Valcon 2010
Playing To Win:
Effective Valuation Analysis And Strategies
For Restructurings, Reorganizations,
Distressed Sales And Auctions
Donald S. Bernstein
Partner
Davis Polk & Wardwell,
LLP
New York, NY
J. Scott Victor
Managing Director
SSG Capital Advisors, LLC
Philadelphia, PA
Kaaran E. Thomas
Of Counsel
McDonald Carano Wilson, LLP
Reno, Las Vegas, NV
D. Bobbitt Noel, Jr.
Partner
Vinson & Elkins, LLP
Houston, TX
George Angelich
Partner
Arent Fox LLP
1675 Broadway
New York, NY
Barry M. Monheit
Senior Managing Director
FTI Palladium Partners
Phoenix, AZ
February 2010
Overview
Current Restructuring Landscape
The Distressed Company’s Options: Out of Court
Restructuring v. Chapter 11 Alternatives
Valuation Dynamics In Chapter 11
Resolving The “Battle of the Experts” Without
Litigation
2
The Current Restructuring Landscape
3
Senior Loan Volume
1999 – 1H 2009
762.4
$800B
$700B
643.8
226.2
$600B
163.2
$500B
444.8
$400B
355.8
288.2
$300B
36.2
81.4
247.7
54.8
$200B
204.2
65.7
536.2
219.3
81.2
53.7
38.2
274.4
192.9
138.5
144.8
235.7
480.6
183.0
251.9
$100B
147.0
297.9
45.6
165.7
154.5
15.0
30.6
$0B
1999
2000
2001
US Market
2002
2003
2004
2005
2006
2007
2008
1H09
European Market
Note: This chart reflects the estimated primary volume to the US and European loan markets. The US Market includes tranches denominated
in non-USD currencies as well as US dollars. The European Market includes tranches denominated in non-Euro or Sterling currencies as well
as Euros and Sterling. Exchange rates from non-USD currencies are based upon date of launch of the individual transactions.
Source: Standard & Poor’s LCD M&A Stats
4
1Q97
2Q97
3Q97
4Q97
1Q98
2Q98
3Q98
4Q98
1Q99
2Q99
3Q99
4Q99
1Q00
2Q00
3Q00
4Q00
1Q01
2Q01
3Q01
4Q01
1Q02
2Q02
3Q02
4Q02
1Q03
2Q03
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
($ in millions)
Second Lien Volume
1Q 1997 – 3Q 2009
$15,000
$12,500
$10,000
$7,500
$5,000
$2,500
$0
Source: Standard & Poor’s LCD M&A Stats
5
Number of Middle-Market Deals By Quarter
(Defined as Issuers with EBITDA of $50 Million or Less)
1Q 1997 – 3Q 2009
140
120
100
80
60
40
20
0
Source: Standard & Poor’s LCD M&A Stats
6
Total US Leveraged Buyout Volume
1996 – 3Q 2009
By Quarter
By Year
$180B
80
$160B
70
$140B
433.7
$450B
60
$300B
$120B
50
233.0
$100B
40
$80B
30
$60B
$20B
10
$0B
0
93.9
56.7
20
$40B
130.3
$150B
33.0
28.9
110.8
52.5
47.0
40.5
21.9
19.5
4.6
$0B
LBO Volume
Number of Deals
Total Common & Preferred Equity
Other Sources
Note: The volume on this page includes the Total Sources (loans, secured debt, unsecured debt, sub debt, and equity) involved in Leveraged Buyouts.
Source: Standard & Poor’s LCD M&A Stats
7
M&A Leveraged Loan Volume
1Q 1997 – 3Q 2009
$150B
105.6
95.1
91.2
$100B
70.0
62.7
60.0
51.1
$50B
45.2
31.5
51.2
51.7
51.5
39.8
34.2
32.6
66.6
64.1
45.8
41.5
31.7
24.9
20.8
15.6
29.8
26.2
17.0
16.9
11.0 10.2
35.2 33.6
29.0 31.6
21.4
18.2
14.6
9.8
9.5
32.4
31.5 31.8
12.3
10.4
11.1
10.3
5.5
4.3
4.1
0.8 2.0
4.0
$0B
Institutional
Pro Rata
Source: Standard & Poor’s LCD M&A Stats
8
Initial Institutional Defaults Loan Amounts by Quarter
Comprises Institutional Loans closed between 1995 - 3Q 2009 for Issuers that File Publicly
$30000M
$25000M
$20000M
$15000M
$10000M
$5000M
$0M
Default Date
Source: Standard & Poor’s LCD M&A Stats
9
Below Investment Grade Debt Maturity Schedule
$250B
$200B
$150B
$100B
$50B
$B
2008
2009
2010
2011
Leveraged Loans
2012
2013
2014
> 2014
High Yield Bonds
Note: Leveraged Loans include term loans, revolvers, and other loans.
Source: DealLogic, Fitch Ratings
10
Quarterly Corporate Chapter 11 Bankruptcy Filings
1Q 2005 - 3Q 2009
4,500
3,965
4,000
3,431
3,500
2,941
3,000
3,060
2,485
2,500
2,000
1,521
1,500
1,812
1,692
1,384 1,310
1,291
1,079
1,192 1,170
1,283
1,430 1,410
1,612
1,658
1,000
500
Q
1
20
05
Q
2
20
05
Q
3
20
05
Q
4
20
05
Q
1
20
06
Q
2
20
06
Q
3
20
06
Q
4
20
06
Q
1
20
07
Q
2
20
07
Q
3
20
07
Q
4
20
07
Q
1
20
08
Q
2
20
08
Q
3
20
08
Q
4
20
08
Q
1
20
09
Q
2
20
09
Q
3
20
09
0
Source: American Bankruptcy Institute
11
Restructuring Today – New Factors
Debt trading – “loan to own”
Credit bidding
Fraudulent transfer attacks on leveraged
transactions
Use of “collective action” to bind minority holders
Developing case law and practice in each area
12
The Distressed Company’s Options:
Out of Court Restructuring v. Chapter
11 Reorganization
13
Out of Court Restructuring
Types Of Restructurings
•
Debt for Equity Exchanges
•
Debt Buybacks
•
Sale of Assets/Company
•
Standstills, forbearances, overrides
14
Out of Court Restructuring (Cont.)
Obstacles
• Recalcitrant Creditors – asset grabs. How to punish hold
outs and reward cooperation
• Squeamish buyers –inability to provide warranties,
bonds, indemnities
• Inability to control/manage assets due to creditor
interference, lawsuits, threats of foreclosure
15
Out of Court Restructuring (Cont.)
Lender Obstacles
– Reluctant bank group agents
– Recalcitrant bank group members
– Inability to deleverage overleveraged assets
– Inability to reach lender consensus – especially with
perception that recession is ending, values increasing
16
Out of Court Restructuring (Cont.)
Statutory Obstacles
– Fraudulent transfer laws
– Bulk Sales laws
– Challenges to buyer if insiders of seller remain active,
get special consideration
– No binding determination of value of assets being
sold, refinanced
– Exposure to second guessing after the fact. See, e.g.,
Tousa Official Committee of Unsecured Creditors v.
Citicorp North America, et.al. Case 08-01435 Bankr.
S.D. Fla., Oct. 30, 2009 (on court website)
17
Out of Court Restructuring (Cont.)
Advantages of Out of Court Restructuring
• Cost – but may be offset by cost of controlling parties
and replacing assurances available in bankruptcy
• Time – Chapter 11 cases require (pre GM) time for
procedural safeguards. (May not be true today)
• Less Scrutiny, fewer procedural hurdles
18
Out of Court Restructuring (Cont.)
Chapter 11 Alternative -- Prepak
–
Prepak combines out of court + bankruptcy
–
Approach out of court solution as potential Chapter 11
–
Addresses holdout problem
–
Begin Chapter 11 process pre-filing like out of court
workout
–
Build in protections of Chapter 11 as last resort – or as
conclusion to out of court efforts
19
Valuation Strategy for Out of Court
Restructurings
•
•
•
•
•
•
•
Obtain supportable valuation for each party’s interest
Seek creditor approval for the valuation – attempt to
resolve any valuation disputes
Identify each party’s claim in Chapter 11 and their most
likely distribution in a liquidation
Estimate Chapter 11 costs; compare to out-of-court costs
Hire reputable advisor/credible valuation firm to use as gobetween (remember that their work will not be privileged in
litigation)
Be prepared to file if pre-defined triggers occur (cost,
assets at risk, etc.)
Negotiate “amend and extend” (aka “amend, pretend,
extend”) provisions to defer valuations
20
Criteria Guiding Selection
Debtor’s Viewpoint
• What is debtor’s goal? Reorganize? Sell? Other?
• Do operations need to be restructured or just debt?
• Value of Debtor’s assets – going concern vs. fair
market vs. liquidation
• Allies – senior secured? Junior secured?
Investor? Trade?
• How cooperative are the parties in interest
• Liquidity and available funds
• Prospect of holdouts
21
Criteria Guiding Selection (cont.)
• Senior Secured Lender Viewpoint
– Preference between sale and reorganization
• Value of collateral – going concern vs. fair market vs. liquidation
• Possibility of credit bidding
–
–
–
–
–
–
–
View of management - need for a change?
Available buyers, investors
Liquidity to reorganize - provide defensive DIP?
Lien priority issues (e.g. mechanics liens)
Potential for litigation claims
Lending group issues – first/second lien? dissidents?
Status of junior classes
22
Criteria Guiding Selection (cont.)
Junior Creditor/Unsecured Viewpoint
– Legal issues – developing interpretation of ability to sell free and clear of
junior liens under Section 363 (c)(2) outside of a plan
– 9th Circuit, Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391
B.R. 25 (9th Cir. BAP 2008). In single asset real estate case failure to
obtain a stay does not render moot appeal of order approving sale to
senior lender for credit bid free and clear of junior liens. The Panel held
that § 363(m) applies only to protect the portion of sale orders issued
under § 363(b) or (c), but not to the "free and clear" relief under § 363(f).
reversed order approving sale. No showing of a justification for
eliminating junior liens under 363(c)(2).
– Contra: In re Nashville Senior Living, LLC,407 B.R. 222(6th Cir.BAP
(Tenn.),2009). (363(m) applies to “free and clear “ section of 363(c)).
– Sale free and clear outside plan also discussed in In re Gulf Coast Oil
Corp.,404 B.R. 407(Bkrtcy.S.D.Tex.,2009.)
23
Criteria Guiding Selection (cont.)
Junior Creditor/Unsecured Viewpoint (cont.)
• Valuation Issues
– Going concern vs. fair market vs. liquidation value
• Liquidity
• Value of claims against secureds
• Strategic issues
– Value to constituents of keeping Debtor alive
(contractors, landowners, customers)
24
Criteria Guiding Selection (cont.)
Dissident Lender Viewpoint
– “Dissident Lender” means participant in loan who disagrees with
decision of majority of other participants and agent.
– Under credit documentation, dissident lender is generally bound by
the vote of majority regarding exercise (or forbearance from
exercise) of remedies.
• Recent developments under state law regarding “collective action” to
bind dissident lenders in restructuring. Beal Savings Bank v. Sommer, 865
N.E.2d 1210 (N.Y. 2007)
– In bankruptcy dissident lenders are “parties in interest” entitled to
be heard
• But can’t ignore agreements – “collective action” can apply in
bankruptcy as well.
25
Criteria Guiding Selection (cont.)
Dissident Lender Viewpoint (cont.)
– Valuation scenario – define lender’s ability to align with
group that will provide highest recovery or best leverage
• Bankruptcy clarifies the various parties in interest and their
positions
• Easier to evaluate options
– Valuation strategy
• Review participation/agency agreements for leverage
– Limits on agent powers
– Controls/sanctions on dissident lender
– Indemnity agreements, hold harmless, etc
– Evaluate which party in interest supports dissident’s
position and align with that party
26
Valuation Dynamics in Chapter 11
Valuation Alternatives
• Negotiated value (required for consensual plan or
prepak)
– The parties determine the ultimate value.
– Required for any consensual plan, including a prepack.
• Market value (usually 363 sale)
– If parties cannot agree to reorganize
• Reorganization value – valuation by the court
– Valuation to satisfy best interests test (liquidation)
– “Cram down” value in order to apply absolute priority rule
27
Negotiated Value
Negotiating Tactics – Threats (Sale, Conversion, Plan)
– “Be careful what you wish for”
– Valuation strategy
• obtain competent liquidation analysis
• identify market and possible buyers
• construct realistic alternative for key parties
– Avoid bluffing
• Threatened sales/competing plans need buyers, take out financing,
• Litigation requires funds, experts, witnesses
28
Market Value
“Testing the Market”
• Possible alternative to negotiated value if parties cannot agree
Pursuing sale concurrently with restructuring
• Sales establishes value and provides options
• Parties may be stuck with bad offers as valuation
• Evidence for all valuation purposes
• Sales of some assets deleverage estate
• Sale may remove dissidents, troublemakers
29
Market Value (cont.)
Quick 363 Sale
– GM: US government orchestrated 363 sale to US
Treasury sponsored entity to be owned by US
Government, pre-bankruptcy bondholders, UAW
union healthcare fund and the Canadian government
(Conventional?)
– Chrysler: US government orchestrated 363 asset
sale to a company to be owned by Fiat, a UAW union
retirement plan and the US government
(Conventional?)
30
Market Value (cont.)
• Caveat to “Quick Sales”
– Ability to sell “free and clear” See e.g., Clear
Channel Outdoor, Inc. v. Knupfer (In re PW,
LLC), 391 B.R. 25 (9th Cir. BAP 2008).
– Ability to sell outside plan – See e.g., In re Gulf
Coast Oil Corp.,404 B.R. 407 (Bkrtcy. S.D.Tex.,
2009.)
31
Reorganization Value
Traditional Reorganization
– Requires liquidity to finance the Chapter 11
• DIP Financing
• Cash Collateral
• Unencumbered Cash
– Requires consensus -- “Dividing up the pie” or
cramdown - risky
32
Reorganization Value (cont.)
Cram Down Value
– Determined at trial
– Requires valuation experts
– Risky – judge is least knowledgeable person in the room
– Requires multiple guesses – correct discount rate,
multiple WACC
– A “guess compounded by an estimate”
– An option of last resort
33
Valuation Dynamics In Chapter 11
34
Perspective of Debtor’s Financial Advisor
Manage The Parties’ Expectations
– Management
– Stakeholders
• Public Company
• Family Business
• Private Equity
Realistic Assessment Of What Company Can Do
The Other Professionals
–
–
–
–
Attorneys
CRO
Investment Banker
Appraiser(s)
35
Perspective of Debtor’s Financial Advisor
Prepare Management, Board for Alternatives
Organizing the Creditors
Who should the debtor “hook up” with in the process
–
–
–
–
–
–
Senior Lenders
Bondholders
Unsecured Creditors
Labor
Trade group
Suitor
36
Perspective of Debtor’s Financial Advisor
Valuation Preparations And Tactics
– Transparency of Information
• Open process
• Stop bad information
– “Sing from the same hymn book”
– Need to value assets to see what is available in the
negotiations
– Collateral for DIP
– Real Estate
– Enterprise value
• Subsidiaries
• Business plan assumptions
– Tactical Perspective
• ITS ALL ABOUT THE NUMBERS
• Choice of Valuation Methods
• Usefulness of “valuation ranges”
37
Perspective of Debtor’s Financial Advisor
Debate Over Assumptions
– ITS ALL ABOUT THE NUMBERS
– Understand the position of all the parties on
assumptions
– The equity split
• Should the debtor care
– Proposing alternatives to litigation
• Recovery model
• Assumptions regarding causes of action
– Settle? Preserve?
• Do you really want the judge to decide valuation?
Should the expert who will testify on valuation
participate in the negotiation process?
38
Perspective of Senior Lender Expert
• Inherent Tensions
– Adequate protection and priming risks
– Post-petition interest
– Plan of reorganization
• Inclination To Favor Conservative Valuation
• Tendency To “Keep Powder Dry” Early In Case
– Settle adequate protection, use of cash collateral, DIP
priming to avoid early valuation fight
• Fear: being “held hostage” by out of money
junior classes
39
Perspective of Creditor’s Committee Expert
Avoiding “Out of the Money” Presumption
– Risk in highly leveraged debtors (second lien structures)
Favor Aggressive Valuation
– Higher valuation means a higher proportion of the enterprise
value goes to unsecured creditors
– Fight tendency of debtor to take “path of least resistance”
favoring senior lenders with a conservative valuation
– Show unsecured creditors will be substantial ongoing
stakeholders
– Involvement in business plan critical -- driver of valuation range
Explore Testing Market To Enhance Credibility Of
Valuation
When All Else Fails, Play For Time: “Who knows?
Maybe the horse will talk.”
40
Resolving The “Battle of the Experts”
Without Litigation
41
Chapter 11 Valuation Negotiations
• Backdrop: Threat Of Judicial Valuation
– Contested confirmation: cram down valuation
– Non-expert judge must weigh expert testimony & decide
• Battle Of The Experts
– Valuations are “fuzzy” absent market test
– Debatable variables
•
•
•
•
•
Projections
Discount rates
Comparable companies
Replacement cost
Bankruptcy “discount”
– Wide variations in testimony
• In re Mirant Corp., 334 B.R. 800 (Bankr. N.D. Tx. 2005)
– Market vs. Expert Testimony
• In re Exide Technologies, Case No. 02-11125 Bankr. Delaware
– Court appointment of expert under FRE 706?
42
Negotiations: Role of the Experts
•
Identifying Experts
–
–
Problem Using Same Expert For Negotiation And
Litigation
Negotiating expert vs. testifying expert
•
Presenting Each Side’s Case
•
Debating Assumptions
–
–
Reconcile differences in valuations, if possible
Identifying differences in assumptions
•
•
•
Business plan
Valuation methodology
Finding Ways To Bridge The Gap
43
Negotiations: Bridging The Valuation Gap
“Parallel Track” Sale Process
•
•
–
–
–
–
–
Simultaneously pursuing sale and reorganization
In re Adelphia Communications Corp., Case No. 02-41729 Bankr.
S.D.N.Y.
Sale in lieu of reorganization
In re Chrysler LLC, Case No. 09-B 50002 Bankr S.D.N.Y. Appeal of
sale order: In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009)
In re General Motors Corp. Case No. 09-50026 Bankr S.D.N.Y.
In re Delphi Corp. Case No. 05-44481 Bankr. S.D.N.Y.(“Delphi”)
Possibility of credit bid to keep the process honest (Delphi)
Third party intervention
–
Mediators and Examiners
Rights Offerings
–
–
“Put your money where your mouth is.”
Rights offerings are viable way to bring valuation negotiations
to a close.
44
Negotiations: Rights Offerings
Opportunity to “buy in” to restructuring
– Provides a form of consideration for potentially out-ofthe money classes
– A way to avoid a contested confirmation hearing.
There is typically a backstop
– Underwritten by an existing creditor/investor (hedge
fund).
45
Negotiations: Contingent Value Plans
Reallocation of consideration based on future valuation
Allocation Formulas For Contingent Assets, Contingent
Distributions
–
Classic example: In re Penn Central Transp. Co., Case No 70347 Bankr. E.D. Pennsylvania
•
Litigation claims against United States were valuation variable
Securities With Option Features
–
–
–
–
Allow future market value to determine plan allocations
Warrants
Convertible securities
Valuation of options
•
•
Negotiating over Black-Scholes valuations (“VAR”)
See, e.g., In re Conseco, Inc., Case No. 02 B 49672 (Bkr. N.D. Illinois,
Eastern Division
46