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Revco Drug Store, hampered by the increasingly reluctant suppliers and unable to restructure its heavy debt load filed for protection under Chapter 11 of the Federal Bankruptcy Code on 29thJuly 1988.The bankruptcy filing came just 19 months after the Revco Drug chain was taken private in a $1.3 billion leveraged buyout.(Holusha, 1988) It was about 3 months since it had stopped making the interest payments on the high – yield debt used for the financing of the buyout. The bankruptcy filing makes Revco the largest leveraged buyout to fail financially.
Leveraged buyout refers to the process in which the management of the company borrows heavily to buy back the shares of the company, thereby placing the burden of extra debt on the company. This buyout technique had been used very aggressively in years before the filing as large number of leveraged buyout funds had been formed to provide financing for the deals. In most of the buyout cases, management of the company and the buyout – fund investors can take over the company by putting up only 10 % or so of the purchase price as the permanent equity capital.
Revco bankruptcy filing had been anticipated by the analysts on Wall Street ever since the news of a breakdown in the company’s negotiations with the holders of its junk bonds spread like a fire.Revco’s bankruptcy produced jitters among other holders of high risk bonds from buyouts in which the companies have heavy debt loads and weak or non-existent earnings.
Revco’s chairman, Boake Sells, said that the filling was essential to keep the stores operating. As per him, the best solution to save Revco was to continue to operate rather than selling the stores or other assets.He also revealed that the negotiations with stockholders and bondholders had collapsed over the terms of a proposed debt for equity swap which would have been sufficient in producing partial payments for the bondholders. During a news conference at the company’s headquarters, he said that “This is a fight about who owns Revco, and not about how Revco operates”.
Meredith Adler, an analyst with L. F. Rothschild & Company, said the failure at Revco was a result of the high price paid by the managers who took the company private in December 1986 and the financing terms that left the company pressed for cash.”They paid too much for the buyout and it was structured badly, with all interest currently payable,” she said. ”Basically, they were not given time to fix the problems.”
In some buyouts, she said, managers are given an interest-free grace period to improve a company’s operations before additional demands are made on its cash flow. Mr. Sells said Revco had to pay $150 million in interest payments during the fiscal year ending May 31, 1988, but annual cash flow was estimated at only $125 million.
There were management problems as well. The buyout anticipated rapidly rising sales and profits. But competition in the $34 billion drugstore industry stiffened as supermarkets expanded their pharmacy departments and discount stores fought for non-pharmacy sales. Revco responded by cutting prices, but that squeezed already-thin margins.The company ran a huge promotion to clean out inventory but neglected to replenish shelves for the all-important Christmas season. To broaden margins, the emphasis was switched from pharmaceuticals to higher-priced, but slow-selling items, like appliances.
Sales stagnated. The buyout plan projected that sales would reach $3.37 billion in the year ending May 31, 1988.(Harris, 1992) In fact, through early February 1988, sales were only $1.66 billion.Profits had disappeared as well at Revco, which was once the nation’s largest drugstore chain. In the last year before it went private, Revco earned $39 million, according to the company. For the fiscal year 1988 through early February, it had posted a net loss of $51 million. The projections called for Revco to earn $103.6 million in the full year ending May 31.
Revco was also hampered by the reluctance of banks to finance inventory build-ups for holiday sales. ”They did not even have enough to meet seasonal working capital needs,” Ms. Adler said. ”In the previous year, they needed $90 million in bank financing for the Christmas season, but banks only gave them $60 million.”The buyout added $1.1 billion in debt to a company whose previous debt had been less than $300 million. Although some debt had been repaid through asset sales, the company remains $1.16 billion in debt.
Revco announced in April that it would miss a $46 million interest payment on its junk bond debt, causing concern among some merchandise suppliers. Mr. Sells said some suppliers had refused to ship orders until they had been paid for previous orders.The leveraged buyout was led by Revco’s founder, Sidney Dworkin, who built the chain, starting in 1956, from a single drugstore in Detroit. While the buyout was being arranged, the price was increased by 10 percent to fend off a competing bid by the Dart Group.
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• South Africa, a CRT-4 country, is an emerging market with moderate economic and financial system risk and high levels of political risk.
• According to the IMF, growth in 2016 slowed in about two-thirds of the countries in Sub-Saharan Africa, which account for more than 80% of the region’s GDP. (Country Risk Information – South Africa, n.d.)
• Reasons for the economic slowdown include continued soft commodity prices, challenging conditions (drought), and security/terrorism concerns. Growth in the region averaged 1.4% in 2016, the lowest in two decades.
Economic Risk: Moderate
• South Africa has a diversified economy with abundant natural resources. Financial services and manufacturing now contribute more to GDP growth than mining and agriculture.
• Low levels of economic growth have led to vulnerabilities including higher levels of unemployment and income inequality. A 2016 survey found average income for blacks is one-fifth of that for whites.
Political Risk: High
• President Zama has been implicated in several corruption scandals. In March 2016, South Africa’s Constitutional Court ruled that he had violated the constitution by failing to repay the government for money used for private construction. Despite the ruling, however, Zuma was able to survive a no-confidence vote in November 2016 and again in August 2017 by a slimmer margin. The ANC will likely lose popularity due to the lack of accountability.
• Political uncertainty and instability will likely weigh on consumer and investor confidence, limiting domestic demand and private investment.
Financial System Risk: Moderate
• The capital markets are well developed, with Africa’s largest stock exchange and among the top 20 exchanges in the world.
• Lower sovereign credit ratings have also weakened ratings for corporations, including state owned enterprises, reflecting contingent liabilities, and banks. However, the financial sector has been largely resilient amid slowing economic activity.
• The banking sector has historically been highly profitable and well-capitalized due in part to limited competition and pricing power, including sizable fees for financial services.
• France is a CRT-1 country with low or very low levels of economic, political, and financial system risk. (Country Risk Information – France, n.d.)
• Over the last few years, real GDP growth has been constrained due to high levels of unemployment, labour inflexibility, and weak domestic demand growth. However, GDP growth in 2017 is forecast to increase to 1.4%, from 1.2% in 2016.
• Economic growth should be supported by improving labour market conditions, growing consumer confidence, and rising investment spending.
Economic Risk: Low
• France’s economy, the second-largest in the eurozone, is experiencing a cyclical recovery, as GDP growth remains positive. Nevertheless, GDP growth continues to fall below expectations, indicating the need for structural reforms.
• Public and private investment are expected to remain strong. Public investment will be supported by President Emmanuel Macron’s proposed USD 56 billion investment plan.
• Debt levels have risen to 96% of GDP, a reflection of the government’s sizeable expenditures and lower-than-expected growth. France’s 2016 fiscal deficit remained above the EU’s 3% of GDP threshold, but is projected to decline.
Political Risk: Low
• President Macron, member of the La Républiqueen Marche party, defeated far-right candidate Marine Le Pen in the April 2017 presidential elections. In the recent parliamentary elections, La Républiqueen Marche secured an absolute majority, which will facilitate passage of legislation and provide political stability.
• The new administration will be focusing on improving the labour market, lowering taxes, and accelerating fiscal consolidation. Macron’s labour market reforms, especially those to cut labour costs, will most likely face considerable resistance from the trade unions.
Financial System Risk: Very Low
• The banking sector has bolstered its balance sheets considerably since the 2008 crisis, doubling its levels of capital. However, the regulatory framework is still being strengthened, as banks work to finalize aspects of Basel III guidelines.
• Credit growth has been strong. As of April 2017, credit to private households had grown by 5.6%. This credit growth should be monitored as too much growth could become problematic.
Thailand, a CRT-3 country, has a low level of economic risk and moderate levels of political and financial system risk. Thailand’s economy experienced an uptick in growth last year and expanded by 3.2%. Growth is projected to remain around 3% for the medium term and will depend on infrastructure investment and prudent public policies. The government aims to attain higher long-term growth through structural reforms such as improvements to competitiveness and education. (Country Risk Information – Thailand, n.d.)
Economic Risk: Low
• Thailand’s economy has experienced difficulty achieving fast-paced growth, owing to lagging industrial production and structural inefficiencies. U.S. protectionist policies, should they materialize, also have the potential to subdue growth.
• Private investment in the past year fell as political uncertainty persisted. However, it is expected to experience a partial recovery in the short term. The government’s planned infrastructure investment is intended to assist in private investment’s recovery.
Political Risk: Moderate
• The 2016 referendum confirmed the military’s permanent role in politics and will restrict the power of elected officials. General elections are expected to occur in late 2017 or 2018. These elections have been delayed several times.
• The government hopes to promote faster growth through state investment in infrastructure and creating a more conducive business operating environment. Currently Thailand ranks relatively well at 46 out of 190 countries in the World Bank’s Ease of Doing Business Survey.
Financial System Risk: Moderate
• Thailand’s insurance industry is regulated by the Office of the Insurance Commission under the Ministry of Commerce.
• Due to recent hikes in U.S. interest rates, Thailand has the potential to experience capital outflows, which would serve as a somewhat destabilizing force.
• The banking sector is relatively stable and demonstrates sufficient capitalization and liquidity. The number of non-performing loans is relatively low.
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