Jefferies & Company, Inc.
Skadden, Arps, Slate, Meagher & Flom LLP
Corporate Restructuring:
International Best Practices
www.jefco.com
Developing Markets for
Distressed Corporate Debt
Skadden
March 23, 2004
www.skadden.com
Jefferies & Company, Inc.
>
>
A leading investment banking firm – led by one of the most powerful capital markets trading platforms
in the industry
Principal operating subsidiary of Jefferies Group, Inc. (NYSE: JEF), a holding company with an equity
market capitalization of over $2.0 billion and over 1,600 employees in 20 offices worldwide
www.jefco.com
San Francisco
Los Angeles
Chicago
Nashville
Dallas
Atlanta
Austin
Houston
New Orleans
Boston
Stamford
New York
Jersey City
Washington*
Richmond
London*
Paris*
Zurich*
Tokyo*
Skadden
Sydney**
Melbourne**
1
www.skadden.com
Skadden, Arps, Slate, Meagher & Flom LLP
and Affiliates: A Global Law Firm
CANADA
USA
•
•
•
•
•
•
•
•
•
•
2
• Toronto
Boston
Chicago
Houston
Los Angeles
Newark
New York
Palo Alto
San Francisco
Washington, D.C.
Wilmington
EUROPE
• Brussels
• Frankfurt
• London
• Moscow
• Paris
• Vienna
www.jefco.com
ASIA
• Beijing
• Hong Kong
• Singapore
• Tokyo
AUSTRALIA
• Sydney
Skadden
www.skadden.com
Speakers
> John Wm. Butler, Jr.
Partner and Co-Practice Leader
Corporate Restructuring
Skadden, Arps, Slate, Meagher & Flom LLP
www.jefco.com
> William Q. Derrough
Managing Director & Group Co-Head
Recapitalization & Restructuring
Jefferies & Company, Inc.
> N. Lynn Hiestand
Partner
Corporate Restructuring and Cross-Border Transactions
Skadden, Arps, Slate, Meagher & Flom (UK) LLP
3
Skadden
www.skadden.com
Definition of Distressed Debt
> Bank debt, private placements or public debt
of companies that:
• have defaulted on their debt obligations;
• have initiated insolvency or reorganization
proceedings;
• are in such financial distress that their debt is
trading more than 1000 basis points above
comparable US Treasury bonds; OR
• have debt trading below 70%
4
www.jefco.com
Skadden
www.skadden.com
Scope of Investments
> Distressed Debt Investors (DDIs) invest
across distressed entities’ capital structure:
• Bank and bond debt (e.g., typically defined as
“distressed debt”)
• Trade claims
• Equity
> Investment allocations across an entity’s
capital structure may be used to hedge risk
and to foster change of control transactions
5
www.jefco.com
Skadden
www.skadden.com
Sector Analysis
> DDIs invest across industry sectors
> Risk analysis includes prevalence of
defaults within industry sector
www.jefco.com
Skadden
6
www.skadden.com
Defaults by Sector
Top Ten Sectors - Number of Defaults in US 2003
Telecommunications
Printing, Publishing & Broadcasting
Metals & Mining
Chemicals
Electric Utilities
Retail
Transportation
Beverage, Food & Tobacco
Healthcare & Education
Textiles & Apparel
www.jefco.com
0
2
4
6
8
10
12
Number of Defaults
Skadden
» Source: Moody's; Fitch; Standard & Poor's; Deloitte & Touche
LLP, Distressed Debt Marketplace: Opportunities & Challenges
as the Economy Improves, Turnaround Management Association
(March 12, 2004)
7
www.skadden.com
Defaults by Volume
Top Ten Sectors - Defaults in US by Volume 2003
(US$ billions)
Electric Utilities
Healthcare & Education
Telecommunications
Transportation
Printing, Publishing &
Beverage, Food & Tobacco
Metals & Mining
Texitiles & Apparel
Chemicals
Insurance
www.jefco.com
0
2
4
6
8
Skadden
» Source: Moody's; Deloitte & Touche LLP, Distressed Debt
Marketplace: Opportunities & Challenges as the Economy
Improves, Turnaround Management Association (March 12,
2004)
8
www.skadden.com
Company Analysis
> DDIs also conduct due diligence to analyze
company risk:
•
•
•
•
•
•
•
•
9
Depressed or declining markets/sales
Shrinking margins
Operating losses/unanticipated losses
Cash crunch
Covenant violations
Aging accounts receivable/payable
Accounting irregularities
Management initiatives
www.jefco.com
Skadden
www.skadden.com
Historically Significant
Global Defaults
US REITS
1970s
Latin
America
10
1975
Japan Banking
Crisis
1989
1993
US Savings & Loan
Crisis; Canada &
Mexico
Russia, CIS,
and Czech
Republic
1997 1998
Asian
Financial
Crisis; Mexico
Europe
Others?
2002
www.jefco.com
2004
Argentina; India;
Philippines;
Taiwan; China
Skadden
www.skadden.com
Stages of Global Development
in the Distressed Debt Market
www.jefco.com
Developed, efficient market
Skadden
Currently developing
Early stages of development
Undeveloped
11
www.skadden.com
Major Distressed
Debt Investors (“DDIs”)
> Private equity investors and hedge
funds are the major players in the
industry
www.jefco.com
Soros Fund
Management
Cerberus Capital
Management
Elliott
Associates
> Mutual funds are newer participants
Skadden
12
www.skadden.com
Vibrant US Distressed Debt
Market
U.S. Secondary Loan Market Volume
(US$ billions)
www.jefco.com
150
Distressed
100
Par
50
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
0
Skadden
» Source: http://www.loanpricing.com
13
www.skadden.com
Vibrant US Distressed Debt
Market
Size of the Defaulted and Distressed Debt
Market (US$ billions)
www.jefco.com
1000
500
Face Value
20
02
20
00
19
98
Market Value
19
93
19
90
0
Skadden
» Source: Edward I. Altman, Defaults & Returns on High Yield
Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004
14
www.skadden.com
Forecasts for the US Market
Estimated & Forecasted Face and Market Values of Defaulted and Distressed
Debt
(US$ billions)
Face Value
Market Value
Face Value
Market Value
12/02 12/03 12/02 12/03 12/04 12/05 12/04 12/05
www.jefco.com
Public Debt
Defaulted
Distressed
Total Public
187.7
204.7
392.4
193.6
50.5
244.1
37.5
102.4
139.9
87.1
32.8
119.9
151.3
49.7
201.0
119.0
78.0
197.0
72.6
32.3
104.9
59.5
50.7
110.2
Private Debt
Defaulted
Distressed
Total Private
262.8
286.6
549.4
271.0
70.7
341.7
157.7
215.0
372.7
189.7
60.1
249.8
211.8
69.6
281.4
166.6
109.2
275.8
154.6
59.1
213.7
125.0
92.8
217.8
Total Public &
Private
941.8
585.8
512.6
369.7
482.4
472.8
318.6
328.0
Skadden
» Source: Edward I. Altman, Defaults & Returns on High Yield
Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004
15
www.skadden.com
Distressed Debt is Cyclical
Distressed and Defaulted Debt as a Percentage of Total
High Yield Debt Market, 1990 - 2003
www.jefco.com
50
40
30
20
10
0
Distressed
2003
2002
2001
2000
1999
1998
1995
1993
1992
1990
Defaulted
Skadden
» Source: Edward I. Altman, Defaults & Returns on High Yield
Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004
16
www.skadden.com
Possibilities for Growth
Exist in the US
Value of Distressed US Corporate Debt
(US$ billions)
www.jefco.com
480
249
102
69
44
37
97
1992
1993
1995
1998
1999
2000
410
312
2001
Q1 Q4
Q2
2002 2002*
Q3
2003**
Skadden
» Source: McKinsey Quarterly, 2003 No. 1
17
www.skadden.com
Opportunities Exist in Other
World Markets
> With some exceptions (notably, the UK), these
markets are highly undeveloped in comparison to
the US market
> Inaccurate or unavailable data provide the greatest
obstacle to market analysis outside the US
> As a result, non-performing loan market data
provides best indicator of forward trends in the
international distressed debt market
• This data may also be more relevant outside of the US
since non-US companies typically use bank debt as their
primary form of financing (due to less developed public
debt markets)
18
www.jefco.com
Skadden
www.skadden.com
Nonperforming Loans:
Asia (aggregate)
Nonperforming Loans, 2001,
(US$ billions)
1200
Japan
480
China
Taiwan
60
Thailand
46
Malaysia
32
South Korea
31
Indonesia
18
Philippines
www.jefco.com
8
Skadden
» Source: McKinsey Quarterly, 2002 No. 1
19
www.skadden.com
Nonperforming Loans:
Asia (percentage of total)
Nonperforming
Loans
Commercial
Secondary
Marketin
for
Nonperforming
3
1.5 Banks
Loans
billions
(face value)
(%$of
total loans)
14
22
300
Indonesia
South Korea
22
Thailand
14
China
1.5
Korea
Malaysia
Rest of Asia-Pacific
www.jefco.com
300
Japan
Jun. 03
Dec. 02
Dec. 01
3
Dec. 00
Philippines
Dec. 98
Thailand
0
20
40
60
Skadden
» Source: From Cyclical Recovery to Long Run Growth, World
Bank, Oct. 2003
20
www.skadden.com
Secondary Market: Asia
Secondary Market for Nonperforming Loans
(US$ billions (face value))
www.jefco.com
Japan
300
South Korea
22
Thailand
China
Rest of Asia-Pacific
14
1.5
3
Skadden
» Source: McKinsey Quarterly 2002 No. 1
21
www.skadden.com
Nonperforming Loans:
Europe
Total Nonperforming Loans
(US$ billions)
www.jefco.com
Germany
France
Italy
UK
Spain
0
50
100
150
200
250
300
Skadden
» Source: McKinsey Quarterly 2002, No. 1
22
www.skadden.com
Secondary Market: Europe
Estimated Bank Debt Trading Volume in Europe and the Middle East
(US$ billions)
50
44
35
40
30
30
www.jefco.com
36
30
28
20
20
10
0
1997 1998 1999 2000 2001 2002 2003
USD
Skadden
EUR
» Source: Loan Pricing Corporation. Change in reporting currency
in 2002
23
www.skadden.com
Exceptions to Undeveloped
International Markets
> United Kingdom
• Market has grown in the past 5 years
> Europe’s cable and telecom industry
• Debt more accessible as companies raising
capital through corporate bonds rather than bank
debt because these companies do not have the
typical assets banks are able or willing to accept
as security
• For example, Apollo Advisor invested in the
publicly traded bonds of German cable company
Kabel Hessen GmbH
24
www.jefco.com
Skadden
www.skadden.com
Value of the Market to
Corporate Restructuring
> Provides risk capital to the marketplace
> Offers liquidity
> Strengthens banking system
www.jefco.com
• Important as countries prepare for stricter requirements
under Basel II and some countries prepare to open
their borders to global competition under agreements
with the World Trade Organization
> Provides a group of investors willing to take
creative recoveries in contrast to traditional
banks
Skadden
25
www.skadden.com
Value of the Market to
Corporate Restructuring
> Provides expertise to the procedure
• Experienced investors add value by restructuring
debt or improving management of the operations
www.jefco.com
> Provides impartial outsiders
• Resolves conflicted relationships, for example
where a bank is the creditor, shareholder and is
running the distressed company
• May be in a better position to compromise claim
26
Skadden
www.skadden.com
Many Types of Entities Cannot
Work Out Debt Themselves
> Many have constraints which limit
ability to hold bad debt, including:
• Covenant restrictions
• Regulation
• Risk profiles
www.jefco.com
> Should be more likely to write off
debt/sell at a discount than risk taking
an equity stake in a restructured entity
Skadden
27
www.skadden.com
Types of Entities Typically
Subject to Bad Debt Constraints
> Insurance companies
> Certain investment firms/funds
> Commercial and/or public banks
> Collateralized debt obligations (CDOs)
www.jefco.com
Skadden
28
www.skadden.com
Why Markets Have Flourished
in North America & the UK
> Predictable outcomes
> Permissive trading under Chapter 11 in US
• Currently not regulated under Securities Laws
>
>
>
>
Experienced professionals
Fair process
Significant returns to DDIs
Developed financial markets
• Both in distressed securities and in postrestructured securities
29
www.jefco.com
Skadden
www.skadden.com
Distressed Indices Performance
> Historically distressed debt returns are negatively correlated with the
stock market
basis points
300.0
250.0
www.jefco.com
200.0
150.0
100.0
50.0
0.0
12/31/95
1/2/97
1/5/98
1/8/99
1/12/00
1/14/01
Altman-NYU Salomon Combined Defaulted Bond & Bank Loan Index
CSFB/Tremont Hedge Fund Index
S& P Returns
» Source: Edward I. Altman,
Russell 2000 Returns
1/17/02
1/21/03
1/24/04
Skadden
Defaults & Returns on High Yield
Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004;
CSFB/Tremont
30
www.skadden.com
Historical High Yield Spread
to Treasury
>
Spread correlates to default risk in market
basis points
800.0
www.jefco.com
700.0
600.0
500.0
400.0
300.0
200.0
2/1/91
5/17/92
9/1/93
12/16/94
4/1/96
7/17/97
10/31/98
2/15/00
5/31/01
9/15/02
12/31/03
Skadden
»Source: Thomson Financial
31
www.skadden.com
Post Chapter 11 Equity
> Post-bankruptcy equities that trade over-the-counter tend to be
overvalued in the plan of reorganization
Performance Relative to Reorg. Plan
by Offering Exchange after Exit
(1=Plan Price)
1.5
Performance Relative to IPO Price
after IPO
(1=IPO Price)
www.jefco.com
1.5
1.3
1.3
1.1
1.1
0.9
0.9
Nasdaq
NYSE
OTC
Nasdaq
0
30
0
27
0
24
0
21
0
18
0
15
0
12
90
60
ay
s
Skadden
D
0
30
0
27
0
24
0
21
0
18
0
15
0
12
D
OTC
90
0.5
60
0.3
30
0.7
ay
s
0.5
30
0.7
NYSE
»Source: Jefferies
32
www.skadden.com
Drawbacks of DDIs
> Short investment horizon of some
DDIs
> Contentious and aggressive
constituencies
> Confidentiality and insider problems
> Constantly changing group
Skadden
33
www.skadden.com
www.jefco.com
Obstacles to Emerging
Distressed Debt Markets
Reorganization/Insolvency Law
> Europe:
• Reorganization/insolvency law focuses on liquidation
• Senior lenders often control the process
• No consistent reorganization/insolvency regime across
Europe
www.jefco.com
> Lesser-Developed Countries
• Undeveloped reorganization/insolvency law: little
precedent makes outcomes unpredictable for investors
• Outside influences on judicial/administrative process:
political pressure
• Enforcement of judgments often difficult
Skadden
34
www.skadden.com
Obstacles to Emerging
Distressed Debt Markets
Regulatory Impediments
> Unaccommodating/inconsistent tax structure
• For example, in Germany, the tax law contains provisions
unfavorable to distressed debt investors. Further, the
government continually changes the tax law affecting
distressed debt investors, making it difficult to structure
deals
> Inefficient government approval process
• For example in China, Huarong AMC’s first distressed
debt sale took almost 3 years to complete because of
government delays
35
www.jefco.com
Skadden
www.skadden.com
Obstacles to Emerging
Distressed Debt Markets
Transparency
> Europe
• In some countries banks control the majority of corporate
debt so pricing and transaction information are difficult to
obtain
> Asia
• Difficult to get information from the AMCs, particularly
where mass loans are sold
• Necessary because AMCs are subject to intense political
and social pressures to favor certain borrowers
36
www.jefco.com
Skadden
www.skadden.com
Obstacles to Emerging
Distressed Debt Markets
Limited Players
> Few players have expertise to invest
• Europe: investing requires knowledge across multiple
legal and regulatory regimes
• Asia: must rely on foreign investors as domestic
investors do not have the institutional knowledge and
resources
www.jefco.com
Skadden
37
www.skadden.com
Possibilities for Growth
> The distressed debt market is likely to
grow rapidly over the next few years
• The availability of distressed debt to
investors will likely increase as
governments and banks become
committed to dealing with the problem
• Investors are seeking new frontiers as
traditional investment opportunities are
limited
38
www.jefco.com
Skadden
www.skadden.com
Asian High Yield Issuance
>
The Asian HY market has yet to show much of a pattern, but as markets
integrate the HY market should develop.
(US$ millions)
5,000
4,000
www.jefco.com
3,000
2,000
1,000
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
Asian High Yield
2004
Skadden
»Source: Thomson Financial. Converted to US Dollars
39
www.skadden.com
European and German
Investment-Grade
>
Due to the scarcity of data outside the US, corporate debt provides a proxy for
predicting future defaults
(US$ thousands)
1,400,000
www.jefco.com
1,200,000
1,000,000
800,000
600,000
400,000
200,000
Skadden
01
03
20
European Investment-Grade
20
99
19
97
19
93
95
19
German Investment Grade
19
91
19
89
19
87
19
85
19
83
19
19
81
0
»Source: Thomson Financial. Converted to US Dollars
40
www.skadden.com
European and German High
Yield Issuance
> High yield debt provides a particularly useful proxy for predicting defaults
(US$ millions)
30,000
www.jefco.com
24,000
18,000
12,000
6,000
Skadden
0
1995
1996
1997
1998
1999
German HY Offerings
2000
2001
2002
2003
European HY Offerings
»Source: Thomson Financial. Converted to US Dollars
41
www.skadden.com
Latin American High Yield
Issuance
>
Having been in emerging doldrums the last few years, Latin America also has
yet to show the development that European markets have.
(US$ millions)
8,000
www.jefco.com
6,000
4,000
2,000
Skadden
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Latin America High Yield
»Source: Thomson Financial. Converted to US Dollars
42
www.skadden.com
Fund Flows into CDOs by Region
>
The growth of CDOs, particularly overseas, indicates an increasing appetite
for alternative fixed income products.
www.jefco.com
Skadden
»Source: JPMorgan
43
www.skadden.com
International Trends & Solutions
> Denial and fear of selling assets at less than
their originally perceived value
> Xenophobia
> Establishment of Asset Management
Companies in Asia
> Creation of Bad Banks recently in Germany
> Growing understanding of going concern
value vs. liquidation
44
www.jefco.com
Skadden
www.skadden.com
New Trends in Insolvency Laws
EU
UK
45
The European Regulation on Insolvency
Proceedings, which came into effect in 2002
provides for the 1st uniform set of rules to resolve
conflicts (primarily jurisdiction) in cross-border
insolvencies

The Enterprise Act in effect since 2002 has
codified the London Approach of informal DIPs &
DIP financings, as well as formally strengthened
the position of unsecured creditors
Notable Impetus: Albert Fisher, Marconi,
Telecoms and US Bankruptcies
www.jefco.com

Skadden
www.skadden.com
New Trends in Insolvency Laws
France
Germany
46
The current draft law provides debtors with more
time to avoid liquidation and gives super
seniority (except for employees) to creditors that
re-negotiate repayment schedules
Notable Impetus: Alstom

The 1999 Insolvency Law, modeled on Chapter
11, provides for DIP, senior financing, automatic
stay for unsecured and temporary stay for
secured creditors
Notable Impetus: Reunification
www.jefco.com

Skadden
www.skadden.com
New Trends in Insolvency Laws
Italy
Latin
America
Recently passed legislation empowers a
restructuring commissioner for large firms.
Growing understanding of need for formal
creditors committees and greater bondholder
rights.
Notable Impetus: Parmalat

Argentina (May 2002), Mexico (2000), Brazil (in
process) are all undergoing shifts in insolvency
laws to make them more rehabilitative.
Notable Impetus: Cyclical emerging market
downturns and globalization
www.jefco.com

Skadden
Though it will take time for the spirit of these reforms to take effect, the regulatory
groundwork is in place.
47
www.skadden.com
Examples of Success
> DDIs gained initial successes through litigation
arbitrage of defaulted sovereign debt in emerging
markets. As a result, governments became aware of
workouts. (Peru, Russia & Asian crisis countries)
> A consortium led by Morgan Stanley and Goldman
Sachs purchased $1.5 billion in face value of
distressed debt from Huarong Asset Management
> Sumitomi Mitsui Financial Group and Goldman
Sachs entered into a $1.2 billion deal
> Dresdner Bank sold €511 million bundle of credits
to Deutsche Bank
48
www.jefco.com
Skadden
www.skadden.com
Stages of Global Development
in the Distressed Debt Market
www.jefco.com
Developed, efficient market
Skadden
Currently developing
Early stages of development
Undeveloped
49
www.skadden.com