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In a Competitive Economy, What are Your Corporate Financing Options?

The following article is excerpted from a recent GE Lending Views Newsletter.

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At a time when the opportunities presented by a slowly expanding economy are threatened by rising interest rates, CFOs are increasingly devoting more time to identifying flexible and attractively priced sources of capital financing. The good news, according to Dan Hom, Senior Vice President GE Corporate Lending, is that the availability of a variety of financing options means that most companies should be able to meet their borrowing needs in a competitive, cost-effective manner. But the challenge, he says, is to ensure that CFOs are aware of all the choices that are out there. Following this discussion, see a Case Study involving K2, Inc., NYSE: KTO, for a realization of the Corporate Financing options discussed.

"When we consider senior secured debt financing, the segment generally consists of two broad categories: term loans and revolvers," says Hom. "A term loan has a contractual repayment schedule, while a revolver, which is often tapped to enhance working capital, is similar to a line of credit in that there is no principal amortization-instead a company pays a commitment fee and may then borrow and repay funds until the maturity date of the facility. It is usually used for operating purposes, fluctuating each month with revenues and expenditures."

CFOs, he notes, are generally familiar with the nuances of term loans and revolvers. "Some companies require an asset-based loan (ABL) structure; other companies have the option to elect either an ABL or a cash-flow structure. The addition of a securitization as part of a senior debt facility may also offer a reduced cost of capital," adds Hom. "That's why a relationship with a lender that has extensive experience with a wide range of financing alternatives, can be especially valuable."

Cash-Flow and Asset-Based Loans Each Offer Benefits

Hom notes that both cash-flow and asset-based structures offer unique advantages. While a cash-flow loan requires less reporting than an ABL, the availability is capped by a leverage multiple, and it typically carries a higher interest rate margin. An asset-based loan may be better suited for companies with cyclical cash flow, or negative cash flow trends-though many profitable companies utilize an ABL structure because of the reduced covenants package. Depending on a company's circumstances-in particular, a high leverage ratioan asset-based loan may also offer greater liquidity than a cash-flow structure.

"Usually, a company must have a credit rating of 'B' or 'BB' or better to qualify for a cash-flow based loan," explains Hom. "However, the size of such a loan will generally be limited to a multiple of the company's EBITDA (earnings before interest, taxes, depreciation and amortization). In the current environment, that senior debt multiple will cap out at two to three times EBITDA."

"In contrast, an asset-based loan is based on the value of receivables, inventory, equipment and other assets, which means that a company's borrowing ability will no longer be tied to its cash flow," he says. "In an ABL transaction, borrowing capacity is tied to the underlying value of the firm's assets-value that might otherwise never be tapped."

A Loan's Characteristics Should Match a Company's Needs

But while an asset-based loan may offer increased liquidity and other advantages, GE's Hom cautions that before a potential borrower enters into negotiations with a lender, it should be familiar with the different categories of loans. Noting that GE Corporate Lending offers a variety of both cash-flowbased and asset-based loans, he lists them, from least expensive (in terms of interest rates and fees) to most expensive:

  • Senior Revolver Facility - Structured as either asset-based or cash-flow. An asset-based revolver is designed for higher-leveraged borrowers that experience considerable variation in their cash-flow performance. Meanwhile, cash-flow-based revolvers have less reporting but more covenants, the violation of which can result in additional fees or termination of the loan. Cash-flow-based loans also generally require more consistent operating history, and restrict the degree of leverage in the capital structure.

    Term A Loan - This tranche is structured to reflect the value of fixed assets, but may also be capped by a senior leverage ratio. Considered to be pari passu (treated equally in terms of security) with the revolver, Term A loans generally carry a similar interest rate to the revolver and are amortized on a straight-line basis over the life of the term.

  • Term B Loan - This tranche is generally structured to support a cash flow structure utilized by companies with minimum EBITDA of $40 to $50 million though companies with lower but more sustainable EBITDA may also be able to obtain a Term B structure. For large Term B loans (over $100 million in size - also known as an Institutional Term Loans), the number of active investors has grown considerably as a proliferation of institutional investors such as Collateralized Loan Obligations (CLOs), Prime Rate Funds, and insurance company funds have replaced domestic and foreign banks that have left the cash flow financing market. Term Bs are also structured to be pari passu with the revolver and Term A, but carry a higher interest rate. Unlike a Term A, they are not amortized on a straight-line basis-a Term B has a nominal principal amortization schedule, and carries a "bullet" or balloon payment at maturity.

  • Tranche B Loan - This tranche will carry an interest rate that may range from 12% to 18%, and can be used when capital is required in an expedited manner to augment liquidity. It is structured as part of the senior secured facility, but repayment is second to the senior revolver and term tranches. The amortization of a Tranche B is usually back ended, but can be negotiated based on the borrower's projected excess cash flow. Typically, scheduled repayment will not begin until the senior credit facility is substantially or completely repaid. Although they have historically been viewed as a short-term capital solution, with maturity dates of 36 months or less, recent transactions trend from three to five years as a result of wider market acceptance of this tranche.

"There's a significant amount of confusion among borrowers regarding the subtleties of asset-based and cash-flow-based loans, and the differences between Term A and B, and Tranche B loans," comments Hom. "This is unfortunate, since timing considerations, closing fees, interest rates and other issues have a significant impact on a company."

He notes that financing institutions with a broad base of knowledge and experience can help borrowers navigate through the loan issues, matching their specific needs with the program that will best serve them.

A Case Study:

GE's Flexibility and Speed of Commitment Provide K2 Lift in Expanding Their Business

GE's relationship with K2 began in the Fall of 2001, when it extended a $75MM asset-based revolver to the noteworthy maker of skis, skates, snowboards and other sports equipment. The company was in the midst of relocating manufacturing to China in order to remain cost competitive, and whereas other lenders showed little interest in providing new financing, GE entered into a sizable financing arrangement with K2.

So in March 2003, when K2's CEO Heckmann, initiated a concerted acquisition strategy resulting in the addition of Rawlings, GE was quick to co-lead a refinancing facility that provided K2 the flexibility it needed, while maximizing its availability.

"As things worked out, we were selected as co-agent on a $225 million facility consisting of a $205 million asset-backed revolver and a $20 million 'Tranche B' loan," says Larry Ridgway, GE Corporate Lending Vice President. "Following our usual approach, we took a significant hold position that made the syndication process easier to close and easier for K2 to manage."

He adds that K2 opted for the Tranche B portion in order to maximize the revolver's availability.

At the time, in addition to its stepped-up acquisition efforts, K2 was implementing a series of programs-domestically and in places like Asiadesigned to maximize its manufacturing efficiency while minimizing cost structures. The company's strategy meant it was an excellent candidate for an asset-backed loan.

"Although K2's earnings results made the company eligible for a cash-flow loan, K2 CEO Heckmann and his advisers were attracted by the flexibility of fewer covenants and favorable pricing offered by an asset-based facility," says Ben Silver, Vice President GE Corporate Lending. "The size of the new facility enlarged the company's 'acquisition basket' line of credit, which will enable it to move in timely fashion on future acquisitions. K2 also gained a certain comfort level from the fact that it had dealt with GE as a lender before, and has noted it is impressed with GE's speed, flexibility and expertise across a wide range of products and industries."

As Silver observes, the market favorably views K2's growth through acquisition, enabled by its additional financial resources including this new senior credit facility.

"When the expanded credit facility was signed, K2's stock price was hovering around $8 a share," reports Silver. "Six months later it was closer to $18 a share. Needless to say, the company's very pleased with this, and I've been advised that K2 remains focused on strategic acquisitions and plans to continue and expand its long-term relationship with GE."

For more information reflecting current thought leadership on trends, timely issues, and White Papers with "Deal Detail" case studies in Commercial Lending at GE in cooperation with Wharton sign up for our free GE Lending Views Newsletter.

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