Restructuring

Question 1

What do you do in restructuring?

Answer 1

Restructuring bankers advise distressed companies - (i) those going bankrupt, (ii) in the midst of bankruptcy or (iii) getting out of bankruptcy - and help them change their capital structure to get out of bankruptcy, avoid it in the first place or assist with a sale of the company.

Question 2

What are the two sides of a restructuring deal?

Answer 2

Debtor - advising the company. Like advising the sell-side in M&A, you’re advising the company that’s trying to sell or get out of the mess it’s in.

Creditor - buy-side. Advising buyers and lenders that are trying to take what they can from the company.

Question 3

Why are you interested in restructuring?

Answer 3

Canned answer - gain a very specialized skill set and the work is more technical and interesting than other fields.

My answer - working with complicated capital structures and brokering agreements between conflicting constituencies presents a unique challenge, requiring strategic thinking and diplomacy. Legal background also helps.

Question 4

How are you going to use your experience in restructuring for your future career goals?

Answer 4

• Stay in RX IB

- Best background for distressed/special situations

Question 5

How would a distressed company select its restructuring bankers?

Answer 5

Requires extremely specialized knowledge and relationships:

(i) experience doing similar deals and
(ii) relationships with the parties in interest.

Question 6

Why would a company go bankrupt in the first place?

Answer 6

1. Can’t meet its obligations / interest payments
2. Creditors accelerate debt payments and force company into bankruptcy
3. Acquisition goes poorly or company has written off the value of its assets steeply and needs extra capital to stay afloat
4. Liquidity crunch - can’t afford to pay vendors/suppliers

Question 7

What options are available to a distressed company that can’t meet debt obligations?

Answer 7

1. Refinance and obtain fresh debt / equity
2. Sell the company (as a whole or in pieces via asset sale
3. Restructure financial obligations to lower interest payments / debt repayments, or issue debt with PIK interest to cut cash interest expense
4. File for bankruptcy: obtain additional (DIP) financing, restructure obligations and be freed of onerous contracts.

Question 8

What are the pros/cons of each option?

Answer 8

1. Refinance:
   A. Pro - least disruptive, help revive confidence
   B. Con - difficult to attract investors to distressed firm
2. Sale:
   A. Pro - SH could get some value, creditors less mad
   since funds are coming
   B. Con - may only get fire sale value
3. Restructuring:
   A. Pro - quickly resolve problems w/o 3rd parties
   B. Con - lenders reluctant to increase exposure to firm;
   tensions b/w mgmt. / lenders
4. Bankruptcy:
   A. Pro - could be best way to negotiate w lenders,
   reduce obligations and get add’l financing
   B. Con - significant disruption, lack of confidence from
   customers, prob. wipe out equity

Question 9

What strategies do creditors have to recover their capital in a distressed situation?

Answer 9

1. Lend additional capital / grant equity to company
2. Conditional financing - only agree to invest if co. cuts expenses, stops losing money and agrees to other terms / covenants
3. Sale - force company to hire banker and shop itself/assets
4. Foreclosure - bank seizes collateral and forces a BR filing

Question 10

How are restructuring deals different from other types of transactions?

Answer 10

• More complex, involve more parties, require more specialized/technical skills and must follow Bankruptcy Code
• Negotiations are bigger than bilateral

Question 11

What’s the difference between Ch. 7 and Ch. 11?

Answer 11

• Ch. 7 - liquidation. Sell off assets to repay claims.

- Ch. 11 - reorganization. Change terms/renegotiate.

Question 12

What’s DIP financing and how is it used with distressed companies?

Answer 12

Money borrowed by debtor on a superpriority basis. For that and other reasons, lenders consider it safe.

Question 13

How would you adjust the 3 F/S for a distressed company when you’re doing valuation or modeling work?

Answer 13

• Adjust COGS for higher vendor costs (no trust from suppliers)
• Add back non-recurring legal/professional fees from process
• Add back excess lease expenses (lack of trust) to EBIT and excess salaries (private cos. saving on taxes)
• Adjust working capital for A/R unlikely to turn into cash, overvalued/insufficient inventory and insufficient A/P
• Capex is often off: too high can cause distress; too low could be a consequence of distress

Question 14

Would those adjustments differ for public companies vs. private companies?

Answer 14

Excess salaries - harder to manipulate in a public firm

Question 15

If the market value of a distressed company’s debt exceeds its assets, what happens to its equity?

Answer 15

• Book equity - turns negative (A = L +E, L > A)

- Market cap - remains positive

Question 16

In a bankruptcy, what is the order of claims on a company’s assets?

Answer 16

1. Administrative claims
2. DIP lenders
3. Secured creditors (RCFs + TLs)
4. Unsecured creditors (HY)
5. Sub debt investors (sub. HY)
6. Mezzanine investors (converts, pref., PIK)
7. Common equity

Question 17

How do you measure the cost of debt for a company if it is too distressed to issue additional debt?

Answer 17

Look at yields of bonds / CDS spreads of comparable companies. Could also current yields on firm’s existing debt, but only if it’s liquid.

Question 18

How would valuation change for a distressed company?

Answer 18

• Comps (public co., transaction): use lower range, and use acct. adjustments. May need revenue multiples if EBIT/EBITDA/EPS-negative.
• DCF: lower projections since need a turnaround period.
• Do liquidation valuation, assuming company’s assets will be sold to repay creditors.
• May need to do valuations on (i) assets-only and (ii) current liabilities-assumed bases.

Question 19

How would a DCF analysis be different in a distressed scenario?

Answer 19

• More value comes from TV, given CF-negative turnaround period
• Sensitivity on hitting/missing earnings forecast
• Add operating distress premium to WACC

Question 20

If you’re selling a distressed company, how would the M&A process differ from for a healthy company?

Answer 20

1. Timing is quicker - sell or go bankrupt
2. May producer fewer upfront marketing materials (i.e., Info Memo, Mgmt. Presentations) in the interest of speed
3. Creditors often initiate the process
4. Distressed sales can’t “fail” - result in a sale, bankruptcy or a restructuring.

Question 21

What are the differences between stock purchases and asset purchases, and which would buyers/sellers in distressed sales prefer?

Answer 21

• Stock purchase - acq. 100% of shares, assets and liabilities. Used for large/public/healthy companies.
• Asset purchase - only acq. certain assets and assume certain liabilities. Used for divestitures, distressed M&A and smaller private companies.

Buyers prefer asset purchases to avoid assumption of unknown liabilities (+ tax benefits). Distressed sellers prefer stock purchases to rid itself of liabilities and avoid heftier taxes.

Question 22

Normally in a sell-side M&A process, you always want to have multiple bidders to increase competition. Is there any reason they’d be especially important in a distressed sale?

Answer 22

YES - in a distressed sale you have almost no negotiating leverage (distressed co.), so competition is best way to improve sale price.

Question 23

Sometimes a distressed sale doesn’t end in a conventional stock/asset purchase - what are some other possible outcomes?

Answer 23

• Foreclosure
• General assignment (faster alt. to bankruptcy)
• Section 363 asset sale
• Ch. 11
• Ch. 7

Question 24

Normally M&A processes are kept confidential - is there any reason why a distressed company would want to announce the involvement of a banker in a sale process?

Answer 24

YES - to increase bidding/competition and drive a higher purchase price.

Question 25

Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?

Answer 25

It depends, but probably not. If debts > assets not much to get, esp. in liquidation.

Question 26

Let’s say a company wants to sell itself or simply restructure its obligations - why might it be forced into a Ch. 11 bankruptcy?

Answer 26

Oftentimes, aggressive creditors - if they won’t agree to the restructuring or can’t finalize a sale outside court, they may force a company into Ch. 11 by accelerating debt payments.

Question 27

Sometimes distressed companies “buy back” their debt at a discount (i.e., 50%). What’s the motivation for doing this and how does it work accounting-wise?

Answer 27

• Rationale: use excess csah to buy back debt cheaply and sharply reduce go-forwaard interest expense / obligations. Works b/c foregone interest on cash < interest rate on debt, so net interest expense falls.
• Accounting: B/S cash and B/S debt decrease in equal amounts

Question 28

What kind of companies would most likely enact debt buy-backs?

Answer 28

Over-levered companies that were acquired by PE sponsors in LBOs, now facing burdensome interest payments and have excess cash.

Question 29

Why might a creditor have to take a loss on the debt it loaned to a distressed company?

Answer 29

Junior (esp. unsecured) creditors may fall below the line - not enough to repay in full.

Question 30

What is the end goal of a given financial restructuring?

Answer 30

Not to change the amount of debt outstanding in and of itself, but to change the terms thereof (e.g., interest payments, monthly/quarterly principal repayment requirements and the covenants).

Question 31

What’s the difference between a Distressed M&A deal and a Restructuring deal?

Answer 31

Restructuring is one possible outcome of a distressed M&A deal. Company can be distressed for many reasons, but solution isn’t always to restructure its debts - may declare bankruptcy, may liquidate and sell assets or it may sell 100% of itself.

Question 32

What’s the difference between acquiring just the assets of a company and acquiring it on a “current liabilities assumed” basis?

Answer 32

• Assets = JUST assets.
• CL assumed - must make adjustments b/c distressed working capital can be extremely skewed. “Owed expenses” like A/P and accrued expenses are often much higher than they would be for a healthy company, so you have to subtract the difference if assuming CLs.

Question 33

How could a decline in a company’s share price cause it to go bankrupt?

Answer 33

TRICK QUESTION. As a result of share price drop, customers, vendors, suppliers and lenders may be reluctant to deal with the distressed company, causing revenues to fall and A/P and accrued expenses to climb very high. This could cause failure, but not share price.

Question 34

What happens to A/P days with a distressed company?

Answer 34

They get very high b/c can’t pay vendors / suppliers

Question 35

Let’s say a distressed company wants to raise debt or equity to fix its financial problems rather than selling or declaring bankruptcy. Why might it not be able to do this?

Answer 35

• Debt: if company is too small or investors don’t believe its turnaround plan is credible, they’ll refuse to lend
• Equity: same, but worse, since lower priority. Further, getting “enough” equity to turnaround could mean selling ~100% of firm b/c of depressed market cap.

Question 36

Will the adjusted EBITDA of a distressed company be higher or lower than the value you would get from its F/S?

Answer 36

Generally higher, b/c adjusting for higher-than-normal salaries, one-time legal and restructuring charges, etc.

Question 37

Would you use levered free cash flow for a distressed company in a DCF since it might be encumbered with debt?

Answer 37

NO - want to analyze unlevered CF precisely b/c they might have higher-than-normal debt expenses. “True earnings power.”

Question 38

Let’s say we’re doing a liquidation valuation for a distressed company. Why can’t we just use the shareholders’ equity number for its value? Isn’t that equal to assets minus liabilities?

Answer 38

NO - assets will prob. be sold for fire sale value, leading to realization of less than the S/E account.

Question 39

What kind of recovery can you expect for different assets in a Liquidation Valuation?

Answer 39

A. Cash - ~100%, since highly liquid
B. Investments - varies by liquidity; close to 100% for those like cash and less for equity in other firms.
C. A/R - less than cash, since customers may not pay a distressed company.
D. Inventory - less than cash or A/R b/c useless minimal utility to another company.
E. PP&E - similar to cash for land and buildings; less for equipment
F. Intangibles - 0%. No one cares about goodwill or brand of distressed firm.

Question 40

How would an LBO model for a distressed company be different?

Answer 40

Purpose of LBO would be to assess how quickly company could repay its debts and IRR for new debt/equity investors, not determine sponsor’s IRR.

Returns probably lower since distressed.

Structurally, LBO more likely to take form of an asset purchase than a stock purchase.