Loan Structuring - David Jones Limited - Case Study Example

LOAN STRUCTURING–CASE STUDY Loan Structuring ­–Case Study Customer Inserts His/her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name 10/05/2012 Table of contents Executive summary 1 Introduction 3 The requirements for a Revolving cash advance financing 3 Suitability of the Revolving cash advance financing for DJS ltd. 4 The benefits of lending 7 Scenario analysis 10 Conclusions 12 Reference List 13 Executive summary This financial analysis report was prepared for David Jones Pty Ltd., who through their Chief Finance officer has requested funding from our Investment firm amounting to $ 500m. A business analysis tool is critical in deciding whether or not a company or firm deserves to be awarded a credit facility by a bank or investor. The operation of any business is unique as determined by the nature of the company as well as the managements experience and style. It becomes incumbent upon organizations to have a common and standardized method of presenting a business request for a facility and it is this information that is summarized in a credit analysis report. The main aim of this document is to offer a concise and in an objective manner, the need for the funds and to demonstrate the ability of the borrower to repay the loan facility within the set period of time. This is the reason why it has to be succinct, objective and well supported by data and facts. In this document we demonstrate why revolving cash advance lending is the most appropriate loan facility for David Jones limited given the unique circumstances under consideration. This facility requires an entity to fulfill some broad criterion such as registration with the Register of companies and having a legal mandate to operate. It basically uses the performance based collateral evidenced from strong cash flow projections of the borrower. It requires a shorter time before draw down and is basically much easy to manage. We therefore go a head and clarify why David Jones meets these criteria in the early sections. The next section clearly describes the funds which our investment company has to offer. As an investment bank, our firm specializes in offering loan facilities inform of revolving fund for local as well as international foreign organizations who have demonstrated their ability to operate at a profit and are great players in an industry with promise and potential for continued growth and profitability. David Jones operates in a dynamic environment and with great diversity which portrays strength in this regard. The focus of this analysis was on the potential risks to the continued operation and or profitability of the organization. Particular emphasis was on the danger these risks implied to the funds hereby requested for by David and Jones and if at all, the mitigation measures suggested were adequate enough to cover the effects of these risks. In this light the five major risk factors identified were; the rising cost of imports, the instability of the world markets, the escalating cost of rental property, the fast changing trends in fashion and the increasing competition from other major players in this industry. This section gives detailed measures that the company envisages in order to minimize the said risks to continue attracting customers, increase volume of sales and enhance her competitive advantage. This report has relied on the data provided from the various audited accounts of David and Jones limited as well as the various articles published by the regulators in the industry where David and Jones operates or (ASX). In fact, due to the independence of the reports and the organizations which drafted them, our firm had a lot of confidence that these data represents a true reflection of the performance and possible trends of David and jones as of the times reported. The key tools reviewed include the balance sheet, the profit and loss accounts, the financial forecast reports and other relevant reports. The last section gives a scenario analysis plus additional issues considered in this review. Introduction Based on the immediate and future financial needs of The Davis Jones we have proposed $500m unsecured syndicated funds based on the same previous condition of borrowing and collateral. These funds are targeted to improve the major operations of the going concerns whose desire is to expand areas of operation by investing in capital expenditure or technology advancement. The major criteria are that the organization must demonstrate a steady growth in the preceding years as well as a blissful future. Davis have expressed desire to utilize the funds in expanding her business operations and to upgrade their online operations to capture more customers as well as to bring in more revenue. Considering the audited accounts over the past few years illustrate that even though David Jones sales dropped in the first quarter of 2012, they have continued to invest in areas such as longer times of operations and better employee remunerations which portends a rosy picture for future marketability (David Jones 2012). The requirements for a Revolving cash advance financing David Jones has requested for funds as described below: $350m, refinancing as a loan that runs for less than a year to mature in September 2012. Second, they have proposed to reduce the dependence on payables to $ 150m and to raise a further $ 50m for their expansion programme into other prime areas within Australia. Of this amount, land as a capital expenditure is estimated to attract 25% while about $10m will go towards obtaining initial inventory with the rest going into construction and related services. To achieve the desire to create online and new digital point of sales facilities, the company has also requested for additional $97.5m running for between 2013 and 2014 to integrate use of ICT and new technology to her business. This however will be a gradual drawdown commencing at $7.5m and rising to $10M quarterly and ending in June, 2014 (UTS Business 2012). Suitability of the Revolving cash advance financing for DJS ltd. The data presented by DJS for the first half trading of 2012 paints a good picture of an elaborate plan by management of DJS to keep on the tight path of profitability while always looking for better ways to do business and reduce possible future risks. In our best considered opinion, the audited financial accounts form, a basis for consideration of the CFOs’ requirement. To begin with, the revolving cash advance option is a suitable alternative because we already have a working relationship with David Jones having offered the previous facility which they have since repaid and has been canceled. As things stand, the need for this cash is almost immediate and given the fact that this kind of finance has very limited requirements in terms of administration cost, it is definitely a better option. Secondly, the immediate need for finances requires a facility that will allow a faster drawdown which is the reason for considering this as a priority facility. Last, the drafting procedures are easy and less involving and thus David Jones may begin on their ambitious plans immediately for farter return. Risk Factors surrounding this kind of financing option: The revolving cash advance option is usually an unsecured facility with David Jones expected to put forth only their strong financial balance sheet and performance based cash flow as the collateral. Moreover such a lending basis has serious implications and is therefore high risk given the factors considered under the Scenario analysis. Even though choosing this option may not give us the best return, our interaction with the accounts of David Jones and their long record of profitability, has convinced us that this facility suffices. The last risk has to do with recovery of this facility which may be uncertain but this uncertainty is taken care of in the context of the risk mitigations. Risk Mitigations An over five year previous cash flow and including three year cash flow projection paint a positive picture of a growing cash flow and healthy balance sheet with very low debts to asset ration. The company cannot make any abrupt changes to their management without our approval as this may plunge company into more uncertainty. The contract clauses also indicate terms that have to be certified during any lapse of this engagement including penalties, rights and obligation of each party. These will be signed and agreed by both parties to be legally binding. Lastly, should the bank be unwilling we have considered the second option with much more collateral and strict control. Details of the chosen product The facility is a $500Million limit given to David Jones Ltd by International Investment Bank for a period running three years beginning June, 2012. David Jones Limited has provided performance related collateral backed by independently audited accounts for a period not less than five years. At the same time, they have agreed to avail mandatorily a Letter of comfort. Last, David Jones Limited has obliged to offer financialisation facility and security documentation to International Investments Banks’ satisfaction. Repayment shall be a single repayment at the end of the facility term and at an interest rate pegged at Bank’s base lending rate and a margin of 1.5% p.a payable quarterly. The lending fees The bank shall charge an establishment fee pegged at 0.5% of the facility limit and payable upon the acceptance of the term sheet by the borrower. The second set of fees will be a 0.25% p.a. portion of unused part of the facility as commitment fee and payable quarterly. Last, the borrower will be required to pay any legal and or facilitation fees (out of pockets) incurred by International Investment Bank as direct result of drawing up the loan facility for the borrower. Contract Clauses David Jones must explicitly provide the following warrantees: First, that they are capable of entering a legally binding agreement with International Investment Bank over the facility they require. Second, that the company is currently duly registered under the Australian company’s Act and that they have corporate authority to enter a legally binding agreement. On representation, the company must represent that: there are no pending litigations or legal cases on going at the time of this request and second that no major changes have occurred since the date of last financial reporting. Lastly, David Jones must represent that all the information they have availed to International Investment Bank is true and accurate. On the other hand, International Investment Bank must also warrant and represent to David Jones that they have the full capacity to enter into legally binding agreement with them. The details of the warrantees and representations including any negative pledges have been provided in the term sheet. Covenants David Jones must pledge to maintain their insurance obligations to the satisfaction of the International Investment Bank and their Debt to asset ratio at a figure less than 80%. Collateral These funds are for capital as well as for expansion of the operations at the David Jones limited. The collateral is based on the proven performance of the organization for the past few years. The attached excel spread sheet gives the desired details. The benefits of lending David Jones is one of the world’s oldest retail outlets operating under its very name. Having been established in the late 1880s, the vast experience and business acumen of David Jones the founder has ensured the fundamentals that have enabled the company to survive for over a hundred centuries. It operates a number of departmental stores located all cross Australia. Currently David Jones has over 37 such stores located along the prestigious lanes in many Australian streets. Her only real competitor has been Myer chain of stores. The operations have been greatly enhanced by the boom that has been witnessed in consumer spending over the past few years. Also, David Jones has had strategic exclusive deals with many major world brands which have greatly enhanced her profitability. This growth has seen an increase in her share prices, reaching over $ 4.50 in the year in 2012. The Global economic crisis had an impact in the operations of David Jones, leading to 6.4% decline in profits. However the prospects have improved significantly with steady profitability as shown by recent annual report of 2012. The steady cash flow recorded from the company operations are capable of repaying the loans and still allow the company to pay her dividends as before to retain shareholder confidence (ASX AND MEDIA RELEASE 2012). Financial Summary Year to Jul NPAT EPS EPS chg (%) PER DPS Yield (%) Franking (%) 2013  F 113.2 21.6 6.0 11.0 18.0 7.6 100.0 2012  F 106.8 20.4 -34.3 11.7 17.0 7.1 100.0 2011  A 161.4 31.0 -6.1 14.6 28.0 6.2 100.0 Source: (Briefing.com 2010). The company projects a decrease in the Net Profit After Tax (NPAT) in the immediate year but which is to increase marginally by a point of seven in the 2013 financial year. The same trend is captured by the earnings per share capital on shareholders’ equity. The focus as demonstrated by the table above shows an expected increase in yield over the same period (Drucker & Pun 2009). Risk Ratings David Jones has an impressive credit rating of an A which is reason for consideration for this kind of facility. This rating basically based on our having dealt with David Jones before and their long history of presence spanning more than a century and after careful consideration of other criteria laid down by International Investment Bank. Operations analysis Over the five year period the financial indicators have shown mixed performance but with a general upward trend. Starting from EBIT, the audited accounts by Ernest and Young revealed a general increase within the five years under review. The same case applies to the Profit after tax performance which rose steadily to peak in 2010, and then followed by a slight decline over the next period of 2012. Sales have grown over the five year period as revealed by the audited accounts, with 2008 and 2010 capturing the most sales and a slight decline being recorded for the year 2011 as well as early 2012. However, considering the sales percentage this was almost constant at 30% over this period under reviews. The retail contributions have steadily improved over the period of the last five years. The increase in Earnings before Interest (EBIT) is a clear indicator of the presence of financial reserve which the company may draw from at any moment that the need arises to facilitate their operations. However, the uncertainties regarding fluctuating prices of the company stock is an issue the company must consider keenly. The company has also greatly retained a high margin of profitability for the past five years. This was as a result of the improved expenditure by companies clients who are rewarding the company on the basis of loyalty (Bloomberg 2012). The predictions of the next years according to the directors report portrays a warm picture to capture and retain her customers while attracting new ones through the many new areas that the company has designed to boost her operations in the next few years. Some of the places the company has decided to focus include the launch of a new online site to ensure that her clients are treated to the best shopping experience whenever they visit the site. In addition plans are underway to roll out a mobile shopping application which will see a shift in the demand for convenience thus attracting many curious customers to buy David Jones products Scenario analysis In considering our drafting of this deal, we have taken great efforts to look at possible outcomes that will negatively impact this transaction. To this end, a scenario analysis tool which entails a clear definition of the problem, the type of data reviewed and trends has been used. Also considered are the possible conjectures and use of the scenarios in planning for this facility. According to the reviewed audited financial accounts, the company currently holds enough Inventories to derive sales for the next few months this ensures that there is little strain on the cash generated from the sales. However an unnecessary holding of the inventory may hinder company cash flow particularly working negatively on the company’s liquidity. On the other hand, the other current assets held by the company show a healthy balance sheet since the company is holding much of her assets in the form of equipment and property which are acceptable collateral for advancement of the loan facility. The rest of the noncurrent assets are much lower compared to assets held as property and equipment which shows healthy ratio as expressed by the debt equity ratio. The interest bearing liabilities are manageable displaying the company’s capacity to absorb more of this kind of financing should the opportunity require. For the same period under review, the company’s management has reduced debt on equity from over 140% in 2007, to an almost constant two figure digit at below 20%. This is a clear demonstration of an astute management keen on delivering value to the investors. The shareholders have enjoyed a high return on their equity with the figures ranging at about 21-22% which is an impressive return on equity even as compared to the peers (Monday, 2010). The Best and Worst case Scenarios In the best case scenario, we envisage a continued growth and profitability of David Jones despite the stiff competition from other players in this field. More so, the expansion activities David Jones have put in place will begin to pay dividends thus improving their revenue and enhancing liquidity and their capacity to absorb the effects of the loan repayment. The worst case scenario happens when the company fails to put this money into the suggested ventures thus tying crucial finances without them being able to create wealth. This risk has been mitigated by having in place the commitment fees that ensure that International Investment Bank does not loose on borrowed finances. The other aspect of a worse case scenario is if the company should run into unprecedented losses and is forced to file bankruptcy. The loan facility mitigates this, by ensuring the enforcement of the term sheet on the fact that David Jones cannot liquidate without paying in full any amounts due to International Investment Bank. Other Factors considered in choosing the facility The recommendations of the ASX through the Policy document entitled the ‘ASX Corporate Governance Principles and Recommendations’ formed the basis for reinforcing and bringing clarity to every decision made to prefer this facility for David Jones Limited. Conclusions The retail industry where David and Jones operate has seen a measureable progress over the last few years with the changing lifestyles being the determinant of the current trends in this industry. More so, the globalization trends use of information technology platform and the World Wide Web to conduct business operations are other key drivers as seen from these indicators. The various lines and brands of the company have also been considered and their individual contribution to the competitiveness of David and Jones in this industry noted. David Jones Pty has a strong management style which has seen her continued prosperity for the over the past years. The challenge though is retention of this vast talent to continue in a path to strategically reach her business objectives. The data accruing from all the sections have been analysed and additional information regarding the credit rating and worthiness Jones have been obtained from other authentic ASX sources. This section has looked at key aspects of the business such as operation, cash flow, financial health of the organization and capitalization and based on these factors have picked on Revolving cash advance financing for David Jones. Major threats and weaknesses of these areas have also been noted. The report closes by presenting two key areas. One, the three year cash flow projection is presented based on the in depth consideration of the areas of business operations and future projections. Second, the related analytical areas represent externalities with a bearing on the effectiveness of the implementation and success of the financial and operational strategies implied by David Jones Pty. Reference List ASX AND MEDIA RELEASE 2012. Available from . [11 May 2012]. Briefing.com 2010, finance.yahoo. Available from (18 May 2012) Bloomberg 2012, Market snapshot. Available from . [11 May 2012]. David Jones 2012, David Jones Annual Report 2012. Available from . [11 May 2012]. David Jones. (2011). David Jones Annual Report 2011. Available from . [11 May 2012]. Drucker, S & Pun, M 2009, “On Loan Sales, Loan Contracting, and Lending Relationships”, Review of Financial Studies, vol. 22, no.7, pp. 2835-2872. Monday, G 2010, “Structuring shareholder loans to reduce risks in bankruptcy”, Family Business, vol. 21, no.3, pp. 24-26. Appendix Attached excel spread sheet with three year cash flow projections. Read More