Corporate Restructuring: The Breaking Wave
Chapter Summary
The restructuring cycle: categories of distress and lender behaviour
By Andrew Merrett, Managing Director and Co-Head, and Alistair Dick, Director, European Restructuring, Rothschild
Survival, as much as value maximisation, is the primary goal for many companies and their lenders at the current stage of this restructuring cycle. Three distinct categories of distressed corporate situations have become clear, each category determining the depth of restructuring that lenders are prepared to countenance: companies which generate enough cashflow to service senior debt through the cycle; companies with sufficient cashflow for operating requirements, but not to service current cash-pay debt; and companies that have a cash requirement at an operating level. In the third and most severe category, the balance of restructuring power shifts away from lenders towards new money providers
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New capital structures: sponsor challenges, valuations and creditor agendas
By Jonathan Trower, Managing Director, and Andrew Cleland-Bogle, Associate Director, European Debt Advisory Group, Close Brothers
‘Sticking plaster’ capital structures which characterised 2008 restructurings – with equity injections and covenant resets –may not stand the test of time. Private equity sponsors, some struggling for survival, now have to engage in more fundamental restructurings, where their negotiating strength depends as much on the importance of their new money to lenders’ recoveries as on the value they can add as owners. Rival sponsors, focused on distressed M&A, may also seek to provide third party new money. Agreeing on valuation is the backbone of restructuring negotiations, while CLO funds are to be to found on all steering committees and need to be understood
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The restructuring process: key issues, stakeholder perspectives and solutions
By Matthew Prest, Managing Director, and Charles Noel-Johnson, Executive Director, Recapitalization & Restructuring Group, Moelis & Company
The speed and scale of the downturn in Q4 2008, together with pressing liquidity needs, has cut the time available for management to find restructuring solutions. Given continued uncertainty over future performance, valuation remains a challenge and there are opposing interests: new equity investors will want mark-to-market valuations, but lenders will typically wish to avoid crystallising further write-downs, which is extending the restructuring cycle. Refinancing out of trouble is a thing of the past. Public equity and bond markets offer limited recourse to refinance existing bank debt; for many companies, there is little option but to work with existing lenders
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Restructuring transaction phases: from immediate needs to implementation
By Simon Davies, Managing Director, The Blackstone Group
Full balance sheet restructurings are happening mainly if a business is about to run out of money, and then speed is vital in order to salvage the business from the jaws of insolvency. However, transactions are best viewed not as short term ‘band aid’ solutions, but as long term solutions that provide the debtor with operational and financial flexibility to continue trading. What stands out today is that because of significant value loss, many companies need comprehensive balance sheet restructuring and new capital. However, ranged against achieving that is the complexity of corporate and capital structures, and the lack of visibility over future financial performance
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The impact of credit default swaps and CLOs
By Alistair Hill, Senior Associate, Allen & Overy
CDS contracts and CLO funds are a significant, new feature in restructurings. Credit derivatives, allowing for default risk to be sold separately from ownership, mean that the interests of a distressed debtor and its creditors may not be aligned. ‘Empty creditors’, waiting for a credit event, might oppose a consensual debt-for-equity swap, as already demonstrated in certain deals. As for collateralised loan obligations, which boomed in 2006-07 fuelling leverage for lower quality credits, they were always an unknown quantity going into a restructuring cycle. Because of their fund structures, CLO managers may want to prop up the system as long as possible
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Liquidity issues, loan markets and alternatives routes to capital
By Fenton Burgin, Partner, Chris Skinner, Director and Floris Hovingh, Assistant Director, Deloitte, Debt advisory team
The biggest impact of the financial crisis will be on 2006/07 private equity transactions involving aggressive business plans. Bankers must decide whether to push for debt-for-equity swaps, while sponsors need to consider injecting new funds into investee companies. Bold decisions have yet to be taken: there could be another wave of restructurings in 2010. On the funding side, LPs hold the dice as to which GPs survive and raise new funds to replace the 2005-07 vintage, while new deals must go back to basics. 2009 and 2010 are likely to remain tough, with both low levels of liquidity and tight lending criteria
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Distressed debt trading, complex capital structures and securitisation
By Sonya Van de Graaff, Partner, Bankruptcy & Finance, Brown Rudnick
Under such extreme conditions, secondary debt markets include a mix of distressed debt and discounted, performing debt - attracting both distressed buyers and primary originators.
For distressed debt, trading is where the value breaks. LBO loans, originated between 2005-2007, are under such stress that valuations have burnt through lower tranches to the top of capital structures: The debt purchase price will include a consideration of what rights the class, and other classes, have regarding the occurrence of a default. With European commercial property values plunging, and LTV covenant breaches expected, loan notes in CMBS securitisations are attracting significant interest
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Where the debt breaks: cost of capital, financial projections and market testing
By Robert Bartell, Managing Director, Duff & Phelps
Identifying where value breaks in debt structures can determine the outcome of restructurings. Slight adjustments to EBITDA, and to the enterprise value multiples applied to EBITDA, will swing equity value from deficit, across the debt structure and up towards positive. But cost of capital – traditionally the driver of enterprise value analysis – is proving difficult to estimate amid market volatility and uncertainty. Assessing the reasonableness of financial projections and business plans is another challenge, which links with the question of how much new money may be needed. There are also potential flaws in using market testing to obtain fair value
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Pensions: UK policy shifts and the role of the pension trustee
By Donald Fleming, Managing Director, Rachel Jones, Managing Director, and Tony Green, Managing Director, Gazelle Group
Progressive legislation – up to the Pensions Act 2004 and ensuing regulation – has pushed pension scheme issues up the agenda in restructurings. Ongoing funding and deficits are being dealt with earlier, sometimes under the eye of the Pensions Regulator. The more distressed a company is, the more the Pensions Protection Fund becomes a player. Where pension scheme liabilities are large, or where there is a risk of insolvency, trustees will sit at the table alongside other active creditors. Trustees can face some difficult decisions: finance deals which are critical to a company’s immediate viability may reduce member benefits in the event of insolvency
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Trade credit insurance: cover reduction and market responses
By Andrew Cavenagh, Reporter, Acquisitions Monthly
Just three insurers account for 80% of the trade credit insurance market – Euler Hermes, Atradius and Coface. Escalating payouts have pushed the big three into losses, and available insurance cover has been running at half previous levels. In some sectors, the trade creditors have been blamed for contributing to a self-fulfilling collapse of companies by withdrawing credit cover, a charge they resist strongly. Governments have launched short-term initiatives to help plug the insurance gap, and companies are being expected to manage credit exposures and risks better, but ultimately the industry is waiting for the insurance cycle to turn up again
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Automotive sector: survival of the fittest
By Philip Wylie, Director, Houlihan Lokey
Distress in the automotive sector has been widespread. In the first half of 2009, light vehicle production fell by 50% in North America and 30% in Europe. Government support packages across the US and Europe total US$100bn. There has been a record number of bankruptcy filings in the US, and fears of many more in Europe, potentially disrupting the entire supply chain. Lenders who take control rather than write off debt are banking on a risky recovery in valuations. The outlook is for further restructuring of the supplier base, and although the industry will survive, volumes will take 4-5 years to recover to 2008 levels
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Commercial property sector: predicting fall out
By Edmund O’Kelly, Senior Real Estate Restructuring Director, KPMG
Commercial property has dropped around 50% in value, but further declines are expected. Rents are still under pressure and, as they fall, so will values. Around £200bn of loans on commercial real estate are at stake, but it could be five years before values recover to meet outstanding debt. For investors who bought property at the top of the market in 2007, the problems will be magnified. A wave of fall outs is predicted, as the true scale of losses becomes apparent. Working out the commercial property debt burden could prove to be the next, watershed moment in the recession
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Retail sector: restructuring options for struggling businesses
By Michael Rutstein, Partner, Laurent Assaya, Of Counsel, and Christian Staps, Associate, Jones Day
The property-led, credit-driven consumer boom is over and the retail sector is suffering. In the UK, where the sector employs one in ten of the workforce, forecasters have predicted that 10% of all retail stores may close by the end of 2009. Familiar names such as Woolworths have already fallen. In France, out of 60,000 formal insolvencies filed in the past year across the economy, 13% were in the retail sector. In Germany, 5,000 retail businesses are expected to close their doors in 2009.
Across Europe, there are likely to be further insolvencies as retailers struggle to meet their overheads, rising costs and rental obligations
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