Restructuring Flashcards
Pass technical questions
What do you do in restructuring?
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.
What are the two sides of a restructuring deal?
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.
Why are you interested in restructuring?
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.
How are you going to use your experience in restructuring for your future career goals?
- Stay in RX IB
- Best background for distressed/special situations
How would a distressed company select its restructuring bankers?
Requires extremely specialized knowledge and relationships:
(i) experience doing similar deals and
(ii) relationships with the parties in interest.
Why would a company go bankrupt in the first place?
- Can’t meet its obligations / interest payments
- Creditors accelerate debt payments and force company into bankruptcy
- Acquisition goes poorly or company has written off the value of its assets steeply and needs extra capital to stay afloat
- Liquidity crunch - can’t afford to pay vendors/suppliers
What options are available to a distressed company that can’t meet debt obligations?
- Refinance and obtain fresh debt / equity
- Sell the company (as a whole or in pieces via asset sale
- Restructure financial obligations to lower interest payments / debt repayments, or issue debt with PIK interest to cut cash interest expense
- File for bankruptcy: obtain additional (DIP) financing, restructure obligations and be freed of onerous contracts.
What are the pros/cons of each option?
- Refinance:
A. Pro - least disruptive, help revive confidence
B. Con - difficult to attract investors to distressed firm - Sale:
A. Pro - SH could get some value, creditors less mad
since funds are coming
B. Con - may only get fire sale value - Restructuring:
A. Pro - quickly resolve problems w/o 3rd parties
B. Con - lenders reluctant to increase exposure to firm;
tensions b/w mgmt. / lenders - 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
What strategies do creditors have to recover their capital in a distressed situation?
- Lend additional capital / grant equity to company
- Conditional financing - only agree to invest if co. cuts expenses, stops losing money and agrees to other terms / covenants
- Sale - force company to hire banker and shop itself/assets
- Foreclosure - bank seizes collateral and forces a BR filing
How are restructuring deals different from other types of transactions?
- More complex, involve more parties, require more specialized/technical skills and must follow Bankruptcy Code
- Negotiations are bigger than bilateral
What’s the difference between Ch. 7 and Ch. 11?
- Ch. 7 - liquidation. Sell off assets to repay claims.
- Ch. 11 - reorganization. Change terms/renegotiate.
What’s DIP financing and how is it used with distressed companies?
Money borrowed by debtor on a superpriority basis. For that and other reasons, lenders consider it safe.
How would you adjust the 3 F/S for a distressed company when you’re doing valuation or modeling work?
- 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
Would those adjustments differ for public companies vs. private companies?
Excess salaries - harder to manipulate in a public firm
If the market value of a distressed company’s debt exceeds its assets, what happens to its equity?
- Book equity - turns negative (A = L +E, L > A)
- Market cap - remains positive
In a bankruptcy, what is the order of claims on a company’s assets?
- Administrative claims
- DIP lenders
- Secured creditors (RCFs + TLs)
- Unsecured creditors (HY)
- Sub debt investors (sub. HY)
- Mezzanine investors (converts, pref., PIK)
- Common equity
How do you measure the cost of debt for a company if it is too distressed to issue additional debt?
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.
How would valuation change for a distressed company?
- 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.
How would a DCF analysis be different in a distressed scenario?
- More value comes from TV, given CF-negative turnaround period
- Sensitivity on hitting/missing earnings forecast
- Add operating distress premium to WACC
If you’re selling a distressed company, how would the M&A process differ from for a healthy company?
- Timing is quicker - sell or go bankrupt
- May producer fewer upfront marketing materials (i.e., Info Memo, Mgmt. Presentations) in the interest of speed
- Creditors often initiate the process
- Distressed sales can’t “fail” - result in a sale, bankruptcy or a restructuring.
What are the differences between stock purchases and asset purchases, and which would buyers/sellers in distressed sales prefer?
- 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.
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?
YES - in a distressed sale you have almost no negotiating leverage (distressed co.), so competition is best way to improve sale price.
Sometimes a distressed sale doesn’t end in a conventional stock/asset purchase - what are some other possible outcomes?
- Foreclosure
- General assignment (faster alt. to bankruptcy)
- Section 363 asset sale
- Ch. 11
- Ch. 7
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?
YES - to increase bidding/competition and drive a higher purchase price.
Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?
It depends, but probably not. If debts > assets not much to get, esp. in liquidation.
Let’s say a company wants to sell itself or simply restructure its obligations - why might it be forced into a Ch. 11 bankruptcy?
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.
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?
- 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
What kind of companies would most likely enact debt buy-backs?
Over-levered companies that were acquired by PE sponsors in LBOs, now facing burdensome interest payments and have excess cash.
Why might a creditor have to take a loss on the debt it loaned to a distressed company?
Junior (esp. unsecured) creditors may fall below the line - not enough to repay in full.
What is the end goal of a given financial restructuring?
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).
What’s the difference between a Distressed M&A deal and a Restructuring deal?
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.
What’s the difference between acquiring just the assets of a company and acquiring it on a “current liabilities assumed” basis?
- 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.
How could a decline in a company’s share price cause it to go bankrupt?
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.
What happens to A/P days with a distressed company?
They get very high b/c can’t pay vendors / suppliers
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?
- 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.
Will the adjusted EBITDA of a distressed company be higher or lower than the value you would get from its F/S?
Generally higher, b/c adjusting for higher-than-normal salaries, one-time legal and restructuring charges, etc.
Would you use levered free cash flow for a distressed company in a DCF since it might be encumbered with debt?
NO - want to analyze unlevered CF precisely b/c they might have higher-than-normal debt expenses. “True earnings power.”
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?
NO - assets will prob. be sold for fire sale value, leading to realization of less than the S/E account.
What kind of recovery can you expect for different assets in a Liquidation Valuation?
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.
How would an LBO model for a distressed company be different?
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.
