Case Study: Clean Water Case
Clean Water is a local distributor of pums for a broadly diversified set of applications. The firm's net revenues are roughly EUR 3.4 million, 2/3 of which are trading revenues and 1/3 from service and maintenance.
Upon reaching age 65, the owner-manager of Clean Water has decided to sell the company. After careful consideration of the various potential buyers, he finally agreed to sell the company to an external manager at a price of EUR 4.5 million.
1. Introduction
Clean Water is a local distributor of pumps for a broadly diversified set of applications. The firm's net revenues are rougly EUR 3.5 million, 2/3 of which are trading revenues and 1/3 is from service and maintenance.
Upon reaching age 65, the owner-manager decided to sell the company. After careful consideration of the various potential buyers, he finally agreed to sell Clean Water to an external manager for EUR 4.5 million.
The new buyer financed the acquisition price as follows:
- Equity: 0.5 million
- Senior bank loan: 2.5 million. Credit terms (selection): Annual interest rate of 2%; Linear repayment of 0.5 per year over the next 5 years.
- Subordinted vendor's loan: 1.5 million. Credit terms (selection): Annual interest rate of 4%. Linear repayment of 0.5 million per year after the senior bank loan has been repaid in full.
One of the most pressing questions for the new buyer was whether Clean Water would be able to generate sufficient cash flows to service the buyer's hefty debt burden. Based on the credit terms outlined above, the following table summarizes the future debt payments for the new buyer:
|
Debt Schedule (EUR 1'000) |
Today |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
Year 7 |
Year 8 |
Year 9 |
|
Senior bank loan |
2'500 |
2'500 |
2'000 |
1'500 |
1'000 |
500 |
0 |
0 |
0 |
0 |
|
Subordinated vender's loan |
1500 |
1'500 |
1'500 |
1'500 |
1'500 |
1'500 |
1'500 |
1'000 |
500 |
0 |
|
Total debt outstanding |
4'000 |
4'000 |
3'500 |
3'000 |
2'500 |
2'000 |
1'500 |
1'000 |
500 |
0 |
|
|
||||||||||
|
Debt payments (EUR 1'000) |
Today |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
Year 7 |
Year 8 |
Year 9 |
|
Interest expenses |
||||||||||
|
Bank loan (2%) |
50 |
50 |
40 |
30 |
20 |
10 |
0 |
0 |
0 |
|
|
Vendor's loan (4%) |
60 |
60 |
60 |
60 |
60 |
60 |
60 |
40 |
20 |
|
|
Total interest expenses |
110 |
110 |
100 |
90 |
80 |
70 |
60 |
40 |
20 |
|
|
Repayment of notional |
||||||||||
|
Senior bank loan |
0 |
500 |
500 |
500 |
500 |
500 |
0 |
0 |
0 |
|
|
Subordinated vender's loan |
0 |
0 |
0 |
0 |
0 |
0 |
500 |
500 |
500 |
|
|
Total repayment of notional |
0 |
500 |
500 |
500 |
500 |
500 |
500 |
500 |
500 |
|
|
Total debt payments |
110 |
610 |
600 |
590 |
580 |
570 |
560 |
540 |
520 |
The numbers imply that the new buyer would have to make a total payment or EUR 110'000 one year after the acquisition, a total payment of EUR 610'000 two years after the acquisition, etc.
Formally, the transaction was structured through an acquisition holding. Therefore, Clean Water would have to distribute the aforementioned cash flows as dividends to the acquisition holding, which, in turn, would forward them to the bank and the vendor. So, the ultimate question was whether Clean Water would be able to pay dividends in the magnitude as shown in the last row of the previous table. To find out, a financial plan was needed.