Ian H. Giddy/NYU
Distress Valuation-1
Distress Valuation
Prof. Ian Giddy
New York University
What’s Marvel worth?
Who’s winning?
Who’s losing?
Ian H. Giddy/NYU
Distress Valuation-2
When Default Threatens,
Value the Company
Highest Valuation of Company?
Merged Value
Sale to Strategic Buyer
Going Concern Value
Auction
Voluntary Reorganization Ch 11 Reorganization
Liquidation Value
Voluntary Liquidation
Ch 7
Existing Management New Management
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 3
Example of Valuation:
Zombie, Inc.
Zombie, Inc
Share Valuation
Shares
Book Value
Acquisition Value
Management Est.
NPV, based on
EBITDA
WACC
Growth
Debt
Going Concern Value
$
$
$
Before
400,000
10.00 $
8.00
20.00 $
After
850,000
10.00
9.41
1,100,000
1,100,000
17.48%
11.22%
2.5%
2.5%
10,100,000
5,600,000
$
(6.43) $
8.62
Option value?
Bank lenders
Debt (at market)
Equity (NPV value)
Total
Copyright ©2003 Ian H. Giddy
Before
7,182,749
0
7,182,749
After
4,500,000
3,876,905
8,376,905
Corporate Financial Restructuring 4
Ian H. Giddy/NYU
Distress Valuation-3
Valuation in Distress Restructuring
q Liquidation
value
q Acquisition price
q Enterprise value
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 6
Enterprise Valuation in Distress
Restructuring
q Multiples
q FCFF
discounted at WACC
q APV
q Capital
Cash Flows
q Option Value
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 7
Ian H. Giddy/NYU
Distress Valuation-4
Multiples in Distress
Allied Industries
Multiples: Enterprise Value
Industry (D+E)/EBIT
Allied EBIT
Allied est. Enterprise Value
12.9
32
412.8
Do
Dothese
thesemake
makesense?
sense?
Source: morningstar .com
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 8
Free Cash Flows to the Firm @ WACC
Historical
financial
results
Adjust for
nonrecurring
aspects
Gauge
future
growth
Projected sales
and operating
profits after tax
Adjust for
noncash
items
Projected free cash flows
to the firm (FCFF)
Year 1
FCFF
Year 2
FCFF
Year 3
FCFF
Year 4
FCFF
Discount to present using weighted
average cost of capital (WACC)
Present
value of free
cash flows
Copyright ©2003 Ian H. Giddy
+ cash,
securities &
excess assets
- Market
value of
debt
…
Terminal year FCFF
Stable growth model
or P/E comparable
Value of
shareholders
equity
Corporate Financial Restructuring 9
Ian H. Giddy/NYU
Distress Valuation-5
Free Cash Flows to the Firm @ WACC
Allied Industries
FCFF@WACC: Enterprise Value
EBIT
EBIT after tax @34%
Adjustments
FCFF
Terminal Value
NOL tax shield
Debt
WACC
PV
Enterprise value
1
32
21.1
2
34.4
22.7
3
87.9
58.0
4
90.3
59.6
5
163.2
107.7
-2.1
-9.3
39
36.8
2.7
300
10.0%
0.5
638.7
3.4
302
10.0%
-4.9
21.9
311
9.9%
45.9
19.6
272
10.5%
37.9
68.7
876.6953
0
235
11.1%
559.2
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 10
Capital Cash Flow Method
Use NPV approach
q Project cash flows based on:
q
u Net
income: (R-C-D-I)*(1-t)
u + Loss tax shield: NOL*t
u +Cash Flow Adjustments: D-CE-∆WC+Asset sales
u +I
Find terminal value based on CF(1+g)/(r-g)
q Discount at unlevered WACC, ie cost of equity
with Beta: βu
q
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 11
Ian H. Giddy/NYU
Distress Valuation-6
Capital Cash Flow Method
Allied Industries
Capital Cash Flow Enterprise Value
EBIT
Tax at 34% after NOLs
EBIAT
Adjustments
FCFF
Terminal Value
Ra
PV
Enterprise value
1
32
0
32.0
-10.0
22.0
2
34.4
0
34.4
-19.2
15.2
3
87.9
0
87.9
-25.5
62.4
4
90.3
4.2
86.1
-29.0
57.1
12.0%
19.6
711.3
12.0%
12.1
12.0%
44.4
12.0%
36.3
Copyright ©2003 Ian H. Giddy
5
163.2
50
113.2
-28.4
84.8
970.5
12.0%
598.8
Corporate Financial Restructuring 12
Option Value
For
For some,
some, The
The riskier
riskier the
the better!
better!
Mean
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 13
Ian H. Giddy/NYU
Distress Valuation-7
Common Stock as a Call Option
q
q
q
The equity in a firm is a residual claim, i.e., equity
holders lay claim to all cashflows left over after other
financial claim-holders (debt, preferred stock etc.)
have been satisfied.
If a firm is liquidated, the same principle applies, with
equity investors receiving whatever is left over in
the firm after all outstanding debts and other
financial claims are paid off.
The principle of limited liability, however, protects
equity investors in publicly traded firms if the value of
the firm is less than the value of the outstanding debt,
and they cannot lose more than their investment in
the firm.
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 14
Payoffs to Shareholders on Liquidation
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 15
Ian H. Giddy/NYU
Distress Valuation-8
Option Pricing Model
ENTER THESE DATA:
=================
-> FUTURES PRICE
-> STRIKE PRICE
-> TIME IN DAYS
-> INTEREST RATE
-> STD DEVIATION
94.75
94.5
300
7
15
1.8
CALL OPTION PRICE
1.6
CALL PRICE IS.........
1.4
PUT PRICE IS.......
0.40
0.17
1.2
1
0.8
0.6
0.4
0.2
0
Copyright ©2003 Ian H. Giddy
93
93
94
94
95
FUTURES PRICE
95
96
96
Corporate Financial Restructuring 16
Black-Scholes Option Valuation
Co = So N(d1) - Xe-rTN(d2)
d1 = [ln(So/X) + (r + σ2/2)T] / (σ T1/2)
d2 = d1 - (σ T1/2)
where
Co = Current call option value.
So = Current stock price
N(d) = probability that a random draw from a
normal dist. will be less than d.
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 17
Ian H. Giddy/NYU
Distress Valuation-9
Marvel’s Option Value, Nov. 96
Option Value
When
When Marvel’s
Marvel’s stock
stock
price
priceisisbelow
below$9.18,
$9.18,
Perelman’s
Perelman’sinvestment
investment
ininthe
theHolding
Holding
Companies
Companiesisis
worthless
worthlesson
onaa
liquidation
liquidationbasis,
basis,but
but
still
has
option
still has optionvalue.
value.
Breakeven
Breakevenstock
stockprice
price
=Debt
value/No.
of
=Debt value/No. ofcollateral
collateralshares
shares
Debt
Debt value=Mkt
value=Mktprice*face
price*face value
value (Ex
(Ex 6)
6)
Collateral
shares=77.3m
Collateral shares=77.3m
=$709.5/77.3
=$709.5/77.3
=$9.18
=$9.18
nn
nn
Breakeven stock price
Nov 96 stock price
Copyright ©2003 Ian H. Giddy
$4.63 $9.18
Marvel Ent. Price
Corporate Financial Restructuring 18
The Conflict Between Bondholders and
Stockholders
q
Stockholders and bondholders have different
objective functions, and this can lead to conflicts
between the two.
u For instance, stockholders have an incentive to take riskier
projects than bondholders do, and to pay more out in
dividends than bondholders would like them to.
q
Since equity is a call option on the value of the firm,
an increase in the variance in the firm value, other
things remaining equal, will lead to an increase in
the value of equity.
u It is therefore conceivable that stockholders can take risky
projects with negative net present values, which while
making them better off, may make the bondholders and the
firm less valuable.
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 19
Ian H. Giddy/NYU
Distress Valuation-10
Vulture Investors
q
q
q
q
These funds typically buy large blocks of debt (often
across different seniority classes) in distressed firms in
order to gain a seat at the bargaining table.
As the term “vulture” implies, these investors have been
viewed as “bondmailers” who seek only to delay and
disrupt reorganizations in order to extract concessions
from debtors.
But by consolidating large blocks of debt, vulture
investors facilitate restructurings by reducing the number
of claimholders and aligning incentives across seniority
classes.
3 largest players: Trust Company of the West, Fidelity
Management and Research, and Apollo Investors.
Example:
Example:Trust
TrustCompany
Companyofofthe
theWest
Westplayed
playedaacrucial
crucialrole
roleininfacilitating
facilitating
the
theprepackaged
prepackagedbankruptcy
bankruptcyofofKinder-Care
Kinder-CareLearning
LearningCenters
Centersby
bybuying
buying
up
most
of
that
firm’s
bank
debt
and
subordinated
debentures.
up
most
of
that
firm’s
bank
debt
and
subordinated
debentures.
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 20
Ian H. Giddy/NYU
Distress Valuation-11
Marvel
q
1. Why did Marvel file for Chapter 11? Were the problems
caused by bad luck, bad strategy, or bad execution?
q
2. Evaluate the proposed restructuring plan. Will it solve the
problems that caused Marvel to file for Chapter 11? As Carl
Icahn, the largest unsecured debtholder, would you vote for the
proposed restructuring plan? Why or why not?
3. How much is Marvel's equity worth per share under the
proposed restructuring plan, assuming it acquires Toy Biz as
planned? What is your assessment of the pro forma financial
projections and liquidation assumptions?
4. Will there be a "contagion effect," making it difficult for Marvel
or other companies in the Perelman group to issue debt in the
future?
q
q
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 22
Source of Problem?
q Bad
luck?
q Bad strategy? “Diversified youth
entertainment company”
q Bad execution?
uOverpaying
for acquisitions
uCOGS 50% → 65%, SG&A 19→28%
q Bad
Copyright ©2003 Ian H. Giddy
finance?
Corporate Financial Restructuring 23
Ian H. Giddy/NYU
Distress Valuation-12
Bad Finance?
Financing Ratios
Debt/Capital
D/(D+E)
Year Total Debt
1991
1992
236.3
1993
250.2
1994
384.3
1995
586.5
1996Q3
654.5
73.60%
62.90%
61.30%
73.80%
78.40%
Copyright ©2003 Ian H. Giddy
Interest Coverage
EBITDA/Interest
10.1X
10.4X
8.2X
8.oX
1.2X
1.4X
Corporate Financial Restructuring 24
Marvel Structure
Marvel Group
Shareholders
Perelman 100%
Holding Company
Bondholders
Icahn 25%
78.8%
Public shareholders
18.8%
Marvel Entertainment
Creditors
26.7%
Toy Biz
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 25
Ian H. Giddy/NYU
Distress Valuation-13
Perelman Proposal
q Buy
427m new shares for $365m @
$0.85
q Pay Marvel creditors in full
q Acquire 100% of Toy Biz to use NOLs
q Bondholders get 15% of shares (77.3m)
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 26
Marvel
n
Banks
n
n
Choices:
n Accept Perelman’s plan
n Sell the debt at $.14-$.17
n Reject plan and propose own
n
Controls Marvel equity
NPV is negative
Option value may be positive
Icahn et al.
Perelman
n
n
Copyright ©2003 Ian H. Giddy
Secured and senior
Get fully repaid under plan
Corporate Financial Restructuring 27
Ian H. Giddy/NYU
Distress Valuation-14
Perelman’s Strategy
q Has
control for 120 days (under Ch 11)
q Holds an out-of-the-money call option
q He can credibly destroy bond debt value
q Hence can extract rents from
bondlholders
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 28
Decision Time
q
q
q
q
Evaluate the proposed restructuring plan. Will it solve
the problems that caused Marvel to file for Chapter
11?
What is the company worth?
As Carl Icahn, the largest unsecured debtholder,
would you vote for the proposed restructuring plan?
Why or why not?
What other options does Perelman have?
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 29
Ian H. Giddy/NYU
Distress Valuation-15
Decision Time
Perelman
Perelman
Shareholder
Shareholder
Group
Group
Copyright ©2003 Ian H. Giddy
Icahn
Icahn
Bondholder
Bondholder
Group
Group
Corporate Financial Restructuring 30
What Happened
Feb 26 – judge lets bondholders seize their
collateral
q Perelman withdraws his plan
q Icahn & bondholders propose own plan to
change management,
q Divest Sky Box and Panini & forgive $385 debt
q Issue rights offering for working capital, pay off
DIP, pay most of bank debt
q Increased value of shares, est. $0.85 to est $2+
q
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 31
Ian H. Giddy/NYU
Distress Valuation-16
Marvel Stock Price
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 32
Marvel Zero-Coupon Bond Price
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 33
Ian H. Giddy/NYU
Distress Valuation-17
Update
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 34
Alphatec
What really caused Alphatec's collapse?
q What was the January 1999 rehabilitation
proposal?
q What, specifically, is the "performance-linked
obligation?"
q Does the January 1999 Rehabilitation Plan
meet investors’ expectations? Look at it from
the point of view of:
q
u Existing
creditors
equity investors
u A possible management buyout
u New
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 35
Ian H. Giddy/NYU
Distress Valuation-18
Contact Info
Ian H. Giddy
NYU Stern School of Business
Tel 212-998-0426; Fax 212-995-4233
Ian.giddy@nyu.edu
http://giddy.org
Copyright ©2003 Ian H. Giddy
Corporate Financial Restructuring 39