Tuesday, April 19th, 2011
Title II of the Dodd-Frank Act provides â€śthe necessary authority to liquidate failing financial companies that pose a systemic risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.â€ť
Under this authority, the government would have had the requisite authority to structure a resolution of Lehman Brothers Holdings Inc. – which, as readers are aware, was one of the marquis bankruptcy filings of the 2008 – 2009 financial crisis.
Readers are also aware that Dodd-Frank is an significant piece of legislation, designed to implement extensive reforms to the banking industry.Â But would it have done any better job of resolving Lehman’s difficulties than did Lehman’s Chapter 11?
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Predictably, the FDIC is convinced that a government rescue would have beenÂ more beneficialÂ - and in “The Orderly Liquidation of Lehman Brothers Holdings Inc. under the Dodd-Frank Act” (forthcoming in Vol. 5 of the FDIC Quarterly), FDIC staff explain why this is so.
The 19-page paper boils down to the following comparison between Chapter 11 and a hypothetical resolution under Dodd-Frank:
[U]nsecured creditors of LBHI are projected to incur substantial losses. Immediately prior to its bankruptcy filing, LBHI reported equity of approximately $20 billion; short-term and long-term indebtedness of approximately $100 billion, of which approximately $15 billion represented junior and subordinated indebtedness; and other liabilities in the amount of approximately $90 billion, of which approximately $88 billion were amounts due to affiliates. The modified Chapter 11 plan of reorganization filed by the debtors on January 25, 2011, estimates a 21.4 percent recovery for senior unsecured creditors. Subordinated debt holders and shareholders will receive nothing under the plan of reorganization, and other unsecured creditors will recover between 11.2 percent and 16.6 percent, depending on their status.
By contrast, under Dodd-Frank:
As mentioned earlier, by September of 2008, LBHIâ€™s book equity was down to $20 billion and it had $15 billion of subordinated debt, $85 billion in other outstanding short- and long-term debt, and $90 billion of other liabilities, most of which represented intracompany funding. The equity and subordinated debt represented a buffer of $35 billion to absorb losses before other creditors took losses. Of the $210 billion in assets, potential acquirers had identified $50 to $70 billion as impaired or of questionable value. If losses on those assets had been $40 billion (which would represent a loss rate in the range of 60 to 80 percent), then the entire $35 billion buffer of equity and subordinated debt would have been eliminated and losses of $5 billion would have remained. The distribution of these losses would depend on the extent of collateralization and other features of the debt instruments.
If losses had been distributed equally among all of Lehmanâ€™s remaining general unsecured creditors, the $5 billion in losses would have resulted in a recovery rate of approximately $0.97 for every claim of $1.00, assuming that no affiliate guarantee claims would be triggered. This is significantly more than what these creditors are expected to receive under the Lehman bankruptcy. This benefit to creditors derives primarily from the ability to plan, arrange due diligence, and conduct a well structured competitive bidding process.
Convinced?Â You decide.
Saturday, February 12th, 2011
Jones Day’s Charles Oellerman and Mark Douglas have just issued The Year in Bankruptcy: 2010.Â Â It is a (relatively) concise, thorough (81 pages), and useful compendium of bankruptcy statistics, trend analyses, case law highlights, and legislative updates for the year.
What to expect for 2011?Â According to the authors:
[M]ost industry experts predict that the volume of big-business bankruptcy filings will not increase in 2011.Â Also expected is a continuation of the business bankruptcy paradigm exemplified by the proliferation of prepackaged or prenegotiated chapter 11 cases and quick-fix section 363(b) sales. Companies that do enter bankruptcy waters in 2011 are more likely to wade in rather than freefall, as was often the case in 2008 and 2009. More frequently, struggling businesses are identifying trouble sooner and negotiating prepacks before taking the plunge, in an effort to minimize restructuring costs and satisfy lender demands to short-circuit the restructuring process.Â Prominent examples of this in 2010 were video-rental chain Blockbuster Inc.;Â Hollywood studio Metro-Goldwyn-Mayer, Inc.;Â and newspaper publisher Affiliated Media Inc. Industries pegged as including companies â€śmost likely to failâ€ť (or continue foundering) in 2011 include health care, publishing, restaurants, entertainment and hospitality, home building and construction, and related sectors that rely heavily on consumers.Â Finally, judging by trends established in 2010, companies that do find themselves in bankruptcy are more likely to rely on rights offerings than new financing as part of their exit strategies.
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Sunday, July 18th, 2010
A recent post over the July 4 holiday weekend offered a “30,000 foot view” of the 2008 world-wide financial meltdown and offered some broad observations about its causes – and remaining challenges to recovery.
From the Federal Bank of New York last week comes yet another broad overview – this one of the “shadow banking” system that has come to comprise a significant portion of the US’s (and the world’s) financial infrastructure – particularly that of the world financial markets.
In Shadow Banking, researchers Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky describe the financial components of thisÂ ad hocÂ banking system, its role in recent asset bubbles, its brittleness under stress, and the role of the Federal Reserve and other federal agencies in relieving that stress.
As described in the abstract:
The rapid growth of the market-based financial system since the mid-1980s changed the nature of financial intermediation in the United States profoundly. Within the market-based financial system, â€śshadow banksâ€ť are particularly important institutions. Shadow banks are financial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees. Examples of shadow banks include finance companies, asset-backed commercial paper (ABCP) conduits, limited-purpose finance companies, structured investment vehicles, credit hedge funds, money market mutual funds, securities lenders, and government-sponsored enterprises.
Shadow banks are interconnected along a vertically integrated, long intermediation chain, which intermediates credit through a wide range of securitization and secured funding techniques such as ABCP, asset-backed securities, collateralized debt obligations, and repo.
This intermediation chain binds shadow banks into a network, which is the shadow banking system. The shadow banking system rivals the traditional banking system in the intermediation of credit to households and businesses. Over the past decade, the shadow banking system provided sources of inexpensive funding for credit by converting opaque, risky, long-term assets into money-like and seemingly riskless short-term liabilities. Maturity and credit transformation in the shadow banking system thus contributed significantly to asset bubbles in residential and commercial real estate markets prior to the financial crisis.
We document that the shadow banking system became severely strained during the financial crisis because, like traditional banks, shadow banks conduct credit, maturity, and liquidity transformation, but unlike traditional financial intermediaries, they lack access to public sources of liquidity, such as the Federal Reserveâ€™s discount window, or public sources of insurance, such as federal deposit insurance.Â The liquidity facilities of the Federal Reserve and other government agenciesâ€™ guarantee schemes were a direct response to the liquidity and capital shortfalls of shadow banks and, effectively, provided either a backstop to credit intermediation by the shadow banking system or to traditional banks for the exposure to shadow banks.Â Our paper documents the institutional features of shadow banks, discusses their economic roles, and analyzes their relation to the traditional banking system.
Monday, July 5th, 2010
Last weekendâ€™s July 4 holiday afforded members of the US business and restructuring community an opportunity for reflection on recent economic history.Â Those who took the opportunity to do so would have benefitted from â€śThe Great Recession of 2008-2009: Causes, Consequences and Policy Responses,â€ť a recent discussion paper authored by Sher Verick and Iyanatul Islam and prepared under the auspices of the Institute for the Study of Labor (an independent think-tank associated with the University of Bonn, Germany).
According to the authorsâ€™ abstract:
“Starting in mid-2007, the global financial crisis quickly metamorphosed from the bursting of the housing bubble in the US to the worst recession the world has witnessed for over six decades.
Through an in-depth review of the crisis in terms of the causes, consequences and policy responses, [the] paper identifies four key messages. Firstly, contrary to widely-held perceptions during the boom years before the crisis, the paper underscores that the global economy was by no means as stable as suggested, while at the same time the majority of the worldâ€™s poor had benefited insufficiently from stronger economic growth.
Secondly, there were complex and interlinked factors behind the emergence of the crisis in 2007, namely loose monetary policy, global imbalances, misperception of risk and lax financial regulation.
Thirdly, beyond the aggregate picture of economic collapse and rising unemployment, this paper stresses that the impact of the crisis is rather diverse, reflecting differences in initial conditions, transmission channels and vulnerabilities of economies, along with the role of government policy in mitigating the downturn.
Fourthly, while the recovery phase has commenced, a number of risks remain that could derail improvements in economies and hinder efforts to ensure that the recovery is accompanied by job creation. These risks pertain in particular to the challenges of dealing with public debt and continuing global imbalances.”
Verick and Islamâ€™s work offers an excellent overview for anyone seeking to view economic events of the last two years through a â€świde-angleâ€ť lens.
Monday, May 17th, 2010
The esoteric world of credit default swaps and other derivative securities often appears far removed from the everyday practice of Chapter 11.Â But the impact of this little-known (and often less-understood) corner of the securities market upon the bankruptcy worldÂ has recently garnered considerable academic interest – andÂ is now attracting some legislators’ attention as well.
Several posts on this blog (beginning here) have summarized the intersection between credit default swaps and bankruptcy.Â Â Some academics haveÂ explored the potential indirect effect of these securities uponÂ out-of-court netogiations – focusing primariliy on theÂ potential problemsÂ of “holdout” creditorsÂ and theÂ ”empty creditor hypothesis.”Â Others (here and here) have offered their preliminary thoughts on the continued usefulness of the Bankruptcy Code’s “securities safe harbors,” originally included to shield financial markets from the effects of large bankruptcy filings – but now perceived as distorting creditor priorities and possibly exacerbating the financial risk created by such events.
Some portions of thisÂ debate (such as the true impact of CDS’s on corporate insolvency) continue to play out in the realities of Chapter 11 economics.Â Â Other portions (such as the continued viability of the Bankruptcy Code’s “safe harbor” rules) are beginning to work themselves – albeit slowly – into legislative proposals.
Within the last 30 days, Florida’s Sen. Bill Nelson has offered a brief, 2-page amendment to the proposed financial reform legislation now working its way through the US Senate.Â In essence, the amendment would strip the “safe harbors” out of the Bankruptcy Code, ostensibly “leveling the playing field” for all creditors.
For its simplicity, the amendment – which has no co-sponsors – has provoked still further discussion amongst academics.Â Seton Hall’s Steve Lubben commends it as a good “first step” toward amending the Bankruptcy Code,Â but believes further compromise is necessary (his proposed compromises are outlined here).Â Harvard’s Mark Roe says, in an updated research paper, that the amendment deserves “central consideration” in connection with financial reform legislation.
Monday, May 3rd, 2010
A recent post by University of Illinois’ Professor Bob Lawless over at the always-stimulating “Credit Slips” blog focuses on an often-ignored, but important, corner of the Chapter 11 world: “Small Business” Chapter 11′s.Â Â Perhaps more accurately, the post focuses on Chapter 11′s that could be – but aren’t – formally designated as “Small Business” Chapter 11′s.
Prof. Lawless – whose research interests include empirical methodologies in legal studies – recently reviewed bankruptcy data from 2007, observing that of 2,299 chapter 11s filed in 2007 where the debtor (i) was not an individual; (ii) claimed predominately business debts; and (iii) scheduled total liabilities between $50,000 and $1,000,000, only 36.8% were designated “small business” bankruptcies.Â Anecdotally, Prof. Lawless refers to one of the cases he surveyed:Â a manufacturer that scheduled about $800,000 in debt and yet did not self-designate as a small-business debtor.
So why don’t more “small businesses” that commence Chapter 11 proceedings (many don’t, but this is a different issue) claim “small business” status?
The answers from practitioners – some of whom responded on the post, and others who voiced their views on a national list-serve also maintained by Prof. Lawless. – appear to coalesce around the following:
- Congress’ 2005 amendments impose additional filing requirements.Â Section 1116 requires the provision of “the most recent” balance sheet, profit-and-loss statement, and statement of cash flows, as well as the most recent Federal income tax return.Â One busy LA practitioner noted that he avoids the “Small Business” designation for this reason.
- The “small business” deadlines are too compressed.Â For example, the Code’s exclusivity provisions generally “caps” the time period in which a “Small Business” debtor may file a Chapter 11 Plan and Disclosure Statement at 300 days.Â This period can, of course,Â be extended within the original 300-day period if the debtor can demonstrate that plan confirmation within a “reasonable period” is “more likely than not.”Â But as a practical matter, the debtor has about 10 months to get a Chapter 11 Plan and Disclosure Statement filed.
- The combination of increased reporting and compressed deadlines puts any “small business” case on a hair-trigger under the expanded dismissal provisions of Section 1112.
- Some practitioners simply overlook the designation – which appears as a “check-the-box” on the face page of the petition’s official form.
- The concept of separate “small business” treatment emerges out of “local practices” implemented by bankruptcy judges for the purpose of streamlining their own dockets, butÂ which were neverÂ reallyÂ aÂ good idea from a practical perspective.
With the possible exception of attorney oversight, these all appear emininently practical reasons for staying away from “Small Business” Chapter 11′s.
But are they always?
It may be that â€śsmall businessâ€ť cases are perceived as problematic because, in fact, they cut against the grain of the traditional law firm business model.Â For example:
- Additional filing requirements.Â There may be circumstances where the clientâ€™s non-compliance with income tax filing requirements preclude any â€śsmall businessâ€ť self-designation.Â But most businesses â€“ even troubled ones â€“ can generate a very rudimentary set of financial statements.Â Even for clients who generally operate without them, it should be possible to generate such statements (albeit very cursory ones) at the initial client interview or very shortly thereafter.Â It’s worth noting that in Californiaâ€™s Central District, the additional â€śup-frontâ€ť filing requirements are offset, at least to some degree, by the dramatically reduced monthly reporting requirements with the US Trusteeâ€™s Office.Â In one â€śsmall businessâ€ť Chapter 11 case handled last year by South Bay Law Firm, the extremely relaxed monthly operating reporting requirements were one â€“ though certainly not the only â€“ reason a â€śsmall businessâ€ť filing was recommended for the client.
- Compressed deadlines.Â Part of South Bay Law Firm’s pre-petition planning involves a review of the clientâ€™s â€śexit strategy.â€ťÂ The fundamental question is: What is the clientâ€™s perceived business objective for the contemplated Chapter 11?Â If there isnâ€™t one,Â the client has more fundamental issues to consider â€“ and the conversation typically turns to a discussion of whether or not Chapter 11 makes business sense.Â If there is a business purpose for the contemplated Chapter 11, the business purpose and the “exit strategy”Â are typically reduced to an informal â€śPlan Term Sheetâ€ť which will, itself, become the nucleus of a combined Chapter 11 Plan-Disclosure Statement.Â At South Bay Law Firm, ourÂ experience is that the combined document is generally a bit easier and less time-consuming to draft than 2 separate documents.Â And with the â€śend gameâ€ť relatively well-defined at or near the outset of the case, getting to a successful exit just got a lot easier.Â ThisÂ is a factor critical to the speed that is so important to an economically successful Chapter 11.
- More reasons for dismissal.Â It is certainly true that Section 1112 imposes draconian consequences for failure to make required filings.Â But more often, the real challenge isnâ€™t Section 1112 â€“ or the US Trusteeâ€™s Office.Â Instead, itâ€™s helping the â€śsmall businessâ€ť Chapter 11 debtor focus on the administrative requirements of a Chapter 11 â€“ and in Californiaâ€™s Central District, there are many.Â To that end, the extra discipline required up-front for a â€śsmall businessâ€ť Chapter 11 is, in fact, an important test of the debtorâ€™s ability and willingness to get through the process with success.Â If the debtor canâ€™t even comply with a few additional filing requirements, it’s preferable to know right away that this debtor will have difficulty dealing with the myriad other contingencies that are certain to emerge in even a small Chapter 11 case.
- Itâ€™s all an impractical (though perhaps well-intended) judicial idea.Â For the reasons described above, the additional filing requirements and compressed deadlines of a “Small Business” Chapter 11 may, in fact, btÂ very practical â€“ at least in the larger scope of Chapter 11 economics.Â But even if the practicalities are questionable (practicality is, after all, in the eye of the practitioner),Â their result -Â docket efficiency and speed of administration â€“ are both great sources of judicial pleasure.Â The judicial clerkship experience resident at South Bay Law Firm attests that there really is noÂ better way to make friends with everyone behind the bench than making their job easier â€“ even if the job is just a tad bit harder on counsel’s end.Â We’ll gladly invest a little extra effort if it will mean the benefit of the doubt on a â€śjump ballâ€ť in front of the person wearing the black robe.
All of this may be very interesting, but how does it implicate the law firm business model?
Only this way: In an industry predominated by an â€śhourly feeâ€ť pricing model and on bringing as much business in the door as possible, the pressure on increased speed and discipline in a “small business” Chapter 11, requires more focus (and time) up-front, drives down administrative costs, demands an internal adherence to business process, and â€śweeds outâ€ť many candidates unsuitable for Chapter 11 â€“ â€śsmall businessâ€ť or otherwise.Â This, in turn, has the effect of making â€śsmall businessâ€ť Chapter 11â€™s generally quicker and cheaper â€“ and therefore potentially less profitable, at least from an â€śhourly feesâ€ť point of view.Â It also tends, at least initially,Â to restrict or limit overall client “volume.”
However, it also has the effect of creating a relatively well-defined â€śproductâ€ť which is potentially salable to a larger segment of troubled small businesses.Â And a larger overall market segment means a larger absolute number of â€śsmall businessâ€ť debtors who are possessed of the discipline and determination to reorganize their businesses successfully.
Sunday, March 14th, 2010
In light of the tumultuous economic events of 2008 and 2009, a number of proposals for significant bankruptcy reform have surfaced – many of which have been summarized on this blog.
One of last year’sÂ posts focused on the ongoing debate over the impact of credit derivatives on failing companies, and on the continued usefulness of Bankruptcy Code provisions designed to insulate the financial markets from the bankruptcy process.
Last week, Harvard’s Mark Roe added to that discussion with a paper entitled “Bankruptcyâ€™s Financial Crisis Accelerator: The Derivatives Playersâ€™ Priorities in Chapter 11”
The essence of Professor Roe’s proposal is set forth at p. 3:
Although several of [the Bankruptcy Codeâ€™s safe-harbor super-priorities for derivatives and repurchase agreements] are functional and ought to be kept, the full range is far too broad. Most are more likely to destabilize financial markets than to stabilize them and most need to be repealed.
Professor Roe’s thoughtful analysisÂ is a worthwhile read.
Monday, March 1st, 2010
With both the global and regional Southern California economies showing early signs of life â€“ but still lacking the broad-based demand for goods and services required for robust growth â€“ opportunities abound for strong industry players to make strategic acquisitions of troubled competitors or their distressed assets.
Ray Clark, CFA, ASA and Senior Managing Director of VALCOR Consulting, LLC, is no stranger to middle-market deals.Â His advisory firm provides middle market restructuring, transactional and valuation services throughout the Southwestern United States from offices in Orange County, San Francisco, and Phoenix.
As most readers are likely aware, distressed mergers and acquisitions can be handled through a variety of deal structures.Â Last week, Ray dropped by South Bay Law Firm to offer his thoughts on a process commonly known in bankruptcy parlance as a â€śSection 363 sale.â€ť
In particular, Ray covers the â€śpros and consâ€ť of this approach.
The floor is yours, Ray.
Todayâ€™s economic environment has created an opportunity to acquire assets of financially distressed entities at deeply discounted prices, and one of the most effective ways to make those acquisitions is through a purchase in the context of a bankruptcy under Section 363 of the Bankruptcy Code (the â€śCodeâ€ť).Â When purchasing the assets of a failed company under Section 363, there are distinct advantages to being first in line.Â Depending on the circumstances, however, it may be best to wait and let the process unfold – andÂ then, only after surveying the entire landscape, submit a bid.
The 363 Sale Process
A so-called â€ś363 Saleâ€ť is a sale of assets of a bankrupt debtor, wherein certain discrete assets such as equipment or real estate â€“ or substantially all the debtor’s business assets â€“ are sold pursuant to Section 363 of the Bankruptcy Code (11 USC Â§363).Â Upon bankruptcy court approval, the assets will be conveyed to the purchaser free and clear of any liens or encumbrances. Those liens or encumbrances will then attach to the net proceeds of the sale and beÂ paid as ordered by the Bankruptcy Court.
A Section 363 sale looks much like a traditional controlled auction.Â Basic Section 363 sale mechanics include an initial bidder, often referred to as the â€śstalking horse,â€ť who reaches an agreement to purchase assets – typically from the Chapter 11 debtor, or “debtor-in-possession” (DIP). Â The buyer and the DIP negotiate an asset purchase agreement (APA), which rewards the stalking horse for investing the effort and expense to sign a transaction that will be exposed to â€śhigher and betterâ€ť or â€śoverâ€ť bids.Â The Bankruptcy Court will approve the bidding procedures, including the incentives, i.e., a â€śbust-upâ€ť fee, for the stalking horse bidder, and will pronounce clear rules for the remainder of the sale process. Â Notice of the sale will be given, qualified bids will arrive and there will be an auction. Â The sale to the highest bidder will commonly close within four to six weeks after the notice and the stalking horse will either acquire the assets or take home its bust-up fee and expense reimbursement as a consolation.Â
Advantages for the Stalking Horse Bidder
Bidding Protections - During negotiations with the debtor for the purchase of assets, the stalking horse will also typically negotiate certain protections for itself during the bidding process.Â These bidding protections, which include a bust-up fee and expense reimbursement, will be set forth in the 363 sale motion and are generally approved by the bankruptcy Court.Â As a result, stalking horse bidders seek to insulate themselves against the risk of being out-bid.Â To do so, proposed stalking-horse bidders commonly require that any outside bidder will typically have to submit not only a bid that is higher than that of the stalking horse, but will also need to include an amount to cover the stalking horse’s transactional fees and expenses.
Bidding Procedures – The stalking horse will also negotiate certain bidding procedures with the debtor, which will be set forth in the 363 sale motion that will be evaluated, and most likely approved, by the Court.Â The sale procedures generally include the time frame during which other potential bidders must complete their due diligence and the date by which competing bids must be submitted.
Other delineated procedures typically included in the motion include the amount of any deposit accompanying a bid and the incremental amount by which a competing bid must exceed the stalking horse bid. Â In addition, if the sale procedures provide for an abbreviated time frame in which to complete an investigation of the assets, a competing bidder will be at a distinct disadvantage and may be unable, as a result, to even submit a bid.
Deal Structure â€“ As the first in line, the stalking horse bidder will also negotiate all of the important elements of the transaction, including which assets to acquire, what contracts â€“ if any â€“ to assume, the purchase price and other terms and conditions.Â In doing so, it establishes the ground rules by which the sale process will unfold and the framework for the transaction, which will be difficult, if not impossible, for another outside bidder to change.Â
â€śFirst Moverâ€ť Advantage – The stalking horse bidder will typically be viewed by the Court as the favored asset purchaser in that it will have negotiated all of the relevant terms and procedures, and established its financial ability and intent to acquire the assets.Â As a result, short of an overbid by an outside party, which typically involves an additional amount to cover the stalking horseâ€™s bust-up fee and expenses, the stalking horse bidder will prevail.
Cooperation of Stakeholders â€“ As the lead bidder, the stalking horse also has an opportunity to negotiate with other key stakeholders in the process and establish a close relationship with those parties that may prove advantageous when all offers are evaluated.
Bust-up Fee and Expense Coverage â€“ Lastly, if an outside party happens to submit the high bid, the stalking horse will typically receive its bust-up fee and expense reimbursement. This generally includes items such as due diligence fees, legal and accounting fees, and similar expenses, but is limited by negotiation.Â
Disadvantages to the Stalking Horse Bidder
Risk of Being Outbid â€“ As noted, the stalking horse will expend a great deal of time, energy, and resources analyzing and negotiating for the purchase of the assets.Â All a competing bidder must do is show up to the sale and submit an over-bid.Â If the competing over-bidder prevails, the stalking horse runs the risk of walking away with only its bust-up fee and expense reimbursement.
Risk of Bidding Too High â€“ After negotiating the APA, the stalking horse then participates in the 363 sale process.Â If no other bidders materialize, it may be because the stalking horse effectively over-paid for the assets.Â
Inability to Alter Terms â€“ If some new information comes to light that would otherwise suggest a reduction in the price or alteration of the terms, the stalking horse may have difficulty altering either of these and may be locked in to the negotiated structure.
Contact email@example.comÂ or firstname.lastname@example.org.
Meanwhile, happy hunting.
Sunday, February 21st, 2010
While some global economic indicators suggest an economicÂ recovery is getting underway in earnest, research released earlier this month by global accountancy Grant Thornton LLP (and co-sponsored by the Association for Corporate Growth) argues that a fresh wave of business bankruptcy is nevertheless about to wash over US Bankruptcy Courts.
In “The Debt Effect“, a white paper addressing the present state of private equity, Grant Thornton’s Harris Smith – Los Angeles-based head of the firm’s Private Equity practice group – agrees thatÂ ”[a] global recovery is under way, albeit slowly, and there are reasons to be cautiously optimistic about 2010 and beyond.”Â Against that backdrop, however, he cautions the arrival of a nascent global recovery does not mean deal-making and the lending supporting it will immediately return to its prior levels – or that it will all look the same as before when it does.Â More importantly, he demonstrates that additional corporate distress is likely on the way.
Specifically, Harris notes that mergers and acquisition activity remains at levels that are a mere fraction of what the same activity was during 2006 and 2007.Â Moreover, a significant portion of deals done earlier in the decade are now in jeopardy:Â According to Moody’s, over 50 percent of the deals done between 2004 and 2007 by big private equity funds are now either in default or distress.Â Many of these situations have been addressed – at least temporarily – through debt extensions and other types of forbearance.Â But many of these temporary fixes are set to expire.Â Moreover, Harris’ research projects that “[t]he number of maturating loans will steadily increase until it peaks in 2013.Â The opportunities for distress buyers will continue to grow during this time because many companies will not be able to meet their debt obligations.”
According to Grant Thornton’s Marti Kopacz, national managing principal of the firm’s Corporate Advisory and Restructuring Services, â€śWe expect the restructuring wave to be a three- to five-year wave.Â This is only the first year.â€ť
Sunday, December 20th, 2009
Several posts this year – theÂ most recent one here – have noted the general buyers’ market prevalent for strategic buyers shopping for distressed M&A.
A recent CFO.com article drives home the same point, but with more specificity . . . and an important caveat.Â Kate O’Sullivan’s piece entitled “Strategic Buyers Still in the Catbird Seat” observes that though overall M&A activity has been off by as much as 1/3 from 2008 levels, strategic buyers closed 94% of this year’s deals.Â Strategic buyers appear to have a continued advantage heading into 2010, and – as was the case this year – distressed assets are expected to comprise a significant portion of next year’s deal activity.
However, the current buyers’ market is not necessarily a bargain-hunters’ bonanza.Â Though a recent survey by the Association for Corporate Growth (ACG) and Thomson Reuters (summary available here, with statistical summaryÂ here) suggests a modest pick-up in transactional volume for 2010, O’Sullivan (citing the ACG data) notes continued constraints on credit and – perhaps more importantly – a fundamental disconnect over valuations buyers and sellers are willing to accept.
Either or both factors may hamper any significant increase in deal volume over 2009, but the ACG survey suggests that pricing multiples may be the sticking point for many deals.Â “[M]ultiples for middle-market transactions in general have fallen markedly, from a high of 10.1 times EBITDA (earnings before interest, taxes, depreciation, and amortization) in 2007 to 8.4 times EBITDA today, according to survey respondents. They may go still lower: 80% of respondents say they expect to pay no more than 5 times EBITDA for targets in the next six months.”
Not surprisingly, most sellers will be reluctant to sell at prices reflecting just half the multiple they could have obtained only 36 months ago: “37% of survey respondents cite valuation problems as the biggest hurdle for deals right now.Â ‘Sellers try to argue that you shouldn’t look at the current environment when valuing their company, that it’s just a bump in the road.Â But buyers are reluctant to buy that argument,’ says [ACG Chairman Den] White.”
What buyers will buy remains to be seen.Â Stay tuned for a fascinating 2010.