IB analysis 1

Company's duty to bondholders

Comply with the Credit Agreement (pay interest and principal as scheduled and follow the covenants).

Company's duty to shareholders

Maximize shareholder value.

6 components of a loan/bond structure (his answer key)

Amortization, Collateral, Covenants, Guarantees, Tenor/Maturity, Pricing. Mnemonic: A-C-C-G-T-P.

Amortization

Required loan repayment schedule.

Collateral

Assets the lender has a lien on.

Covenants

Requirements/rules placed on the borrower (e.g., min EBITDA, max leverage, fixed charge coverage).

Guarantees

Individual or corporation responsible for the loan if the borrower defaults.

Tenor / Maturity

Time until the loan matures. Example: starts 12/30/2026 with 4-year tenor matures 12/30/2030.

Pricing

The interest rate on the loan.

4 accounting drivers of EBITDA (his answer key)

Revenue growth, gross margins, operating expenses (SG&A), EBITDA adjustments. NOT net profit/tax/interest/D&A (that is the formula, not the drivers).

EBITDA formula (bridge)

Net income + taxes + interest expense + D&A. Interest and taxes are ADDED BACK (do not subtract interest).

Adjusted EBITDA

EBITDA plus add-backs of non-recurring or non-cash items: impairments, stock-based comp, pension settlement charges, unrealized gains/losses, acquisition costs, etc.

Bond risk higher or lower year over year? How to answer

ALWAYS mention leverage (Debt / Adj. EBITDA). Leverage up = higher risk. Leverage flat = risk unchanged. Leverage down = lower risk.

Leverage formula

Total Debt / Adjusted EBITDA. Net leverage = (Total Debt - Cash) / Adjusted EBITDA.

Why did Adjusted EBITDA increase in the quiz company? (his answer)

8.4% top-line growth, and gross margin expanded from 22.8% to 24.5% (after backing D&A out of COGS).

Good management questions to ask (his list)

What caused the top-line growth? Why did Adj. EBITDA change? What caused gross margin expansion? What caused the inventory build-up? What portion of SG&A is fixed vs variable? What is the increase in debt used for?

What makes a good question for management?

A value-added 'why did things change' question tied to a driver (revenue, GM, SG&A, adjustments, debt use), not a question about one line item.

Competitor cuts price, so the Company cuts its price. Effect on stock? (his chain)

Price down, so revenue down. Gross margin down. Lower margins mean less free cash flow. Stock price decreases.

Assumptions to change when a competitor forces a price cut

Lower revenue growth, lower gross margins (so lower EBITDA, net income, and free cash flow). Stock falls because value = present value of cash flows.

Why does a big inventory build-up matter?

Cash is tied up in unsold goods: weaker cash from operations, possible markdown/obsolescence risk to margins.

Why does debt rising matter? Key follow-up

Ask what the debt was used for: reinvest in business, boost liquidity, or pay shareholders. Use of proceeds drives the credit story.

AR days formula

AR / Revenue x 365. To forecast: AR = AR days / 365 x Revenue.

Inventory days formula

Inventory / COGS x 365. Forecast: Inventory = Inv days / 365 x COGS.

AP days formula

AP / COGS x 365. Forecast: AP = AP days / 365 x COGS.

Cash conversion cycle

AR days + Inventory days - AP days.

'Working capital turnover in line with 2025' means…

Hold AR, inventory, and AP days constant at 2025 levels and rebuild the balances from the forecast revenue/COGS.

Gross margin 'increases 0.25% per annum' means…

Add 0.25 percentage points per year (25.0% -> 25.25% -> 25.5% … 26.25% in year 5). Not +2.5 pts, not flat.

EBITDA from a P&L where D&A is shown separately

Gross profit - SG&A/operating expenses (D&A and interest are below EBITDA).

Pre-tax income (model)

EBITDA - D&A - interest expense.

Net income (model)

Pre-tax income x (1 - tax rate).

SG&A 'flat as a % of revenue' means…

SG&A grows at the same rate as revenue (same % of revenue every year).

Cash from operations formula

Net income + D&A (and other non-cash charges) - increase in AR - increase in inventory + increase in AP.

Sign rules for working capital

Increase in AR or inventory REDUCES cash. Increase in AP INCREASES cash. Use CHANGES in balances, never the full balance (first-year trap).

Cash from investing in his model

Capex (negative). Cash from investing = capex, so use the same number (CFI = -capex).

Free cash flow (simple model)

Cash from operations + cash from investing (i.e., CFO - capex).

'Pays out 80% of cash flow' means net cash flow =

(CFO + CFI) x (1 - 80%) = 20% of (CFO + CFI). Dividends sit in cash from financing.

Interest sign trap

Interest expense is an expense in the P&L (reduces pre-tax income) and is ADDED BACK going from net income to EBITDA. Keep sign convention consistent.

Total liquidity

Cash + available (undrawn) revolver capacity.

Net debt

Total debt - cash. Net debt / Adj. EBITDA = net leverage.

Tangible equity

Shareholders' equity - intangible assets (goodwill, etc.). Total debt / tangible equity measures leverage vs hard equity.

Fixed charge coverage ratio (FCCR) setup

Cash flow to service debt / Debt service. Cash flow to service debt = Adj. EBITDA - maintenance capex - cash taxes. Debt service = required principal amortization + interest.

Required principal amortization: where to find it

Use the CURRENT PORTION of long-term debt on the balance sheet. NOT the debt repayment line in the cash flow statement (that includes discretionary repayments).

Why does Macy's FCCR look strong?

Macy's has no required amortization, so debt service is mostly interest, which bolsters FCCR.

Debt service coverage, plain English

Can the cash the business generates cover required interest and principal payments? Higher = safer.

Debt maturity profile: what to look for

Large maturities coming due soon versus liquidity on hand. Bankruptcies are usually triggered by an upcoming maturity the Company cannot pay or refinance.

CAPM cost of equity

Rf + Beta x (Equity risk premium).

Unlever a beta

Unlevered beta = Levered beta / (1 + (1 - tax) x Debt/Equity). Removes the effect of capital structure.

Relever a beta

Levered beta = Unlevered beta x (1 + (1 - tax) x Debt/Equity) using the target/own capital structure.

Why unlever then relever betas?

Comparable companies have different leverage; unlever to get business risk, then relever at the target company's capital structure.

WACC formula

E/(D+E) x Cost of equity + D/(D+E) x Cost of debt x (1 - tax).

Why is cost of debt tax-effected in WACC?

Interest is tax-deductible, so after-tax cost of debt = Rd x (1 - tax rate).

Equity recommendation rule (his slide)

Based ONLY on your valuation vs the current market price. Value above market = invest. Value below = do not invest (market is pricing in more growth than you believe).

Personal opinion of a company in an equity rec?

Irrelevant. Even if you love the business model, if the market already prices in more cash flow than you expect, do not invest.

Fixed income recommendation rule (his slide)

Lenders focus on the downside. If the Company keeps appropriate leverage and can service debt in the downside, invest. If it can't, don't.

What is the purpose of a downside scenario?

Illustrate financials if the identified risks (from Risks & Mitigants) are realized. If debt can still be serviced, those risks are not deal-killers.

Downside scenario should be consistent with…

The risks and mitigants section. The downside projections must be a realistic extension of the risks identified.

What makes a good credit write-up (the 'credit story')?

Tell the story of the Company, merits of the deal, risks, and why you're comfortable. The financials, strategy, and projections must be consistent and downside realistic.

Who reads a credit write-up?

Credit Risk team, your direct boss, and the relationship manager.

Blockbuster: key timeline

Peak 2004 (about 9,000 stores globally). Filed bankruptcy 9/23/2010. Netflix launched streaming in 2007. Blockbuster Online launched Aug 2004.

Blockbuster: who controlled it and why it matters

Viacom owned 82% of the common stock. Viacom's priority was Viacom shareholders, not Blockbuster's long-term interest.

Blockbuster: the August 2004 financing

$1,150MM senior secured credit facility ($500MM 5-yr revolver, $100MM 5-yr Term Loan A, $550MM 7-yr Term Loan B) plus $300MM 9% senior subordinated notes due 2012.

Blockbuster: use of proceeds

Special distribution of ~$905.6MM ($5/share) to stockholders, including Viacom. Viacom used its $738MM share to buy back shares. NOT reinvested in the business.

Blockbuster: how much did Netflix spend on technology 2000-2008?

$312.7MM. The $905MM special dividend would have funded a Blockbuster streaming platform.

Blockbuster: stock reaction to Q2 2004 results

Stock fell from $13.60 to $8.05 (-40.8%); first statements with the large impairment.

Blockbuster: 2007 credit agreement amendment

Revolver cut $500MM to $450MM; higher interest margins; FCCR and leverage covenants deferred for 2008-2009; one-time fee; minimum consolidated EBITDA covenant (e.g., $140MM rising to $250MM by Jan 2009); default waived; revolver availability reduced 5% quarterly.

Blockbuster: April 2009 refinance

New $250MM revolver maturing 9/30/2010 with scheduled paydown payments (e.g., $25MM 12/15/2009 … remaining balance due 9/30/2010).

Blockbuster: Oct 2009 notes

$675MM 11.75% Senior Secured Notes due 10/1/2014, issued at a $40.5MM discount. After this, only debt left was these notes and the 2012 subordinated notes.

Blockbuster: why it filed in 2010

Limited liquidity plus large debt service requirements (revolver amortization/maturity). Fine while it had liquidity; once debt came due without cash, it had to file.

Blockbuster: sale and recoveries

Sold to Dish for $320MM ($228MM cash). Senior secured lenders received $303.4MM after $634.5MM outflow = 52.2% loss. Subordinated lenders $0 = 100% loss. Shareholders $0 = 100% loss.

Blockbuster conclusion: Financial Policy

How aggressive is ownership with debt? A ~$1.4Bn facility to pay a special dividend left no capital to build streaming.

Blockbuster conclusion: Use of Proceeds

What will the Company do with borrowed money? Had Blockbuster invested it, a Blockbuster streaming rival to Netflix was likelier.

Blockbuster conclusion: Debt Maturity

Bankruptcy is usually the result of an upcoming maturity.

Blockbuster conclusion: Liquidity

Fine as long as liquidity lasted; once debt came due with insufficient cash, filing was the only option.

Recovery waterfall order (from Blockbuster)

Senior secured first (partial recovery, 52.2% loss), then subordinated (0%), then shareholders (0%).

JetBlue: credit rating action

Fitch downgraded to CCC+ in April 2026; S&P downgraded to CCC+ from B- in June 2026.

What does CCC+ mean (his definition)?

Unsustainable capital structure: unless operations improve, the Company can't keep servicing its debt; may not survive outside a planned bankruptcy.

JetBlue: S&P's reasoning

Oil and jet fuel spike (Middle East/Iran conflict) pressures operations for 12+ months; no positive free cash flow until 2028; leverage ~10x by end of 2027. Stable outlook because liquidity funds the FCF deficit and no near-term maturities.

JetBlue: liquidity position (June 30, 2026)

$2.2Bn liquidity (unrestricted cash, equivalents, investment securities) plus a $600MM undrawn Citibank line of credit.

JetBlue: why did debt increase in FY2020?

Debt rose ~$2.5Bn while cash and investments rose ~$1.8Bn: issued debt to improve liquidity to survive negative cash flows, NOT to reinvest in the business.

Distressed analysis focus

Cash flow burn, liquidity, and nearing maturities: how long can the Company survive, and can it fix the underlying problem in that time?

Liquidity burn analysis: basic idea

Liquidity (cash + undrawn revolver) divided by annual cash burn (negative FCF + required debt payments) = runway. Compare runway to maturities.

Distressed equity: why does equity analysis converge with credit?

As a Company nears distress, the market prices in a probability of default, since equity holders lose everything in bankruptcy.

Industry risk: fixed asset intensive (JetBlue)

Consistently $700MM-$1Bn capex; fixed-asset-intensive companies have less room for deterioration.

Industry risk: commodity price risk (JetBlue)

Uses lots of fuel; hedging/inventory management helps short-term, but sustained fuel increases hurt the industry.

Industry risk: price-sensitive consumer (JetBlue)

Consumers shop on price, forcing airlines to compete on price, worse when discretionary income contracts.

Who goes distressed first? (JetBlue conclusion)

Companies with aggressive balance sheets and/or volatile cash flows even in strong macro periods.

Use of proceeds lesson (JetBlue)

The Company has consistently used debt proceeds to reinvest or bolster liquidity; otherwise it likely would have already filed.

Macy's: company snapshot

Omni-channel retailer: Macy's, Bloomingdale's, Bluemercury. Founded 1858. 455 locations (Nov 2025). Market cap $5.95Bn (10/8/2026). Rated Ba1.

Macy's: key credit question on industry

Why is a company in secular decline (in-person retail; ~16% online as of FYE 2024) rated near investment grade?

Macy's: 'A Bold New Chapter' (Feb 27, 2024) three pillars

1) Strengthen the Macy's nameplate: close 150 underperformers, invest in 350 core. 2) Accelerate luxury: 15 Bloomingdale's, 30 Bluemercury, remodel 30. 3) Simplify and modernize end-to-end operations.

Macy's: market reaction to the strategy

Knee-jerk negative reaction; stock fully rebounded within 2 days.

Macy's: FY2024 Adjusted EBITDA

$2.0Bn (8.8% margin) vs $2.3Bn (9.6%) in FY2023.

Macy's: why did revenue fall in FY2024?

Down 3.5-3.6% (-$799MM). Weak non-First-50 Macy's and digital; 2023 had a 53rd week ($252MM, about 1/3 of the decline).

Macy's: FY2024 gross margin and SG&A

Gross profit $10.1Bn (44.1% vs 44.2%). SG&A $8.3Bn (down ~$45MM) from cost controls.

Macy's: FY2025 sales decline

Down $372MM (-3.0%). 64 closed stores ~$340MM of it; ex-closures sales down only 0.3%.

Macy's: FY2025 gross margin decline

Down 40 bps from proactive markdowns on spring assortments and product bought under 145% China tariffs.

Macy's: EBITDA adjustments (3)

Intangible impairment ($1Bn 2023; $127MM 2024; non-cash), settlement charges (non-cash pension accounting), stock-based compensation (non-cash equity awards).

Macy's: Strengths (3)

Well-established brand (165+ yrs); large size and scale (455 locations, $23Bn+ revenue); access to capital markets (public, Ba1).

Macy's: Risk 1 and mitigant

Secular decline of brick-and-mortar. Mitigant: investing in app/website and growing online share; decline plays out over decades.

Macy's: Risk 2 and mitigant

Execution risk of multi-year restructuring (closures, new format). Mitigant: new-strategy stores (First 50 / Reimagine 125) outperforming the fleet.