Case Study: Fraikin SA
Comparison of Three Financing Options
a. Background Analysis Current Situation Founded in 1994, Fraikin group, the largest French truck rental operation, took up 30% of the market share by 2004. The core operation business of Fraikin is to provide its clients with customized trucks and commercial vehicles, primarily under long-term operating lease contracts. During the period from 1999 to 2002, the number of the leased trucks was continuously increasing (from 59,600 to 74,300), which indicated a stable growth of the company and a possibly booming market in the future. However, as a capital-incentive company, only continuous investment on fleet maintenance and expansion can retain Fraikin’s leader position in the market, which, on the other hand, resulted in negative cash flow recently. Financing Problem Causality In 2003, Fraikin had been acquired by Eurazeo, an investment company, who owned 55% of Fraikin’s stock and with a target internal rate return of 20% and fleet growth rate of 6%. The control of the Eurazeo aimed to enhance the Fraikin’s operational performance and growth and create long-term shareholder value. To make this acquisition successful, CIC and Calyon, two French banks, granted Fraikin a bridge loan on condition that the acquirers would refinance the loan within the year. In March 2004, Gerony, the CFO of Fraikin were hesitated about three financing alternatives, leverage buyout, assets-backed loan, and securitization, which would enable Fraikin to repay this large bridge loan at cost-efficient way. Calculations Notice One of the main incomes of Fraikin was the disposal revenue of the trucks, which were sold on the second-hand market at an average age of 6.5 years. Different from the normal calculation, these disposals represented significant part in Fraikin’s regular operating activities, therefore should be included in the calculation of operating value. b. Leverage Buyout (LBO) Leverage buyout was an acquisition of a company financed with a substantial amount of borrowed funds. Often, the new acquired company was used to secure and repay the interest and loans. CIC and Calyon had offered a LBO debt package to Fraikin with three tranches. The interests of the each tranche were based on the Euribor rate plus specific basis point. The average interest rate was 5.31%. Advantages and Disadvantages The most outstanding advantage of LBO is that company can increase the returns on his equity by employing the leverage while the banks can make substantially higher margins compared to the normal lending. Second, even though Fraikin was facing cash flow shortage, LBO still could enhance its capital investment with very little capital. If the returns of the assets were greater than the cost of debt financing, it would benefit both the firm and shareholders. Third, Fraikin will enjoy large amount of interest tax shield resulting from the high levels of debt, which will enhance the value of firm. The primary risk of LBO is the future uncertainty. Economic crisis, recession, political adjustments and other unpredictable emergencies would result in cash flow shortage, poor line of credit or even worse go to bankruptcy. For another thing, too much leverage will not encourage the company to enjoy the benefit of tax shield, but increased the WACC and overlevered.
Quantitative Analysis CIC and Calyon would depend on Fraikin’s cash flow coverage ratio to determine whether to make or refinance loans. The cash flow coverage ratio is a liquidity indicator of a company’s capacity to repay interest and principal from its operational business. Cash Flow Coverage Ratio= operating cash flow / Total Debt Where operating cash flows means the earnings before interest, taxes, rental payments, depreciation and amortization (EBITRDA). Total debt includes the interest, short-term borrowings, current portion of long-term debt and long-term debt. As is required in this case, the EBITRDA had to...
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