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    Posts Tagged ‘valuation’

    Valuing Companies in Chapter 11 – Courts Weigh In On Supportability Of Assumptions

    Wednesday, July 6th, 2011

    Guest-blogger Ray Clark of Valcor (whose prior posts appear here, here, and here) has recently completed a succinct but helpful piece on the valuation of firms in Chapter 11.

    Ray’s piece focuses on the supportability of assumptions underlying valuations.  As he notes:

    Over the last year, there have been a rash of bankruptcy cases and related lawsuits involving challenges to both debtor and creditor financial experts, wherein opposing parties successfully attacked the relevance and reliability of valuation evidence. In a number of cases, even traditional methodologies were disqualified for lack of supportable assumptions, which severely impacted recoveries for various stakeholders.

    The piece is here.

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    The Value of Valuation

    Monday, March 29th, 2010

    Many readers of this blog understand the importance of asset and enterprise valuation at a number of stages of the bankruptcy process.  Whether it be specific collateral (to address a secured creditor’s concerns) or enterprise value (to determine the viability of a Chapter 11 plan), or for purposes of a fraudulent transfer or an asset sale, the discipline and methodology of valuation forms a fundamental touchstone of business insolvency practice.

    A recent Delaware Bankruptcy Court decision highlights the use of valuation in yet another context:  The appointment of equity committees.  In the Chapter 11 cases of Spansion, Inc. and its affiliates, Judge Kevin Carey reviewed the request of an ad hoc equity committee’s request for official sanction and appointment by the Office of the US Trustee.  To evaluate the committee’s request, Judge Carey turned to case law holding that the appointment of an equity committee depends upon:

    - the substantial likelihood of a distribution to equity holders after all creditors are paid; and

    - equity holders’ inability to represent themselves without such an official committee.

    Central to Judge Carey’s decision was a detailed analysis of the anticipated distribution to equity holders.  Spansion’s disclosure statement, submitted with its proposed Chapter 11 plan, valued the debtors’ enterprise value at less than the amount of creditors’ claims and therefore left nothing for equity.  The ad hoc equity committee (not surprisingly) believed enterprise value after payment was sufficient that equity holders should have a collective voice with respect to the proposed plan.

    Both sides submitted extensive evidence in support of their positions.  Unlike the debtors’ “full-blown” valuation, however, the ad hoc equity committee submitted a “sensitivity analysis” based on the debtors’ numbers and including an analysis of “precedent transactions,” comparable trading multiple analysis, and a discounted cash flow (DCF) analysis.

    A substantial portion of Judge Carey’s 20-page decision denying the ad hoc equity committee’s request revolves around a careful weighing of the parties’ competing valuation evidence.  The ad hoc equity committee’s valuation evidence ultimately faltered on four points:

    - The future of the debtors’ market:  For Judge Carey, the ad hoc equity committee’s analysis was not sensitive enough.  It inferred growth estimates based on the broader semiconductor and memory markets rather than for the debtors’ smaller (and much less healthy) specific memory market.

    - The estimated DCF terminal value:  The ad hoc equity committee’s valuations assumed constant cash flow growth (a view not shared by the debtors), higher EBITDA multiples, and higher terminal values.  By contrast, the debtors’ valuation assumed flat to negative growth, and a lower terminal value.

    - Valuation of specific assets:  The ad hoc equity committee claimed certain valuable assets – such as cash, litigiation claims held by the debtors, and net operating losses - were not accounted for in the debtors’ estimate of enterprise value.  While acknowledging that cash ought to be included in enterprise value, Judge Carey nevertheless found that the ad hoc equity committee offered no support for its valuation of the litigation claims at issue.  He found, further, that ambiguity surrounding the effect of the debtors’ net operating losses was not sufficiently resolved by the ad hoc equity committee to assign it any value for the committee’s analysis.

    - Total amount of claims:  The ad hoc equity committee’s claimed equity stake derived at least in part from its estimate of claims.  However, Judge Carey found that the committee had neglected to include administrative claims and cash requirements necessary to exit from Chapter 11.  The committee also had neglected to estimate the value of claims from as-yet-to-be-rejected contracts.

    In the end, Judge Carey found that “[t]he only thing certain . . . is the uncertainty of the valuations” – and that, as a result, the ad hoc equity committee’s “uncertain” estimate had not established the “substantial likelihood” of distribution required for official appointment.

    Judge Carey’s valuation analysis is instructive.  Specifically, it highlights the evidentiary burden that can attend valuation fights in a bankruptcy case, as well as the thoroughness with which a court may investigate enterprise value.

    Something to consider in a variety of bankruptcy contexts.

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    What’s It Worth?

    Monday, December 7th, 2009

    Prior to the economic downturn – when sales were rising and debt was cheap – many businesses found it convenient to spur further growth by taking on “second-tier” secured financing, or engaging in aggressive leveraged buy-outs (LBO’s).  With the recession and resulting steep drop-off in firm revenues worldwide, many of the same businesses (and LBO targets) found themselves over-leveraged and struggling to service their debt.  First priority lenders have responded to this distress by negotiating exclusively with their debtors for pre-arranged “restructuring” plans that, in effect, provide for the transfer of assets and repayment of the first-priority debt – but provide little, if anything, to “second-tier” lenders and other creditors.

    recent piece from Reuters discusses what junior creditors are doing about it.

    As illustrated in recent Chapter 11 cases such as Six Flags Inc., Pliant Corp., and Trump Entertainment Resorts, Inc., junior creditors are attempting to fight back with competing restructuring plans of their own – proposed plans that provide them with better returns, or with a meaningful equity stake in the reorganized debtor. 

    A review of the dockets in each of those cases indicates that these efforts have met with varying degrees of success.  The Reuters piece suggests three variables that can impact the success of this strategy:

    - Valuation.   Arguably the most critical factor in supporting a plan that competes with one pre-negotiated with the first-priority creditors is evidence demonstrating that the debtor is, in fact, worth more than the first-priority creditors claim.  That demonstration can be challenging, particularly in light of today’s uncertain economy and pricier debt.  Even so, junior creditors are likely to argue credibly that a company whose revenues were historically strong should not be under-valued purely on the basis of weaker performance in a generally weaker economy.  Still other junior creditors seeking to preserve their original position may be willing to advance additional funds, thereby opening up a possible source of financing otherwise unavailable to the debtor.

    - The Court.  Concerns such as docket management and the court’s philosophical disposition to maximize enterprise value or protect the position of junior creditors – or not – are factors that have real effect on the success of junior creditors’ bid to present a competing plan.

    - Cost-Benefit.  Finally, the presence – or absence – of effective negotiation between the parties can impact the perceived benefit of a competing plan.  When everyone is talking and a plan can be effectively built, a successful outcome is more likely than a full-blown “plan fight” which weighs down the estate with administrative expense and can, if sufficiently large, even jeopardize the debtor’s successful post-confirmation operations.

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    The Chrysler Sale – Back to the Future?

    Monday, September 28th, 2009

    The bankruptcy blogosphere is replete with commentary on Chrysler LLC’s sale, through Section 363 of the Bankruptcy Code, to a newly-formed entity.  The sale, of substantially all of Chrysler’s assets for $2 billion, gave secured creditors an estimated $0.29 on the dollar.  Other, unsecured creditors received more.  Though challenged, the sale ultimately received the 2d Circuit’s approval in a decision issued August 5.

    Was the Chrysler sale proper?  Or did it constitute an inappropriate “end run” around the reorganization provisions that ordinarily apply in a confirmed Chapter 11 plan?

    Harvard Law’s Mark Roe and Penn Law’s David Skeel tackle this question in a paper released earlier this month entitled “Assessing the Chrysler Bankruptcy.”  Roe and Skeel argue, in essence, that there was no way to tell whether or not the sale was proper because the sale lacked valuation, an arm’s length settlement, or a genuine market test (i.e., an auction) – all traditional measures of whether or not secured creditors received appropriate value for their collateral.  They then suggest that the Chrysler transaction may portend a return of sorts to the equitable receiverships used to reorganize the nation’s railroads at the end of the ninenteenth century.

    Roe and Skeel follow two fundamental strands of thought.

    First, they review the basic facts of the Chrysler sale against the context of other so-called “363 sales” and ask where Chrysler fits within this context.

    Their answer is that it really doesn’t fit.

    Most complex bankruptcy sales (i.e., sales that effectively determine priorities and terms that the Code is structured to determine under Section 1129) are insulated from running afoul of the Code’s reorganization provisions through judicial innovations such as expert valuations or priority determinations, creditor consents, or competitive auctions.  According to Roe and Skeel, the Chrysler sale had none of these.  Instead,

    “[Chrysler's] sale determined the core of the reorganization, but without adequately valuing the firm via [Section] 1129(b), without adequately structuring a . . . bargain [with creditors or classes of creditors], and without adequately market testing the sale itself.  Although the bankruptcy court emphasized an emergency quality to the need to act quickly . . . there was no immediate emergency.  Chrysler’s business posture in early June did not give the court an unlimited amount of time to reorganize, but it gave the court weeks to sort out priorities, even if in a makeshift way.”

    How was the Chrysler sale deficient in these respects?

    Though it involved a valuation presented by Chrysler, “the court did not give the objecting creditors time to present an alternative valuation from their experts . . . .  Here, the judge saw evidence from only one side’s experts.”

    For those who may protest that the Chrysler sale did, indeed, enjoy the consent of Chrysler’s secured lenders, Roe and Skeel argue that the largest of these lenders were beholden to the U.S. Treasury and to the Federal Reserve – not only as regulators, but as key patrons via the federal government’s rescue program.  They were, therefore, willing to “go along with the program” – and the Bankruptcy Court was inclined to use their consent to overrule other objections from lenders not so well situtated.  On this basis, Roe and Skeel contend that the secured lenders’ “consent” – such as it may have been – wasn’t independent “consent” at all.

    Roe and Skeel also point out that the “market test” proposed as a means of validating the sale was, in fact, not a test of Chrysler’s assets, but of the proposed sale: “There was a market test of the Chrysler [sale], but unfortunately, it was a test that no one could believe adequately revealed Chrysler’s underlying value, as what was put to market was the . . . [sale] itself.”

    The authors then go on to argue that the sale was mere pretense – and that, in fact, “there was no real sale [of Chrysler], . . . at its core Chrysler was a reorganization”:

    “Consider a spectrum.  At one end, the old firm is sold for cash through a straight-forward, arms-length sale to an unaffiliated buyer.  It’s a prime candidate to be a legitimate [Section] 363 sale.  At the other end, the firm is transferred to insider creditors who obtain control; no substantial third-party comes in; and the new owners are drawn from the old creditors.  That’s not a [Section] 363 sale; it’s a reorganization that needs to comply with [Section] 1129.

    . . . .

    [To determine where a proposed sale falls along this spectrum,] [a] rough rule of thumb for the court to start with is this stark, two-prong test: If the post-transaction capital structure contains a majority of creditors and owners who had constituted more than half of the old company’s balance sheet, while the transfer leaves significant creditor layers behind, and if a majority of the equity in the purportedly acquiring firm was in the old capital structure, then the transaction must be presumed to be a reorganization, not a bona fide sale.  In Chrysler, nearly 80% of the creditors in the new capital structure were from the old one and more than half of the new equity was not held by an arms-length purchaser, but by the old creditors.  Chrysler was reorganized, not sold.”

    Was the Chrysler transaction – however it may be called – simply a necessary expedient, borne of the unique economic circumtsances and policy concerns confronting the federal government during the summer of 2009?

    Roe and Skeel argue that, in fact, the government could have acted differently: It could have picked up some of Chrysler’s unsecured obligations (i.e., its retiree obligations) separately.  It could have offered the significant subsidies contemplated by the deal to qualified bidders rather than to Chrysler.  It could even have paid off all of Chrysler’s creditors in full.  But it did none of this.

    Second, Roe and Skeel consider that “[t]he deal structure Chrysler used does not need the government’s involvement or a national industry in economic crisis.”  Indeed, it has already been offered as precedent for proposed sales in the Delphi and Phoenix Coyotes NHL team bankruptcies – and, of course, in the subsequent GM case.

    One very recent case in which South Bay Law Firm represented a significant trade creditor involved a similar acquisition structure, with an insider- and management-affiliated acquirer purchasing secured debt at a significant discount, advancing modest cash through a DIP facility to a struggling retailer, and proposing to transition significant trade debt to the purchasing entity as partial consideration for the purchase.

    The deal got done.

    What’s to become of this new acquisition dynamic?  Employing a uniquely historical perspective, Roe and Skeel travel back in time to observe:

    “The Chrysler deal was structured as a pseudo sale, mostly to insiders . . . in a way eerily resembling the ugliest equity receiverships at the end of the 19th century.  The 19th century receivership process was a creature of necessity, and it facilitated reorganization of the nation’s railroads and other large corporations at a time when the nation lacked a statutory framework to do so.  But early equity receiverships created opportunities for abuse.  In the receiverships of the late 19th and early 20th century, insiders would set up a dummy corporation to buy the failed company’s assets.  Some old creditors – the insiders – would come over to the new entity.  Other, outsider creditors would be left behind, to claim against something less valuable, often an empty shell.  Often those frozen-out creditors were the company’s trade creditors.”

    They trace the treatment of equity receiverships, noting their curtailment in the US Supreme Court’s Boyd decision, the legislative reforms embodied in the Chandler Act of 1938, and the 1939 Case v. Los Angeles Lumber Products decision which articulated the subsequently-enacted “absolute priority rule” (but preserved the “new value exception”).  Against this historical background, “Chrysler, in effect, overturned Boyd.”

    But with a twist.

    “One feature of Chrysler that differed from Boyd may portend future problems.  Major creditors in Chrysler were were not pure financiers, but were deeply involved in the automaker’s production.”  In cases where the value of the assets is enhanced by the continued involvement of key non-financial creditors, “players with similar [legal] priorities will not . . . be treated similarly.”

    Translation: When non-financial creditors are driving enterprise value, a Chrysler-style sale suggests that some will make out, and some creditors - even, on occasion, some secured lenders – will get the shaft.

    If accurate, Roe’s and Skeel’s Chrysler analysis raises some significant considerations about access to and pricing of business credit.  It raises new concerns for trade creditors.  It likewise presents the possibility that the Chapter 11 process – which has, in recent years, tilted heavily in favor of secured lenders – may not be quite as predictable or uniformly favorable as in the past.

    Meanwhile . . . it’s back to the future.

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