure. He was seeking a method that would offer greater liquidity and diversification of his and his family's investment in the company, and at the same time giving key officers a greater stake and control. he was also concerned about the share price, which was well below its 1999 peak of $41. Among the options he was considering were a leveraged recapitalization, a share repurchase, an exchange of common stock for debt, and a dual-class recapitalization. At this time 30% of the 10 million shares outstanding were held by the founder and his family, 10% by management, 20% by venture capital firms, and the remainder was fairly widely distributed. The shares were trading at $24. Net operating income was $30 million. Other key indicators are listed below.
Seattle Capital, a private equity firm, had teamed up with Bank
of America to propose a leveraged recapitalization to Car Toys. The proposal
involved paying a large dividend to outside shareholders. The dividend would
be $24. Discussions with investors suggested the post-dividend share price
would fall to $4. In lieu of cash, management would receive six additional
shares of common stock. The firm's advisors had calculated that of the $216
million needed for the special dividend, $40 million could come from cash,
$100 million from senior debt issuance led by Bank of America, and the remainder
from subordinated debt.
1. What would be the value of what outside investors received? Of what management received?
2. What would be the percentage of ownership held by management after the recapitalization?
3. How receptive do you think senior and subordinated investors would be to this? Develop a pro-forma balance sheet and interest coverage analysis, after the recap, assuming senior debt pays 12% and subordinated debt pays 15%. Would the company be able to pay down its subordinated debt?
4. Suggest how a share repurchase, an exchange of common stock for
debt, or a dual-class recapitalization might be structured for this firm.
Which would be appropriate for this situation?