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Chapter 1: Introduction

1.1 Frontline Strategy Ltd.

Frontline Strategy Pte. Ltd. is an:

* Investment Advisory firm managing Private Equity Investments

* Incorporated in Mauritius in the year 2000

* Managing Director and Founder of the firm is Mr. Atim Kabra

* 2 funds under management - Strategic Ventures Fund and India Industrial Growth Fund, Mauritius are described below:

1.1.1 Strategic Ventures Fund

Strategic Ventures Fund is:

· Established as a closed-ended fund

· Invests in private as well as public companies

· The fund has generated an Internal Rate of Return of 20%

· Sectors of Investment and Investment distribution by this fund include:

1.1.2 India Industrial Growth Fund

India Industrial Growth Fund is:

· Objective of the fund is to achieve medium to long term gains in capital

· Invests in private companies through equity and equity and equity linked investments

· Focuses on investment in the SME segment

· Majority of the investments are in the industrial/manufacturing chain from logistics to engineering and design

· Idea is not to focus on cyclical businesses and try to maximize the return on investment

· Does not focus on heavy fixed asset base investments like cement, minerals and mining, power, oil and gas

· Invests in companies that can be scaled up easily

· Also believes in “cheap valuations” relative to the industry i.e. investment in companies that generate a minimum Internal rate of return of 25%

Chapter 2: Research Methodology

2.1 Objective of the Study

The objective of the study was to identify distressed assets in the High Income European countries so that they can be transferred out of these high cost economies to Low Income Countries.

This ALP was divided into two broad heads:

* The Project -involves the identification of distressed assets in the current time period (during the research) and provide Frontline with a list of suitable distressed firms

* The Process - develops a methodology for Frontline for the identification of distressed assets in the future (post research) with the help of a ‘Guide' which gives a detailed analysis of the various sources of information on distressed assets.

2.2 Scope of the Research

The 2 pronged research objective of the study meant 2 different approaches and a divided scope of the research:

Part1: Project

A top down approach where we identified:

* Country

o First Set of 8 countries out of the High Income European Countries which could be considered

o Second Set of 2 countries to narrow the list further based on additional criteria

o Primary Country or a unique country recommended for frontline as the most suitable for the firm's investments

* Sector

o Initial Filters were applied on the various sectors of the Primary Country economy in order to analyze their strategic fit for Frontline

o Final Filters were used to narrow down the list of sectors (3 sectors) for the firm to look into and identify distressed assets from them

* List of identified distressed firms which could be used by Frontline for analysis and valuation purposes for its future potential investments

Part 2: Process

We mapped out a methodology for Frontline (to follow in the future) for obtaining information on such assets (and thus identify them). This involved designing a Guide wherein the various sources of information for such assets and their independent abilities to provide such information was rated.

In brief the scope of the research with timelines is as follows:

2.3 Literature Review

2.3.1 What is Private Equity (PE)?

Private equity fund operates under the contractual agreements between the fund manager and the investors of the fund and provides as a model of ownership for investors. The investments carried out by the fund are based on predefined investment strategies like the following:

* Unlisted Equity - Invest in the equity capital or equity - related capital of operational but unlisted firms

* Listed Equity - Invest in listed firms only to delist them and convert them into private firms.

* Growth capital - Invest in minority equity stakes in mature firms seeking capital for expansion, restructuring or to finance their takeovers

* Buyout - Invest in a controlling equity stake of mature firms with positive net operating cash inflow

* Venture capital - Invest in the start up or the early stage of the company's life cycle and contribute to its development

* Mezzanine capital - Invest in the most junior form of debt (e.g. subordinated debt or preference shares) but nevertheless is senior to its equity. It is a hybrid financing with the characteristics of both debt and equity and usually gives the debt holder the right to convert the debt into equity if the borrower is unable to pay the loan

* Distressed and stressed investments - Invest in the debt or preferably equity of financially stressed firms i.e. firms in default or under bankruptcy protection or in distress and heading towards bankruptcy/default

Different investment strategies focusing on the different stages of a firm's life cycle

These investment strategies are predefined by the fund and aim to achieve a balance between the firm's investments with respect to the sectors or the maturity of the portfolio firms (i.e. firms in which the fund invests). These strategies are designed with either of the 2 objectives:

* Develop a portfolio of innovative and high growth potential firms e.g. technology firms etc.

* Develop a portfolio of firms with ample potential for ‘value addition' and are currently suffering from management and operational inefficiencies. This would involve the fund's active participation in the management of the portfolio and instituting clear lines of responsibility and control and redesign the inventive system to fall in line with the changed organisation structure.

One of the most important features of a private equity fund is that the investments it makes are ‘long term' in nature as the funds don't seek to exit the portfolio firm on pure speculative grounds or to merely earn nominal capital gains.

2.3.1.1 PE funds in comparison with other Funds

PE funds must not be confused with Mutual Funds or with Index Funds. PE funds usually take a ‘hands on' role in their portfolio firms, unlike these other funds; and look for a return on investments of around 25% whereas these other funds look for returns in the range of 8%-9%. Below is a snap shot of how these funds are different:

(Canada's Venture Capital and Private Equity Association)[i]

2.3.1.2 Structure of a PE

PE funds are usually structured as limited partnerships wherein the limited partners just have a ‘bird's eye view' of the fund's operations given their secured positions on advisory boards or investors committee. Most of the investors are either HNIs or other professional investors who provide equity capital to the PE fund. The fund itself is rarely leveraged and the capital committed by the investors is ‘drawn down' over time (i.e. during the predefined investment period) as and when the fund needs it for its investments. However, the investor is notified about these drawings in advance, unlike other funds, wherein the drawings are upfront.

Some important characteristics of a PE fund are:

* No systemic risk - Lack of redemption rights for the investors (and cant withdraw their investments throughout the life of the PE fund) and leverage in the Fund results in minimal, if at all, systemic risk.

* Life of the fund - the usual life of a fund is almost 10 years wherein the investors have the right to typically 2 extensions and at the end of the life of the fund all the equity capital of the investors is returned back to them.

* Gains - are recorded only when realised and typically need to be distributed among the investors and rarely, can also be reinvested into the fund only under certain conditions.

* Hurdle rate and carried interest - Fund managers (themselves are co-investors in the fund) get a share of realised capital gains (carried interest) after the initial commitment and a predetermined rate of return (hurdle rate) is deducted from the fund's total gains.

2.3.2 Distressed/Stressed Assets

2.3.2.1 What are Distressed/Stressed Assets?

Stressed assets refer to assets which are heading towards becoming distressed. Thus the rule of thumb to identify these assets is to consider bonds with an YTM of 600-800 basis points above the risk free rate.

Distressed assets, on the other hand, are firms which have gone bankrupt and whose bonds have been downgraded to default category, by the different credit rating agencies. Such assets sell at a relatively cheaper price than their original value i.e. they trade at deep discounts compared to their par value (bonds) or below their intrinsic value (assets). Investments in these assets have a large incubation period and they usually earn returns after 4-5 years, on average.

2.3.2.2 Investments Strategies

Various types of distressed asset investing strategies are characterized by their different exit approaches:

* Event driven distressed investment wherein the investor anticipates the occurrence of an event which will affect the value of the asset positively and transform the nature of the asset. Such an event could be anything ranging from restructuring of a firm's debt to liquidation of its assets or even a simple buyback by the firm of its distressed securities i.e. any event set to result in potential capital gains.

* Valuation driven distressed investments do not expect the occurrence of any radical event but rather plan to exit either via the market (selling their securities after a price increase in lieu of a credit strengthening), event (restructuring) or a mere liquidation.[ii]

* Distressed to control or “loan to own” where the investor acquires the debt of the firm in order to own its equity post restructuring

* Turnaround strategies involves rescue financing to firms undergoing financial /operational challenges.[iii]

* Asset Purchase wherein the investor buys the assets of the distressed firm and seeks to either integrate it with an existing firm or to maybe start a new firm.

Distressed asset investing usually involves the purchase of the debt securities of a distressed firm. However, equity valuation should also be carried out before the investments in order to get an accurate picture of the investment; especially because in the event of a restructuring the debt holders are usually given equity control to the firm.

2.3.3 Why invest in distressed assets - Portfolio analysis

The introduction of distressed investments to a portfolio will result in an increase in the tracking error of the portfolio i.e. an increase in the standard deviation of the portfolio returns relative to a benchmark. The investment should be such that the incremental tracking error is compensated by either an increase in the hedge or the alpha (i.e. excess return of the portfolio relative to a benchmark) of the portfolio.

The inclusion of distressed investments in a portfolio has the potential to improve it's:

* VAR (Value at Risk) measures the probability of losses of the portfolio and uses the historical price trends and volatilities as its inputs.

* Sharpe Ratio is a measure of a risk adjusted returns or the return in excess of a risk free rate normalized and adjusted by their standard deviations or volatility.

* Shortfall risks wherein the probability of the capital requirements exceed the capital availability of the portfolio. This risk is mitigated by efficient hedging strategies wherein the fund tries to protect investments from price movements.

* Risk weighted concentrations as the diversification brought out by the distressed investment reduces the concentrations of the fund

* Liability tracking error is the standard deviation of the portfolio's surplus/deficit expressed as a percentage of its liabilities.[iv]

The following diagram shows the benefit of distressed investments for the portfolio wherein it can now attain higher returns (objective).

2.3.4 Distressed Investing - Economic Sense

We wanted to compare the returns obtained from distressed securities as compared to normal Equities. Thus we did the following analysis:

* Analyzed the annualized returns of the S&P 500 Index from 1988 to 2008.

* We also obtained data of the Distressed Securities Index Fund from an Alternate Investment Fund.

* The objective of this exercise was to compare the returns from both the S&P 500 Index Fund and that of the Distressed Securities Fund and see the differences.

· Note: The S&P 500 Index is an equities index and should not be compared with that of distressed securities. The objective is to understand how the 2 indices vary both over time as well as in returns. Also Frontline is not investing in such a distressed Securities Index fund. But the idea is to understand that the market for distressed securities is very huge and it has resulted in creation of Distressed Securities Indices by Hedge Funds, Alternate Investment groups etc that has resulted in reaping huge returns.

The below graphs will make this point clear:

Above we observe that the S&P 500 Index has been giving varying returns over time from positive to negative while the Distressed Index Fund has been giving relatively low returns which have normally been positive. However from Jan 2009 onwards it has shown extremely high returns. The reason for this is the current crisis increased the number of bankrupt/insolvent companies in the market, consequently increasing the distressed assets in the market and thus creating a large market for distressed securities. Thus the returns have been even superior to the S&P 500 Index.

Also the returns of the Distressed Index funds may not be normalized and may be skewed in one particular direction.

Thus we have used the modified Sharpe Ratio to calculate and compare the returns from the Distressed Securities Index as well as the S&P 500 Index. The Sharpe Ratio is a used to calculate the performance of a risk adjusted asset. We use the modified Sharpe Ratio to adjust for abnormal or skewed data. Thus the standard deviation is not used and hence the excess returns are divided by the Modified Value at Risk that is taking into account the Skewness and Kurtosis.

The higher the value of the modified Sharpe Ratio the more the returns the given asset will generate. Thus it reflects higher yields but will obviously also mean higher risks.

In the above case, what we observe is:

Modified Sharpe of Distressed Securities Index

0.69

S&P Index Modified Sharpe

0.29

Implications for Frontline:

* Thus the S&P 500 Index has a lower Modified Sharpe Ratio than the Distressed Index Fund, indicating lower returns but at the same time lower risks.

* Frontline is not investing in these distressed securities indices. The sole objective of this exercise was to understand how the market for these distressed securities has increased and funds investing in them are reaping returns. Indirectly it also means that more number of organizations are becoming insolvent or on the verge of insolvency, thus resulting in more distressed assets. Thus providing a large number of distressed assets for purchase.

2.3.5 Distressed Asset investments post Financial Crisis

The financial crisis poses as an upside for distressed asset investors as it presents immense opportunities for them. Reuter's estimates that in March 2009, there were approximately USD 400 billion outstanding distressed debt and almost USD 700 billion stressed debt. This has resulted in record amount of investments in such assets.

Moreover, the negative effect of the crisis on the PE industry also encourages distressed investing:

* PE funding in the LBO segment is slowing down owing to liquidity drying up and less of bank debt.

* Exit market for PE deals has also fallen down. The IPO market is virtually closed. Consider this: In 2008 there were only 7 venture backed IPOs in USA in 2008.

* There is less number of secondary buyouts. The sellers are holding onto their investments, waiting for the markets to improve, adjusting their prices to new market conditions.

· Liquidity remains low with limited capital from buyers who are unable to use the capital for large acquisitions as well.

2.3.6 Bankruptcy

2.3.6.1 What is Bankruptcy?

Bankruptcy is a condition where by a company is under tremendous financial stress. When it reaches this condition it is under an unsustainable situation and is unable to carry out its day to day normal operations. The number of bankruptcies has risen dramatically from 2008 onwards. The Euro zone has shown a large number of bankruptcies especially in the automobiles, machinery, textiles, retail and manufacturing sectors. Consider this: Denmark itself had an 85% increase in bankruptcies from May 2008 to May 2009.

2.3.6.2 Reasons for Bankruptcy:

There are external as well as internal factors that contribute to the bankruptcy of a firm. These are described briefly as follows:

Bankruptcy and its causes

External Factors

Internal Factors

· Decline in demand for a company's product

· Increasing input and production costs

· Intense competition owing to falling demand

· No access to credit from banks & FIs

· Domino effect observed - one company filing bankruptcy in the supply chain forcing the one next in line into bankruptcy and so on

· The recession initiated in one country spread to others leading to many bankruptcies.

* Excessive Debt on the books of companies

* Ineffective Strategy in place to compete during the financial crisis

* Ineffective management of companies

* Long standing problems not taken care of by companies

* Unprepared to changing market conditions

* Huge borrowings in foreign currencies led to hug losses when domestic exchange rates declined

2.3.6.3 Regulations Relating to Bankruptcy:

A debtor himself or his creditors could file for bankruptcy proceedings when the debtor becomes insolvent. The overall regulations for filing for bankruptcy are quite similar across all the countries in Europe except for a few minor variations across them. The court under whose jurisdiction the bankruptcy is filed will appoint a receiver or an administrator who will assess the finances of the insolvent company and reports this position.

2.3.6.4 Company Reorganization

Debt Reorganizing or restructuring forms an important part of any reorganization of a business. A reorganization plan has to be put in place to improve the company's profitability. For instance in Sweden, a debt reorganization plan will include creditors agreeing to reduce the debt or even reschedule their credit limits.

Reorganization is a mechanism whereby bankruptcy can be prevented by a formal agreement with the creditors. In certain countries reorganization may be decided by a separate counselor rather than a court and the effectiveness of reorganization is not very clear with bankruptcy remaining the obvious choice.[v]

Chapter3: The Process

3.1 Identifying the First Set

The first step of the research was to identify a First Set of countries which could pose as potential investment destinations for Frontline. The study incorporated a 2 step process for identifying the First Set.

Step1: Identify first 12 countries

Herein we merely ranked the European countries in terms of their GDP and size of manufacturing industry. The top 12 countries of this list were

Map of Europe[vi]

Serial No.

Country

1

The United Kingdom

2

Norway

3

Sweden

4

Finland

5

Denmark

6

Germany

7

Belgium

8

Switzerland

9

Netherlands

10

Ireland

11

France

12

Italy

Step2: Identify the First Set

Herein we shortlisted the most suitable 8 countries (out of the 12 chosen in Step 1) i.e. the First Set of countries. The vetting out of the First Set choice was based on an exhaustive study of the environments and potential of these countries. The analysis was based on subjective judgments and the inputs of credible institutions like the World Bank, Apax Partners (a leading Private Equity investment group) and the Economist Intelligence Unit (an eminent research and advisory firm).

A framework was developed for the purpose of the research wherein all the 12 countries were analyzed on the basis of mutually exclusive and exhaustive list of parameters:

* The different parameters were assigned weights as to their importance for the research and

* The 12 countries were rated on these parameters

* The 12 countries were then ranked with respect to their weighted averages of these scores. The top 8 countries with the higher weighted average scores were then chosen as the First Set.

The basic parameters and their respective weights were as follows

Broad Parameters

Weights

Comments

Economic Factors

0.48

* Indicates the availability of assets

* Indicates the competitive potential of such assets or the level of development of the industry

Regulatory Factors

0.15

* Indicates the time and cost investments for Frontline for conducting a transaction in the country

Legal and Policy Environment

0.1

* Indicates the feasibility and ease of transacting in the country

Environment for Private Enterprise

0.12

* Indicates the feasibility and ease of transacting in the country

Investor Protection

0.07

* Indicates the level of risk of transacting in the country

Recovery Rate

0.08

* Indicative of the cost involved in the purchase of distressed assets

The various subcategories within each of these broad parameters are mentioned below:

Source[vii]

The rankings of the 12 countries on the broad parameters were developed after considering the subcategories in details. Each of the sub categories was weighted and the countries were ranked for each of them. The composition of the broad parameters and the related weights were as follows:

Broad Parameters

Sub - Categories

Sub Category Weight

Comments

Economic Factors

a. Absolute size of the Manufacturing Industry (USD)

0.24

Indicative of the relative importance of the sector compared to other countries - cross sectional development

b. Relative size of the Manufacturing Industry in the Overall Economy (% of GDP)

0.24

Indicative of the Overall development of the sector in the economy

Regulatory Factors

a. Cost of Registering Property (% of property value)

0.08

Indicative of the cost of the transaction to Frontline

b. Time taken to enforce contracts (days)

-0.07

Increases the cost of the transaction and thus has a negative weight

Legal and Policy Environment

World Bank Index

Environment for Private Enterprise

a. Over all Rank for Private Enterprises

-0.06

A higher ranking (absolute number) of a country is indicative of additional difficulties and costs for Frontline's transactions

b. Entrepreneurial Environment

-0.06

Investor Protection

World Bank Index

Recovery Rate

World Bank Index

The weighted average scores of all the 12 countries were calculated on these parameters and ranked. The top 8 countries with the highest scores were chosen as the First Set. The working and the individual rankings and scores of all countries are given in Appendix 1. However, the table below shows the weighted average scores of all the 12 countries.

Country

Weighted Average Scores

Germany

18.8

UK

11.1

France

9.6

Italy

3.6

Norway

1.4

Netherlands

-0.1

Finland

-0.2

Switzerland

-0.3

Sweden

-1.1

Denmark

-1.3

Belgium

-1.6

Ireland

-1.9

· From the above figure we will choose the first set of 8 countries. Thus Belgium and Ireland will be eliminated since they are at the bottom with the least scores.

· We will not eliminate Sweden and Denmark since they are finish in third and fourth last respectively. Instead we eliminate France and Netherlands.

· Why do we eliminate France and Netherlands?

o Frontline asked us not to look into France primarily because of language barriers and it being a closed economy. Hence it was eliminated.

o Netherlands was also eliminated since we are looking at distressed assets that can be transferred easily to low cost countries. Thus we will be looking at sectors that will offer these kinds of distressed assets that can be transferred. These sectors include Manufacturing, chemicals, electrical machinery etc (discussed in detail later). Netherland does not offer a large potential for such sectors. Thus it was eliminated.

· Thus the final list of countries in the Second Set of selection along with the Rank according to the scores computed above is as follows:

First Set

Rank based on Weighted Average Scores

Germany

1

UK

2

Italy

3

Norway

4

Finland

5

Switzerland

6

Sweden

7

Denmark

8

3.2 Identifying the Second Set

Step 1- Analyze the First Set

The First Set of 8 countries were analyzed extensively in order to filter then further to derive the Second Set. The analysis involved evaluating the ranks of these countries on various parameters and most of the research was drawn from the Apax and the European Private Equity and Venture Capital Association in 2008.

Understanding the rankings

The scores in the ranking are Z scores i.e. a statistical measure used to assess the number of standard deviations an observation is away from the mean. Thus a country with a positive score is above the mean, or the average of all 33 countries, and is thus relatively (on average) a more desirable destination to attract investments. Whereas a country with a negative score, is less suited for inward investments.

These overall Z Scores are an arithmetic average of the scores of these countries on various parameters listed in Fig...One important point to note here would be the fact that it is the rank that is important here and the absolute value of the score by itself has no concrete interpretation (the relativity of the scores allows meaningful analysis. The scores allow us to rank the countries on six major parameters (both qualitative and quantitative)

The rankings do not provide any indication as to the amount of PE funds these countries attract, e.g. the growth opportunities offered by countries like China and India will far outweigh the drawbacks of their business environments (indicated by their relatively lower rankings but high PE investments). However, one should note that the countries that score high for all these sub-parameters - i.e. they offer stable regulatory frameworks, foster entrepreneurial policies and attitudes, market-based competition and have a highly developed financial system - can be expected to have higher PE activities, on average. Moreover, the uncertainty of GDP growth and financial markets can lead to the boom-bust cycle of PE investments, thus strengthening the argument to include risk as a parameter.

Below we have described what each criteria means since we will be using it to define

Germany

In spite of being one of the most influential countries in the continent Germany ranks 12th amongst all the 33 countries and 8th among the European countries considered. It has performed average on 4 categories, very well in risk and dismal in entrepreneurial environment. It has also been one the few countries to publicize its discontent with PE firms - e.g. one of the govt. officials described PE firms as ‘locusts'. Despite this, the country has experienced a high growth in PE investments for the last couple of years.

Strengths of Germany in relation to these 6 environmental categories:

* Largest European economy with a GDP of USD 3,673,105 million (4th largest in the world)

* Open economy with Liberal trade and foreign exchange regime

* Sophisticated and stable markets; factor, goods, financial

* Highly developed infrastructure

* The stable and structured legal and regulatory environment for financing

* Fairs well on policy towards foreign investments and private enterprise.

* The stable and structured legal and regulatory environment for financing

* Fairs well on policy towards foreign investments and private enterprises

Weaknesses of Germany in relation to these 6 environmental categories:

* Regulated and inflexible labor markets with high wages and tax burden; undergoing reform initiatives

* Complicated and high business and income taxation structure and rates; undergoing reform initiatives

Implications for Frontline:

The large size of the German economy, its liberal trade and forex policies and stable legal and regulatory environment and above all the its liberal policy towards foreign investments makes it a very attractive destination for Frontline. Moreover, as Frontline doesn't aim to operate in the country itself the disadvantages mentioned above have minimal effect on it.

Switzerland

Switzerland performs well above average and ranks 6th for PE environment on all categories.

Strengths of Switzerland in relation to these 6 environmental categories:

* Developed financing environment and a leading banking sector

* Highly developed and well regulated financial sector with the best financing conditions in the world

* Efficient administration as the level of govt. intervention is limited the time spent by firms for govt. related tasks is relatively lower than European standards

Weaknesses of Switzerland in relation to these 6 environmental categories:

* Limited access to the Swiss domestic market

* Slow pace of liberalisation

* Lack of competition in many sectors

Implications for Frontline:

Necessary to conduct a cost- benefit analysis - direct benefit of the efficient administration and limited govt. intervention with the direct cost imposed by lack of competition in many sectors. The other pros and cons of the Swiss PE environment either have limited effect on Frontline (given its objective to transfer assets) or indirect effect.

Finland

Ranks lower than its Scandinavian counterparts, Sweden and Denmark; and is ahead of Norway. Scores very well on, overall environment for private enterprise and good market opportunities; and is a laggard in the case of entrepreneurial environment.

Strengths of Finland in relation to these 6 environmental categories -

* Good environment for private enterprise in terms of corruption, judiciary system, competition policy and protection of private property

* Skilled labour market and superior management

Weaknesses of Finland in relation to these 6 environmental categories -

* High level of state ownership

* Inflexible labor market

Implications for Frontline:

It is an unfavorable destination for Frontline. The advantages presented by the Finnish environment have limited benefits for it whereas the disadvantage of high level of state ownership may either lead to lack of stressed assets in the country or may also make it increasingly difficult for a foreign PE to invest in a Finnish company.

Norway

We analyze the strengths and weaknesses of Norway in the current scenario based on the above parameters.

Strengths of Norway in relation to these 6 environmental categories -

* Favorable Macroeconomic Environment

* Transparent Fiscal Guidelines

* Independent Central Bank

Weaknesses of Norway in relation to these 6 environmental categories -

* Tax and legal environment not so favorable along with lack of certain fiscal incentives

* Inflexible labor market

Implications for Frontline

· Norway ranks moderately compared to its peers i.e. the other Scandinavian countries. It has a favorable macroeconomic policy with hug natural resource endowments. This along with a very credible public policy making, transparent fiscal policies and monetary policies with a stable central bank all make it a stable country to look for investments by Frontline.

· Since Frontline does not aim to operate out of Norway itself, the stringent labor market along with high taxes will not affect it to a large extent.

The United Kingdom

Based on the above parameters we compare the strengths and weaknesses of investing in the UK.

Strengths of United Kingdom in relation to these 6 environmental categories -

* Attractive legal environment

* Open FDI policies and environment

* Lesser restrictions on PE unds

Weaknesses of United Kingdom in relation to these 6 environmental categories -

* Increasing complexity of the taxes

* Fewer fiscal incentives especially for new firms[viii]

Implications for Frontline:

· The United Kingdom has a very favorable legal and policy environment with very few restrictions especially on PE and VC firms. Businesses are given as much freedom as possible to carry out investments, access to the capital markets, relaxed norms to FDI (especially foreign takeovers of domestic companies). Hence a very good investment destination by Frontline.

· Complex tax regime and relatively poor technical skills of the workforce will not be a big problem for Frontline since its primary focus is to locate distressed assets in UK and not operate out of the United Kingdom.

Denmark

Assessing the Strengths and Weaknesses of Denmark based on the above parameters of the country's ranking.

Strengths of Denmark in relation to these 6 environmental categories -

* Setting up a business is easy

* Transparent financial sector

* Less risk in the financial sector

Weaknesses of Denmark relation to these 6 environmental categories -

* Overall size of market is very small

* Restrictions on the size of PE/VC funds

Implications for Frontline

· Although the financial sector is transparent and the overall business environment in the country is good, the overall size of the market remains small. Thus Frontline may find it difficult to find distressed assets along with the difficulties of language and communication barriers.

Sweden

We compare the strengths and weaknesses of Sweden as a country that could make it an attractive investment destination.

Strengths of Sweden in relation to these 6 environmental categories -

* Excellent infrastructure

* Open to foreign ownership and investments

* High quality of technical workforce and management

Weaknesses of Sweden relation to these 6 environmental categories-

* High tax levels

* Highest personal taxes

Implications for Frontline

The overall financing environment of Sweden has improved with improved technical skills of the workforce. The overall industrial environment has improved and it may help Frontline to look into distressed assets in this country since it does have a favorable business environment.

Italy

Comparing the strengths and weaknesses, we evaluate the attractiveness of Italy as an Investment Destination.

Strengths of Italy in relation to these 6 environmental categories -

* Reforms may enable competitive policies

Weaknesses of Italy relation to these 6 environmental categories-

* Rigid Labor markets

* Extreme Corruption and bureaucracy

* High tax environment

Implications for Frontline:

Italy faces an instable political environment, has complex legal procedures that deter potential foreign investment. The overall taxes are very high and hence it is not a very attractive destination for Frontline.

Step 2 Filtering of the ‘First Set' - Second Set

Screening the ‘first set' further we arrived at the ‘Second set' of countries, with the aim of conducting a detailed study on these countries and their various sectors which provide an opportunity for Frontline to invest.

We evaluated the ‘first set' on various categories to be able to determine the ‘second set':

* The suitability of these countries for PE Investments

* The economic scenario of the countries to assess the existence of ‘transferable' stressed assets

* Presence of relevant sectors namely the manufacturing sectors

* The availability and the ease of obtaining data on distressed assets. This is represented in details Chapter 4 of the report ‘The Process'. However, we would like to point out that the scarcity of data was a crucial factor for the project and played a very important role in the short listing of the countries.

The idea was to shortlist only 2 countries from the 8 countries to compare these 2 countries in terms of their competitive advantages and how they would be beneficial to Frontline.

The following table summarizes the analysis of the First Set of 8 countries on the above mentioned parameters. The table has been compiled on the basis of the information provided in ‘Step 1of analyzing the First Set' and Chapter 4: the Process

Germany

UK

Italy

Norway

Switzerland

Finland

Sweden

Denmark

Suitability for PE

High

High

Medium

Medium

Medium

Low

Low

Low

Economic Scenario for stressed assets

High

High

High

High

Low

Low

Low

Low

Availability and ease of obtaining data

High

High

Low

Medium

Low

Low

Low

Low

Presence of the relevant sectors

High

High

Medium

Medium

Low

Low

Medium

Low

Collating the above information and the weighted average scores of these countries, (derived in the beginning for the filtering of the First Set itself) results in the choice of the Second Set.

Thus we conclude that Germany and UK score very high overall. Based on various parameters including but not exhaustive to ease of data availability, ability to contact trade representative from the different countries in Europe, eliminate language barriers etc we were able to shortlist 2 countries that looked attractive for investment by Frontline.

Thus the second set of countries concludes as follows and we will have to choose one primary country between them:

Countries

Rank

Germany

1

United Kingdom

2

3.3 Primary Country

Between Germany and United Kingdom, we need to assess different parameters for the 2 countries that will make them suitable for scouting for distressed assets. Before we describe the various parameters based on which we chose the primary country, we describe the bankruptcy regulations and procedures in UK and Germany:

Comparison of various Bankruptcy Provisions in UK and Germany

[ix]

3.3.1 Methodology to obtain the primary country

Based on the information obtained from trade associations and embassies of the above countries in the form of written trade reports and Tele -conversations with trade partners, we have assessed these countries below. In order to do so it is essential to assess the performance of different sectors that may have distressed assets that can be transferred to low cost countries. The industrial performance and economic situation of various sectors needs to be assessed and that is the approach that is followed:

1) The Share of Industries

* The below graph is a share of the percentage market services share versus the manufacturing percentage share of the countries in the EU region

* UK and Germany figure as follows:

% Market Services share

% Manufacturing share

Germany

Medium-High

High

United Kingdom

High

Medium-Low

[x]

Implications for Frontline

* Since we are looking at transferable distressed assets for Frontline, the manufacturing sector proves to be a better choice than Services sector.

* Owing to Germany's high percentage share of the manufacturing sector, it would offer more transferable assets. Whether these are distressed or not, we will need to figure out. However owing to current market conditions, there is a higher probability for this to occur. Thus Germany will be a better choice than UK.

2) Specialization in different sectors

* Based on a report on the EU Industrial structure on Competitiveness and performance of various countries, they have analyzed the performance of different industrial sectors in the countries in the EU region taking the size of the country into consideration as well. Thus the idea is to assess how many sectors have grown in different countries although they are small in size.

* However although a country may be specialized in a particular sector, it does not mean that it contributes by a large percentage in the overall economy.

* We have used the sectoral specialization indicator that compares “the share of a given sector in a given European country is taken and it is then compared with the share of the same sector in the European Union region.”

* The Interpretation of the values of the Index is as follows:

Equal to 1

Same share of sector in both the country and EU

Less than 1

Specialization is low in that particular sector when compared with the EU

Greater than 1

Specialized country in that particular sector with respect to the EU

* To compute this index we use the following formula for a given country and industry ‘j' where VA is the value added for the sector:

* Germany and UK have a pretty much same level of degree of specialization.

* From the below graph we see that, Germany and UK are on the same level as far as degree of specialization is concerned. Thus they have relatively few specialized sectors.

* However Germany remains specialized in capital goods like machinery, equipment, electrical and optical machinery etc which is not the forte of UK.

* Below is a table that indicates the most specialized industries present in Germany (DE) and UK

Implications for Frontline

* Since we are looking at transferable distressed assets for Frontline, the capital goods and manufacturing sector of Germany is a good choice.

* Although Germany is not specialized in the various other sectors, it is specialized in the machinery and capital goods segment which provides a wider choice for distressed assets than UK

* Germany is the better choice of Investment.

3) Technology factors contributing to share of Industries

* The OECD has classified various industrial sectors based on their technological level and used R&D as the main criteria to assess this.

* OECD has classified the sectors into four groups as follows:

o High Technology Manufactures: Included pharmaceuticals, medical, aircraft equipment, computing and machinery etc

o Medium-High Technology Manufactures: Includes chemicals, transportation vehicles and equipment, electrical machinery etc

o Medium-Low technology Manufactures: Includes cola and refined products, metal, rubber, plastic products, etc

o Low Technology Manufactures: Includes food, beverages, paper, footwear, leather etc.

o The table below shows the percentage share of industries in Germany and UK by technology categories in 1995 and 2005 and how they have changed over time:

[xi]

Where:

HT à High Technology

MHT à Medium High Technology

MLT à Medium Low Technology

LT à Low Technology

· Germany's share of Medium Low technology manufactures is higher than that of UK.

Implications for Frontline

* The same argument holds as before: Since we are looking at transferable distressed assets medium low technology manufactures provide the necessary assets that can be transferred to low cost nations.

* Germany has a larger proportion of these than UK. Thus improving the probability of transporting these to low cost countries. Hence Germany remains the better choice.

* In short we can summarize the various factors and their relevance to the two countries as follows:

Factors

Germany

UK

Share of Manufacturing Industry in the Total EU

High

Medium - Low

Sectoral Specialization with respect to Country Size

High

High

Manufacturing Industry Size

High

Low

Relevance of Sectoral Specialization

High

Low

Relevance of Technology

High

Low

CONCLUSION:

FINAL CHOICE OF COUNTRY = GERMANY

3.4 Sector Selection

The various industries of the economy were analyzed in order to determine the most appropriate sector for Frontline's investment. Various filters were developed to methodically analyze the appropriateness of each industry and they were divided into 2 categories.

3.4.1. Initial Filters

The following were initial “filters” applied for sector selection for Frontline and are in line with Frontline's strategy and objective:

* The acquired assets have to be portable/transferable i.e. the potential to be transported to the target country at a feasible cost; e.g. patents or the formula for an industrial manufactured product like adhesive etc qualify whereas mining machinery or aircraft manufacturing does not.

* Preference for

o Not investing in natural resources based sectors as it will result in additional constraints on the “transfer” strategy of Frontline, especially in terms of location of the transferred assets (as it will then have to be near the pool of required natural resource)

o Commodity like goods which do not rely on branding etc. and are mostly B2B industrial products

* The transferred asset should provide cost advantages after their relocation to the Low Income Country

This condition basically implies that the acquired firm has to be a manufacturing firm wherein it will have the potential to satisfy any one of the above conditions. A service sector firm will not be able to satisfy any of the conditions given the immobility of labor. Moreover, even if the human capital is mobile it will not be appropriate to shift them to the target country, as it underscores the basic strategy of the client to achieve cost advantages. Similarly, the primary or the agricultural sector would not pass this test as the assets cannot be transferred e.g. land etc.

3.4.2. Regulatory Filters

The final decision as to the suitability of the sector depends on its regulatory scenario with respect to the following:

* Foreign ownership:

o Germany tries to encourage foreign investments.

o There is no discrimination between foreign and local companies.

o The various benefits are in the form of investment grants, low interest loans depending on the geographical area and the size of the investing company.

o These kinds of grants would be applicable for investment in R&D and investment subsidies.

o Frontline wants to invest in distressed assets from German companies which will be encouraged by Germany. Since it does not intend to buy out any companies or take an equity stake in a German company, this will not be a problem for Germany.[xii]

· Specific Private Equity investment and taxation related regulations :

o German law makers have introduced the concept of “interest tax barrier” to reduce debt financed transactions. This is in particular true for private equity transactions. With effect from January 1, 2008 the interest expenses would be entirely deductible up to the amount of the interest income. However if there were any interest expenses that exceeded the interest income, these would be deducted up 30% of the taxable profit plus EBITDA. The interest expenses are however subject to 2 exemptions: one being that it is not applicable to business enterprises that do not belong to a group of companies and the second one is that it is not applicable to a business enterprise which belongs to a group but its Equity ratio is similar to or exceeds that of the group. In case of Frontline since it is not part of any group companies, it will be exempt from any kind of “interest barrier” rules imposed in Germany particularly for Private Equity players.[xiii]

* Transferring assets to target country

o Ease: Since Frontline is looking at transferring distressed assets it does not have to worry about labor laws and compensation. It is not buying out a company in Germany and hence there is no problem regarding employees. The tax structure and laws are applicable in case Frontline sets up in Germany.

Customs duty will be paid in case of imports into Germany. When the assets are exported out of Germany, the applicable customs duty will be paid in the country where they are exported to depending upon the laws and regulations of that country.

o The degree to which this is allowed e.g. whether 100% transferring will be allowed etc: Frontline is looking at transferring movable assets like machinery, equipment etc that can be easily transferred. There is no restriction in doing so.[xiv]

3.4.3. Final Filters

These filters are employed to help shortlist the appropriate sectors depending on their fit with the target country. Each filter is a step forward for further narrowing the list of short listed sectors

1. Medium - High technology products are more suited for the purpose of being transferred to a Low Income Country.

Medium to High Technology

Low to Medium Technology

Chemicals excluding pharmaceuticals

Refined petroleum

Machinery and equipment

Rubber and plastic products

Electrical machinery and apparatus,

Other non-metallic mineral products

Motor vehicles, trailers and semi-trailers

Basic metals

Transport equipment

Fabricated metal products

Building and repairing of ships and boats

Low Technology

High Technology

Food products, beverages and tobacco

Pharmaceuticals

Textiles, textile products,

Office, accounting and computing machinery

Leather and footwear

Radio, television and communication equipment

Printing and publishing Manufacturing

Aircraft and spacecraft

Wood and products of wood and cork

Medical, precision and optical instrument

Pulp, paper, paper products

The various NACE classified manufacturing sectors are categorized according to their level of technological advancement.

o Low technology sectors were rejected on the basis of their lack of potential of competitive advantage and a differentiation quotient in low income economies which already have well developed sectors. Moreover, these sectors would not pass the initial filter of providing cost advantages after the transfer e.g. textiles, paper etc.

o High Technology sectors were rejected on the basis of the relatively lower level of technical knowhow, lack of infrastructure etc. prevailing in the Low Income Countries. Moreover, these sectors would not pass the initial criteria of ‘transferability' e.g. aircraft, pharmaceuticals etc. as either transfer was not feasible or would not provide a cost advantage

o Low - Medium Technology sectors were also rejected as :

§ Did not pass the initial filter of preference as they were majorly based on natural resources e.g. Basic metals

§ The absolute advantage of Low income Countries in the production of these products e.g. India and China for refineries, Malaysia for Rubber etc.

§ The existence of ‘low ticket items' (i.e. low margin products) not suitable for such transfers e.g. fabricated metal products

o Medium - High technology sectors were accepted as they pass all the initial filters and also seem to be suitable for the conditions prevailing in the target countries e.g. infrastructure, labor pool etc.

2. Reliance on relatively ‘low qualified' labor is important among the candidate sectors which, in turn, will be looked into individually to assess their viability for Frontline. This is an important filter given the target country is a Low Income Country

Employment by educational attainment

The differentiating factor among the sectors comes from their reliance on either low or high labor qualifications. All the sectors perform relatively equally on the medium skills parameter. Thus concentrating on the low qualifications we chose those sectors which require more than 20% of their labor to low skilled.

The manufacturing sectors that pass this ‘filter' and have high requirement for ‘Low' educational qualification among the employees are shown in the table below:

Shortlisted Sectors

Chemicals

Rubber and plastics

Motor vehicles

Electrical machinery and apparatus

Machinery and equipment

Transport equipment

3. a. Existence of demand in and around the target country is another filter which needs to be applied for deciding the potential sectors. The production cost advantages attained by the transfer could be completely offset by the incremental distribution costs (i.e. diseconomies in distribution) if the market for the product is not near the target country. We anticipate such scenarios to result in diseconomies in distribution as Frontline will not be willing to invest heavily in the distribution infrastructure of the transferred asset as it is already investing in its set up and transfer.

b. Existence of supply of required raw materials in the target countries indicates the suitability of these sectors for Frontline's transfer strategy.

Share of BRICs in EU exports in 1999-2000 and 2007-2008 (%)

Sectors

1999-2000

2007-2008

Chemicals

9.7

14.7

Motor vehicles

6.4

17.8

Electrical machinery and apparatus

14.4

24.4

Machinery and equipment

14.4

26.2

Transport equipment

7.7

9.1

Share of BRICs in EU imports in 1999-2000 and 2007-2008 (%)

Sectors

1999-2000

2007-2008

Chemicals

8.9

14.9

Electrical machinery and apparatus

20.5

38.3

Machinery and Equipment

9.7

29.8

Motor vehicles

4.6

7.1

Transport equipment

4.9

17.9

Source: Euro stat

Considering both these filters together indicates the reliance of these sectors for both sales and key resources for production. This adds on to their attractiveness for Frontline as their transfer will provide immense potential for cost reductions. Important highlights to consider in this case are:

* Increase in the trade (both imports and exports) among the EU and the BRICs for all these sectors except for Transport Equipment where the above table indicates the lack of growth in the BRICs as a market (i.e. demand for EU products or exports) - reject Transport Equipment

* Increase in the imports from the BRICs to the EU for almost all sectors apart from Motor Vehicles. This reflects the differences in the structure of the industry as the sector is radically different in the 2 different groups of countries (i.e. EU and the BRICs). This is particularly true as the Lower Income Countries have developed their own national automobile sectors with industry heavyweights (e.g. Tata's in India etc.) and have their price conscious consumers have a higher demand for smaller cars. Moreover, the commercial vehicle segment does not qualify the initial filter as they require branding and are not majorly B2B sales.

4. Preference for existence of small to medium sized firms in the chosen German sector as the investment would be in line with Frontline's current investment strategy; especially given the nature of the investment i.e. ‘turnaround investment'.

Distribution of Value Added by enterprise size in 2004 (%)

Source: Euro stat

The above Figure very clearly shows the degree of fragmentation and the industry structure of the different sectors. Among the candidate sectors that have passed the previous filters the following sectors have been ranked on the basis of the importance of firms smaller than 250 employees to these sectors:

Sectors

Rank

Machinery and Equipment

2

Electrical machinery

3

Chemicals

4

5. High degree of specialization in the candidate sector is a must if the transferred asset has to be able to position itself in the market as a differentiated product and thus sustain itself in the new market. The following table gives an exhaustive list of manufacturing sectors where Germany is seen to be among the most specialized EU nations.

Sector

Most Specialised

Second Most Specialised

Third Most Specialised

Electrical machinery and apparatus

Hungary

Czech Republic

Germany

Machinery and equipment

Germany

Italy

Finland

Office machinery and computers

Ireland

Hungary

Germany

Motor vehicles

Germany

Czech Republic

Hungary

Source: Euro stat

Thus the following sectors should be considered for the ‘transfer' as they will ensure demand and competitive advantage even after the ‘transfer'. This information also reinforces the eligibility of the mentioned sectors as they pass all the above filters too

6. a. Revealed comparative advantage indicator comparison of these specific sectors of the target countries and the EU. Revealed comparative advantage indicator (RCA) for a sector ‘i' is defined as :

Where X= value of exports; W = reference area including the EU 25 and 38 other countries (see Appendix 2); X EU = exports to the rest of the world (intra EU trade is excluded); XW = exports to the rest of the world by the countries included in the reference area.

RCA is an indicator of competitiveness as it compares the share of a particular sector's exports in the total manufacturing exports of the EU to the same sector export share in total manufacturing exports of all the countries in the reference area.

o RCA> 1 implies that the sector performs better in the EU than in the reference area and thus indicates EU's competitive advantage in the sector - EU has a comparative advantage over the reference area in the sector

o RCA < 1 indicates EU's lack of competitiveness in that particular sector, as compared with the reference area - EU has a comparative disadvantage compared to the reference area (in the concerned sector)

EU RCA Index ranking 2006

Source: COMTRADE

The figure very clearly shows the competitive advantage the EU 27 countries have over the reference area in the shortlisted sectors which passed the previous filters.

Sector

RCA 2006

RCA Average 2002-2004

Comparative Advantage 2006

Electrical machinery and apparatus

More than 0.9

More than 0.9

No

Machinery and equipment

More than 1.5

1.5

Yes

Chemicals

More than 1.4

Less than 1.25

Yes

Given, Germany's specialization in these sectors (as mentioned in filter 5) a country-wise RCA will indicate a higher comparative advantage for Germany.

The sector which shows a comparative disadvantage or a falling RCA would be the one expected to have suffered from a higher bankruptcy related issues - Electrical Machinery reflects a comparative disadvantage. On the other hand, sectors with a high RCA will not have potential

6. b. Matching RCA - Only a competitive advantage will not sustain the asset after the ‘transfer' and it has to be matched with the target country's industry competitive landscape. Taking India and China as prime examples for target countries will help us analyze the suitability of these sectors for the transfer.

India trade in manufactured products - RCA Index 2006

Source: COMTRADE

China trade in manufactured products - RCA Index 2006

Source: COMTRADE

Sector

China's RCA 2006

India's RCA 2006

China's RCA Average 2002-2004

India's RCA Average 2002-2004

Electrical machinery and apparatus

1.2

Less than 0.5

1.2

Less than 0.5

Machinery and equipment

0.75

Less than 0.5

Less than 0.75

Less than 0.5

Chemicals

Less than 0.5

1

Less than 0.5

More than 1

Considering the second and the third largest Asian economies as samples for the ‘target country', helps in understanding the performance of these sectors in Low Income Countries. These countries will serve as benchmarks wherein, China clearly performs far better than India 2 out of the 3 candidate sectors being considered. Moreover, China has a comparative advantage in Electrical Machinery and has maintained its superiority over the 5 years from 2002-2006.

India, however, has a comparative advantage in Chemicals and the sector has been shown a positive development over the years (i.e. the RCA has increased over the 5 years from 2002 to 2006).

This indicates that that none of these sectors can be expected to be developed in the potential ‘target countries' (like in India) and thus provide a lucrative opportunity for Frontline's transfer strategy (from this aspect).

Thus matching the RCAs of the sample target countries with the EU countries indicates the following:

Sectors

Comments

Electrical machinery and apparatus

China has maintained its comparative advantage whereas EU doesn't have a comparative advantage

Machinery and equipment

Only EU has comparative advantage

Chemicals

India has comparative advantage and EU comparative advantage is increasing rapidly

The criteria for choosing a sector are:

* RCA in the EU is falling rapidly so that there is an availability of bankrupt or stressed assets

* RCA in the target country is less than 1 and is compensated for by the higher RCA (greater than 1) of the EU

Applying the above criteria to the shortlisted sectors implies that Machinery and Equipment is the most suitable sector for the transfer as the German assets will help gain competitive advantage in the target countries.

The breakup and definition of the sector is shown in Appendix 2

Chapter4: The Process

4.1: The “Guide” to Identifying Distressed Assets

The primary research objective is to map out a process to identify ‘distressed assets' in developed (High Income) countries.

The Guide aims to aid all further research on ‘the identification of stressed assets in High income countries'. It takes the example of some High Income Countries (the ‘First Set') to

* Explain the various sources of information and

* Rate these sources according to

o the quality of the data and

o the confidence with which data will be made accessible

Step 1- Identify various sources of information

The following sources were shortlisted in order to identify the stressed assets in the different countries:

Bond Credit Ratings

Credit ratings are the opinions of the credit rating agencies about the credit risks associated with the corporate bonds of the different firms i.e. the willingness and ability of the firms to repay their debts. These ratings also indicate the credit quality and the relative probability of default of the various corporate bond issues.

Different rating agencies have different rating scales on which they rate (grade) the different corporate bond issues. Two of the most popular rating agencies are S&P and Moody's.

Stressed assets can be identified as those firms whose corporate bond issues have been rated in the Highly Speculative and the Default categories, specifically ‘C ‘and below for S&P and ‘Ca' and below for Moody's.

Real time data on these ratings can be easily obtained from Bloomberg or the Reuters Terminals. Thomson Reuters Database 300X was used to obtain the 30 day ratings of the different corporate bond issues, for the purpose of this research; and is attached in the Appendix

Paid Sites

There are many paid websites as well that require a member subscription and help to identify different companies that are being liquidated. For example an important site is www.ukdata.com. A list of such sites is mentioned in the Appendix.

Bankruptcy Courts

Distressed assets and firms requiring Restructuring have to be registered under the country's Bankruptcy Courts, by law. Thus one of the direct sources of information has been the repositories of these Courts.

As a part of this research, the Bankruptcy Courts of the various countries were contacted via telephone to obtain information on the Bankruptcy procedures followed by the firms there and to enquire whether they have a centrally administered online database of such filings. In some cases these courts were able to direct us to certain Government websites (paid or unpaid) that included information on companies that have filed for bankruptcy. The contact details and the relevant information obtained by these sources are attached in the Appendix

Administrative Agencies

Some countries had administrative agencies that provide links to different Government websites, which detail information on stressed or bankrupt assets. These websites do not have to be a Govt. undertaking Different kinds of country specific information, bankrupt companies; investment climate etc can be obtained from these websites. e.g. Norway has a good website providing such information.

Govt. Trade Departments

Another important source of information for the purposes of identifying stressed assets is the Govt. Trade Departments of the various countries. These departments also have a foreign ‘wing' in their respective country Embassies/Consulates.

During the course of the research the trade departments of the different countries were contacted both in the Embassies (locally) and in the Govt. Trade Department Headquarters (internationally); in order to obtain information regarding the various bankruptcy procedures in their respective countries as well as to direct us to any central repository of information that might have data on companies that are ‘stressed' or are on the verge of bankruptcy. Contact numbers of Embassies and the Govt. trade department headquarters along with the relevant information obtained from them is attached in the Appendix.

Trade Associations

They may be known as chambers of commerce, Trade Confederation, Industry Association, Institute of Foreign Trade, Trade Council etc depending on which country one is referring to. However they all focus on one aspect i.e. promoting and developing trade with countries around the world and encouraging inward investment by foreigners.

These are important sources for obtaining information on the general health of the various sectors in their countries. They will help ‘funnel' any research to the extent of identifying the ‘focus sectors' for which the stressed asset data should be analyzed - a major benefit, especially as the data from the other sources can either not be retrieved or may become unmanageable if the ‘focus sector' is not during the ‘search'.

Telephone interviews were conducted with the various trade associations in the different countries in order to gather information pertaining to bankruptcy prevalence in the different sectors and also to identify leads to more sources of stressed assets. The relevant data has been mentioned in the appendix along with the contact details of these associations.

Banks

This is an ongoing process where we have been trying to contact all the major banks of the different countries.

Banks are also likely to have data on stressed assets given their ‘investor' role in the corporate bond markets (large firms) and ‘lender' role as they give loans to firms (both small and large firms). Moreover, they will also be among the first few stakeholders to identify the ‘stress' of firms (‘lender' role) as they extend working capital loans and overdrafts. Additionally, interest receipts will be among the first few payments to be defaulted on by the firms, thus helping banks identify ‘distressed assets'.

However this is one of the most difficult sources, as banks are not in a position to reveal confidential information about their clients or their own investments, for both regulatory and trade reasons. During our research we were unable to get any data from the Banks.

Step 2- Develop the Guide

The following matrix has been designed to assess the quality and the accessibility of data from the various sources among the ‘first set' of countries. However, we have left out the Paid sites sources from this assessment as they will undoubtedly be tailor-made for the researcher's requirements - and score a full confidence score of 4. The free sources have been rated on their confidence on a scale of 1 (with least confidence) to 4 (with maximum confidence).

Countries

Confidence Levels of the Various Sources of Information

Confidence Score 4

Confidence Score 3

Confidence Score 2

Confidence Score 1

Germany

Financial Databases e.g. Reuters and Capital IQ

Bankruptcy Court

Govt. Trade Department

-

Trade associations

Switzerland

Financial Databases e.g. Reuters and Capital IQ

-

Administrative Agency

-

Finland

Financial Databases e.g. Reuters and Capital IQ

Govt. Trade Department

Norway

Financial Databases e.g. Reuters and Capital IQ

Govt. Trade Department

Bankruptcy Court

-

-

Trade Associations

United Kingdom

Financial Databases e.g. Reuters and Capital IQ

-

-

Govt. Trade Department

Denmark

Financial Databases e.g. Reuters and Capital IQ

-

Administrative Agency

-

Sweden

Financial Databases e.g. Reuters and Capital IQ

-

-

-

Italy

Financial Databases e.g. Reuters and Capital IQ

-

-

-

Germany

Bond ratings score the maximum in confidence (Score 4) on the data made available as they aid in identifying all the stressed assets (including distressed assets).

The sources with Confidence Score 3 give data on all the Distressed Assets of the country. However, score a score 3 and not 4 as they do not help in identifying Stressed assets (i.e. quality of the data is not up to the mark).

* Bankruptcy Court (www.insolvenzbekanntmachungen.de)

The Govt. Trade departments (Score 2) as of now do not have an exhaustive internal database of stressed assets, but will definitely provide useful information in terms of leading the researcher to another site or will provide data on the macro level e.g. ailing industries etc.

Trade Association (Score 1) as of now does not have any such information at its disposal but its strength and activism in the economy makes it the most suitable candidate (among the rest) for compiling such information in the future.

Switzerland

No data was obtained even after repeated interactions with all the various sources as mentioned in the Appendix

Finland

No data was obtained even after repeated interactions with all the various sources as mentioned in the Appendix

Norway

Government Trade Departments score a confidence score of ‘4' for Norway since were able to obtain very informative data from the Norwegian Embassy located in Singapore. The Innovation Norway group, primarily responsible for trade and innovation from the Embassy, assisted us to the links of 2 large Norwegian banks from whom we could obtain information about troubled assets in Norway:

* DnbNor- https://www.dnbnor.com/site/about_the_group/international/singapore_forside.html?menu=-179215396

* Nordea - http://www.nordea.com/bedrifter+og+institusjoner/international+network+and+services/international+network/singapore/57462.html?q=singapore&link=1_1

The administrative agencies of Norway also score a confidence score of ‘4' since there is an excellent website of the “Registrar of Bankruptcies” that has information of all the limited companies in Norway getting liquidated or on the verge of liquidation. This can be a good source to identify distressed assets:

* http://w2.brreg.no/kunngjoring/index.jsp?spraak=en

The Bond Credit Rating has a confidence score 3 since they just tell us a part of the bond rating of particular companies. Also not all companies may have bonds.

Trade Associations and Bankruptcy Courts have a confidence score of 2 and 1 respectively since these 2 sources were the least helpful. We were unable to gather any useful information from them. A language barrier was also a major issue.

United Kingdom

Financial databases score the maximum in confidence (Score 4) on the data made available as they aid in identifying all the stressed assets (including distressed assets).

Also Administrative agencies score 4 in confidence sine the UK embassy located in Singapore was very helpful in explaining the kind of sources of information available to identify stressed assets. Useful information to look for distressed assets was provided.

Paid Websites score a confidence score 3. A very good example is www.ukdata.com that contains a lot if information on various companies in UK as well as companies getting insolvent. We could not extract all the information since a lot of it was premium content.

Trade Associations (score 2) and Bankruptcy Courts (score 1) do not contain much information at their disposal. They are unsure of the data available and overall did not give us useful information.

Denmark

Language barriers like many countries remain a key concern in Denmark. Overall the confidence level was low in the kind of information that can be extracted from various sources of Denmark. There are certain Bankruptcy courts, trade associations and paid websites. But they did not have enough (correct) information or we were unable to communicate to them.

Sweden

Bond ratings score the maximum in confidence (Score 3) on the data made available as they aid in identifying all the stressed assets (including distressed assets).

Administrative Agencies (score 2) like the Swedish Embassy, did not contain much information on sources of distressed assets and companies in Sweden.

We were unable to extract data from Bankruptcy Courts (score 1) with lack of the ability to communicate in Swedish being a major problem.

Italy

Bond ratings score the maximum in confidence (Score 3) on the data made available as they aid in identifying all the stressed assets (including distressed assets).

Administrative Agencies (score 2) with bankruptcy courts and paid websites (score 1) may have information regarding the regulations in Italy and various investment routes. However from the point of view of identification of distressed assets they were of not much help.

Chapter 5: Conclusion

The 2 pronged objectives imply a 2 pronged conclusion.

Part 1: The Process

The deliverable was explained above as the Guide. The Process outlined in the Guide will aid Frontline for identification of distressed assets in the First set of 8 countries on a regular basis in the future. The research and the Guide, however, is limited to the extent that we did not have access to paid information and is representative, only of the free publicly available information.

This process would not be required when identifying these assets from paid financial databases like Capital IQ etc. as exhaustive data would then be readily available in the required form.

Part 2: The Project

This part of the project seeks to identify assets for Frontline in a country and sectors which would be most suitable for the firm's investment strategy. The following is the list of 4 such firms which fulfil all the criteria and prove to be a strategic fit for the firm.

This study is just the beginning for Frontline, or for that matter, any other firm seeking to follow a similar strategy as that of Frontline. The research is limited to mere identification of assets for Frontline and does not seek to value or design a purchase for the firm.

Nevertheless, the study provides ample guideline and an extensive analysis of all the various aspects or factors determining such an investment decision and all these can be applied for the analysis of any other country not considered in the report.

Appendix

Appendix 1:

Real figures along with the weights

FACTORS

WEIGHTS

Belgium

Netherlands

France

Ireland

Finland

Denmark

Germany

Italy

Sweden

Switzerland

UK

Norway

Absolute size of the Manufacturing Industry (USD)

0.2

90.1

151.9

450.8

72.3

60.7

64.5

809.5

479.6

102.5

100.5

539.1

129.9

Relative size of the Manufacturing Industry in the Overall Economy (% of GDP)

0.2

24.0

24.0

21.0

36.0

31.0

25.0

29.0

27.0

28.0

27.0

24.0

43.0

Cost of Registering Property (% of property value)

0.1

0.1

0.1

0.1

0.1

0.0

0.0

0.1

0.0

0.0

0.0

0.0

0.0

Time taken to enforce contracts (days)

-0.1

505

514

331

515.0

235.0

380.0

394.0

1210.0

508.0

417.0

404.0

310.0

Recovery Rate during closure of business (cents on a Dollar)

-0.1

86.3

82.7

44.7

86.6

87.3

86.9

52.2

56.6

75.1

46.8

84.2

89.0

Strength of investor protection index (0-10)

0.1

7.0

4.7

5.3

8.3

5.7

6.3

5.0

5.7

5.7

3.0

8.0

7.7

Over all Rank for Private Enterprises

-0.1

14.0

7.0

11.0

13.0

5.0

3.0

11.0

27.0

9.0

6.0

8.0

15.0

Legal & Policy Environment

0.1

13.0

11.0

19.0

5.0

8.0

4.0

16.0

26.0

6.0

7.0

1.0

14.0

Entrepreneurial Environment

-0.1

14.0

23.0

32.0

10.0

28.0

4.0

25.0

29.0

7.0

9.0

6.0

19.0

Weighted figures along with the total values

FACTORS

Belgium

Netherlands

France

Ireland

Finland

Denmark

Germany

Italy

Sweden

Switzerland

UK

Norway

Absolute size of the Manufacturing Industry (USD)

21.6

36.5

108.2

17.4

14.6

15.5

194.3

115.1

24.6

24.1

129.4

31.2

Relative size of the Manufacturing Industry in the Overall Economy (% of GDP)

5.8

5.8

5.0

8.6

7.4

6.0

7.0

6.5

6.7

6.5

5.8

10.3

Cost of Registering Property (% of property value)

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Time taken to enforce contracts (days)

-35.4

-36.0

-23.2

-36.1

-16.5

-26.6

-27.6

-84.7

-35.6

-29.2

-28.3

-21.7

Recovery Rate during closure of business (cents on a Dollar)

-6.9

-6.6

-3.6

-6.9

-7.0

-7.0

-4.2

-4.5

-6.0

-3.7

-6.7

-7.1

Strength of investor protection index (0-10)

0.5

0.3

0.4

0.6

0.4

0.4

0.4

0.4

0.4

0.2

0.6

0.5

Over all Rank for Private Enterprises

-0.8

-0.4

-0.7

-0.8

-0.3

-0.2

-0.7

-1.6

-0.5

-0.4

-0.5

-0.9

Legal & Policy Environment

1.3

1.1

1.9

0.5

0.8

0.4

1.6

2.6

0.6

0.7

0.1

1.4

Entrepreneurial Environment

-0.8

-1.4

-1.9

-0.6

-1.7

-0.2

-1.5

-1.7

-0.4

-0.5

-0.4

-1.1

Total Weighted Average Scores

-1.6

-0.1

9.6

-1.9

-0.2

-1.3

18.8

3.6

-1.1

-0.3

11.1

1.4

Appendix 2: Definitions

Appendix 3: Computation of Returns of Greenwich Distressed Securities Index Fund and S&P 500

Monthly Return

Yearly Return

Year

Returns

1.6%

0.188

1995

18.80%

1.6%

0.192

1996

19.20%

1.3%

0.156

1997

15.60%

0.2%

0.026

1998

2.60%

1.1%

0.126

1999

12.60%

0.4%

0.051

2000

5.10%

1.5%

0.178

2001

17.80%

0.2%

0.019

2002

1.90%

2.0%

0.245

2003

24.50%

1.4%

0.171

2004

17.10%

0.8%

0.09

2005

9.00%

1.2%

0.1439

2006

14.39%

0.6%

0.066

2007

6.60%

-2.1%

-0.2523

2008

-25.23%

2.1%

0.254002

2009

25.40%

Std. dev

0.124226

Mean

0.111114

11.11143

Skewness

-1.81432

Kurtosis

4.670239

7.670239

term 1

Mean

11.11143

Zc

1.644854

Zc square

2.705543

0.284257

term 2

-0.51573

Zc cube

4.450223

t-bill rate

3.540625

3Zc

4.934561

3.54%

Term 3

-0.15479

8.900446

8.224268

term 4

0.061828

9.23%

2.478568

term 5

0.124226

Modified VAR

10.99807

Modified Sharpe

0.688376

S&P Index Modified Sharpe Ratio

0.291272

Stats for Greenwich Distressed Securities Index

Mean

0.00973316

Standard Error

0.001574934

Median

0.011

Mode

0.015

Standard Deviation

0.021012237

Sample Variance

0.000441514

Kurtosis

21.32743559

Skewness

1.875595233

Range

0.249402415

Minimum

-0.0777

Maximum

0.171702415

Sum

1.732502415

Count

178

Appendix 4: Countries included in calculation of RCA Index

The other 38 countries included in the calculation of the RCA index

Algeria, Argentina, Australia, Bangladesh, Brazil, Canada, Chile, China, Colombia, Costa Rica, Croatia, Egypt, Hong Kong, India, Indonesia, Israel, Japan, Kazakhstan, South Korea, Malaysia, Mexico, Morocco, New Zealand, Norway, other Asian countries n.e.s., Pakistan, Peru, Philippines, Romania, South Africa, Singapore, Sri Lanka, Switzerland, Thailand, Tunisia, Turkey, United States, Venezuela

Appendix 5:

Credit Rating Agency Name

Tel No.

Corporate Office Address

Comments

Moody's

65-63988308 / 00

Moody's Singapore Pte. Ltd., 50 Raffles Place #23-06, Singapore Land Tower, Singapore- 048623

Was advised to send an email to clientservices.asia@moodys.com with the detailed query and that they would get back to us accordingly. They also mentioned that we need to be subscribers to be able to contact an analyst

Standard and Poor's

65-6438-2881/ 65-6532-7879/ 65-6530-6567 /

30 Cecil Street #24-01, Prudential Tower, Singapore- 049712

Spoke to Aprace who connected to Mr. Anthony who said that CCC is a highly vulnerable company. D is default and asked us to go through the website for rating criteria. Also if interested, we should contact Rudy (65-6239-6328) from the Sales dept. for live feed. However, no information was obtained by further contact

Fitch Ratings

65-6796-7203

6 Tamasek Boulevard, #35-03/04/05, Suntec Tower, Singapore

Unable to obtain information

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