Valuing Distressed Debt

Course Overview

The valuation of a distressed debt security requires significant judgment, not least because the traditional approaches to valuation are invariably undermined by the absence of reliable financial forecasts. In this context, valuation may be affected to a material extent by other, extraneous factors which, in some cases can often have an as much of a bearing on value as the valuation methodology.

Course Content

Overview of Debt Markets

Introduction to the various segments in the debt markets. Most distressed credits will have been high yield pre-distress but a few credits may have started out as I-Grade before they became fallen angels

• The key market segments
• Investment grade (I-Grade)
• High yield (Sub-investment) grade
• Secondary market

Anatomy of a deal

• Anatomy of a Leveraged deal
• Typical leveraged structures (sponsored)
  • Structures pre GCC
  • Current Structures (e.g Priory)
• Typical leveraged structures for Corporates / Sponsor-less Deals (e.g. Virgin Media)
• Typical I Grade structure
  • Key differences between I-Grade and High Yield
  • Security documentation issues

Status/timeline in distress

• Overview of the distress timeline – from decline to enforcement / liquidation
• Early stage decline / smoke signals
• Default vs Event of Default
• Issues arising out of the Steering Committees
  • Role of the Committee
  • When to form & why
  • Who is appointed, getting appointed
  • Who to exclude & why
• Standstill Agreements
  • Typical terms and clauses
  • Dealing with information
  • Transfers & sales
• Formal (Court) Processes
  • Administration
  • Receivership
  • CVA
  • Liquidation

Triggers for restructuring

Restructuring can be triggered by various factors but directors’ personal liability for wrongful trading is usually the key

• Typical early warning signals of distress
• Triggers for non-leveraged corporates (non I-grade)
• Additional triggers for Listed companies
• Triggers & issues specific to leveraged deals
• The main catalyst for restructuring
  • Insolvency defined
  • Directors’ liability

Valuation methodologies

Valuation lies at the heart of any investment or credit decision. However, valuation methods that rely on forecasting future cash flows (or profits) may often be extremely unreliable when the company is in distress and other, extraneous factors may have as great or even greater bearing on value.

• Difference between Enterprise & Equity Value
• Concept of Fair Value
• Overview of Valuation approaches and methods
  • DCF & NPV
  • Comparable companies (CoCos)
  • Comparable transactions (CoTrans)
  • Multiples – Sales, EBITDA, EBIT, PER
  • Net Asset Value / NBV
• Review of the approaches used in IMO Carwash case
• Critical issues in valuing distressed firms
  • Cash flow forecasts
  • Importance of working capital (why it really matters)

Sources of Information

Financial and other relevant Information is critical to developing an acceptable valuation range of the firm or asset. The availability and accessibility of such information will turn on a range of factors critically whether the investor is an existing or new investor. Obtaining information on Listed securities (e.g. Note) is comparatively easy but accessing information on private debt markets can be extremely difficult for potential investors with no locus standi

• Listed Obligations (Bonds, Notes)
  • Sources & availability of information
  • Reliability of available information
  • Market price as a benchmark
  • Issues with distorted markets
• Unlisted Obligations (Loans, Mezz etc)
  • Sources of information for existing holders
  • Steps or rights available to acquire the information under the Loan
  • Reliability of the information
  • Issues in dealing with Steering committees

Problem areas (hidden liabilities)

Identifying the full extent of the liabilities is never easy and, for distressed firms, the lack of timely and reliable information can inhibit this process. Additionally, various restructuring scenarios can produce a range of varying outcomes for these liabilities (e.g. renegotiating leases)

• Pension liabilities
  • defined vs final salary schemes
• Employee contracts (esp Senior employees)
• Legal claims (arising from  decline in quality of products or services)
• Regulatory / legal issues (e.g. Environmental issues, Bribery Act)
• Leased properties
• Exceptional, one-off items (e.g. Restructuring costs)
• Complex inter-company accounts

Reasons for distress

Where the company is overleveraged, rebalancing the capital structure can be done more quickly than having to address strategic issues

• Wrong capital structure / Over-leveraged
• Operation issues
• Strategic issues
• Market dislocation (GCC)

Position in the Capital Structure (Ranking)

Stakeholders in the fulcrum capital will often drive the restructuring process so finding where the value breaks is a key issue for investing in distressed debt. The fair value of a debt obligation expected to receive a partial recovery is often the most difficult to estimate due to the uncertainty surrounding both a distressed company’s value and the value of the individual security.

• Concept of the fulcrum capital
  • What it is and how to find it
  • Why & how it can affect value
• Senior obligations (typical rights and characteristics)
  • Loans
  • Notes (Bonds) Fixed & FRNs
• Junior securities (typical rights and characteristics)
  • Second Lien
  • Mezzanine
  • PIK Loans and Notes
• Issues impacting the ranking (senior, junior)
  • Contractual Subordination
  • Structural subordination
  • Secured vs Unsecured obligations

The role of Security

Historical data has shown that secured lenders invariably achieve a better recovery in distress but having security is not enough

• Nature of security in UK, Europe & the US
• Types of Security in UK (overview)
• Relevance of Financial Assistance in UK, Europe
  • Transactions vulnerable to attack
  • Transactions at an undervalue
  • Transactions defrauding creditors
  • (Voidable) Preferences
• Hot topics
  • Controlling the Security agent
  • Valuation of assets in distress (role of the Security Agent in Loans and Notes)
  • Review of European Directories case

Structure of (Lending) syndicate

The composition of Lending syndicate can include primary and secondary players with competing agendas (e.g. yield, value arbitrage, loan to own) with differing pain thresholds which can also affect the restructuring proposals and thus value

• Profile of primary payers
• Profile secondary players
• Key issues – Thresholds for voting, acceleration, enforcement, amendments
  • Super-majorities vs majorities vs traditional 2/3rds
• Transfer rights and restrictions
  • Consultation vs Consent
  • Blacklists
  • Impact post default

Jurisdiction issues (Forum shopping)

Forum shopping (Jurisdictional) has become increasingly topical and can have material impact on valuation (e.g. Wind Hellas).

• UNCITRAL Model Law – summary of relevant issues
• CoMI Defined & impact on valuation
• Key Requirements to move CoMI
• Review of key cases (Eurofoods, Bear Sterns Hedge Fund)
• US aspects Chapter 15 (Almatis case)

Debt for Equity swaps

Holders of debt will often end up some form of equity via a D4E swap. This section looks at the issue of D4E and the critical issues that follow

• Debt for Equity Rationale
• Formal requirements
• Valuation of the new equity
• Using appropriate “equity” instruments to arbitrage the value gap
  • PIK & PIYC loans and notes
  • Convertible Loans
  • Preference Shares
  • Equity
  • Warrants
• Issues for the New Equity
  • Shareholder protection
  • Board representation & Information issues
  • Exit issues
  • Other matters

Tactics for Managing Key Stakeholders to best effect

The success enjoyed by Oaktree Capital illustrates the importance of adopting the right tactics. Buy too high (safely) risk achieving a low return investors but buy too high and risk losing all.

• Managing the Lead Banks/ MLA & other lenders
• Issues with Junior lenders
• Issues with Suppliers, Landlords and Customers
• Matters affecting Management & Staff
• Issues affecting Corporate Lenders
• Additional matters for Issues for Listed companies
• Matters specific to Leveraged transactions

Delivering this course in-house for you to a number of participants could be very cost effective. Please call us on 020 7387 4484 to discuss this further.

If you have any questions about this seminar please write to us at post@redcliffetraining.co.uk.