Combine Debt


Combination of the advantages of debt and capital resources Historically, corporations have made a straightforward decision to raise funds on the financial market by selling stocks or issuing debt. Media reports about the 1.4 billion dollar Formel 1 securitisation conceal an interesting invention. The Morgan Stanley has restructured a transaction in which the emitter is selling stocks but the investor is buying a bond - a synthetical initial public offering.

Exhibitors can use the facility to obtain non-recourse financing while maintaining a 100% interest in their business. It avoids the degree of disclosures required for a genuine stock offer, and for some firms the synthesised offer will provide less expensive financing than a genuine IPO. Developed by a Morgan Stanley group, the facility will help businesses that want non-recourse financing but can borrow less on the debt than on the stock markets.

Risk capital providers could use the technology to obtain non-recourse financing to buy a business without having to sell stakes in the acquisition. March 1997 saw the announcement by Bernie Ecclestone, the F1 shareholder, of a plan to go public. F1 was not well enough known on the markets to get the best value for its capital.

Thus Ecclestone Salomon rejected Smith Barney, the Ecclestone Salomon bench hired to sign the first transaction, and decided to instead launch a euro bond after Morgan Stanley had outlined the merits of its design. Said the banks could combine the merits of a stock offer with the merits of borrowing. Instead of directly reselling Formula 1 stocks to the investor, Morgan Stanley suggested reselling the stocks to a SPV, which would then launch a bond issuance.

Ecclestone would receive the non-recourse financing it wanted, and the Formula 1 would be introduced for investment. Six different entities were party to the transaction. It is a hold held by the name of Slec, which holds the Formula 1 management - the enterprise that runs the Formula 1 franchise, sells the race broadcasting assets to broadcasters and employs 200 staff to run the enterprise.

The Formula One Administration, which manages the asset to be securitised, and Formula One Finance, which administers the issuance of the bond. Formula One Holdings, which is owned by the Formula One Administration, and Formula One License, which is owned by the Company. Selec sold its stake in Formula 1 management to the Formula 1 administration (see chart).

In order to reimburse for the share, the Formula 1 administration lends 1.4 billion dollars from the Formula 1 financing. Formula One Finance receives the $1.4 billion through the sale of debt secured by interest payments on the loans. Funds from the investors' pocket go to the Formula One Finance issuing company, which is loaned to the Formula 1 administration and used to buy Formula One treasury from Slec.

The Formula One Administration, in a traditional securitisation, would use the funds from the issuance to buy the securitised asset - the TV transfer agreements and the Formula One franchise. However, the Formula 1 administration uses most of the revenue from the bonds to buy stocks.

This way, the cash reached from the issuance Slec. If instead the Formula 1 administration were to buy the Formula 1 management's $1.4 billion of asset value, the loan would end up in the managing director's bank accounts, not Slec's. The bank would be able to buy the asset for $1.4 billion. Following the acquisition, the Formula 1 administration purchases the asset from its own Formula One Management affiliate for the carrying amount - $15 million - and establishes a license agreement for the safe use of the corporate brand.

For $1.25 billion, Slec has divested its stake in Formula 1 management, providing the desired non-recourse financing. The Eurobond launched the business into the merchant environment. Floating Formula 1 will be simpler in the near term because it is trusted by investment community. Enterprises with shallow profit increases can lend on the debt markets at better interest rates than they can buy stocks.

The stock markets will allow a business to benefit if it has a potentially explosives upside. However, a business that offers a flat-rate ROI is less appealing to the investor. It pushes down the stock exchange quotation, which restricts the amount the corporation can achieve through a stock offer. F1 is such a business, but it won't be in the near term.

Under the assumption that Formula 1 successfully commercializes the formula and creates the kind of revenue generation that makes a business appealing to venture capitalists, it can flourish in two or three years and earn more than before. Only Ecclestone will make a tender offer of Formula One Holdings stock owned by SPV - Formula One Administration.

Revenue is then used to settle the debt and Slec gets the balance. It is Steve Din's belief that Formula 1 has done itself an immense favor by postponing floating by two years. One additional advantage of the synthetical initial public offering is that Formula 1 restricts disclosures by delivering debt securities to the final investors.

Exchanges requirements for the publication of debt securities are not as strict as for equities. And, for a business that depends on sensitive agreements, disclosures can be a challenge. A broadcaster must not know the conditions of another's arrangement with the project-executing agency. However, even in the case of a loan issuance, the borrower must reveal some information about the debtor.

In order to prevent this, the bond is not secured by the real asset but by a Formula One Finance credit to Formula One Administration. Formula One Finance only has to reveal certain aspects of the contract, not more. There is a convincing business rationale for the application of the scheme to other firms.

For example, think of a venture equity firm, Cash & Cash, buying a newspaper publishing house for $1 billion. The Cash & Cash publishing house wants to buy the publishing house with loaned cash. In this way it keeps its own funds free and still makes a profit: the discrepancy between the publisher's revenues and the interest paid on the debt to buy it.

Cash-and-Cash purchases the business and then founds an SPV, Magazine Funding PLC, which dispenses $1 billion of debt and purchases all of the publisher's stock. Under the assumption that the publishing house will remain insolvent, Cash & Cash leads the business until it becomes viable and then resells stakes in Magazine Funding to settle the debt and realise its profits.

Cash-and-Cash took up non-recourse financing for the purchase of the publishing house, but did not give up any portion of the takeover. It also works for a shallow profit growing business that wants to go public but can't get a good equity quote - a breast dairy could be a good example.

Issuers receive non-recourse financing but raise funds on the debt markets, where they receive less expensive financing. Once the Formula 1 media discussion is over, the banking community will certainly copy Morgan Stanley's leadership. There is now more choice: selling stocks, issuing loans or both at the same for all.

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