RX practice Q's

Why are you interested in Restructuring besides the fact that it's a "hot" area currently?

1. law + finance 2. strategic aspect 3. More exciting than M&A

why is equity not worth 0 for a bankrupt company

"option value" due to equity tip in reorg (to speed up the reorg process)

What classes do not get vote in POR?

Those who will be made whole and those who won't be made whole at all. Only impaired can vote.

Walk me through a Merger Model

"A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is made, and it determines whether the buyer's EPS increases or decreases afterward. Step 1 is making assumptions about the acquisition - the price and whether it was done using cash, stock, debt, or some combination of those. Next, you determine the valuations and shares outstanding of the buyer and seller and project the Income Statements for each one. Finally, you combine the Income Statements, adding up line items such as Revenue and Operating Expenses, and adjusting for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line; you apply the buyer's Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS."

What's the difference between a Distressed M&A deal and a Restructuring deal?

"Restructuring" is one possible outcome of a Distressed M&A deal. A company can be "distressed" for many reasons, but the solution is not always to restructure its debt obligations - it might declare bankruptcy, it might liquidate and sell off its assets, or it might sell 100% of itself to another company. "Restructuring" just refers to what happens when the distressed company in question decides it wants to change around its debt obligations so that it can better repay them in the future.

What is FCCR (fixed charge coverage ratio)?

(EBITDA - Capex - Cash Taxes) / (Cash Interest Expense + Mandatory Debt Repayment) What its saying: do we have enough cash flow - using the rough approximation in the numerator - to meet what our actual cash obligations are that arise from our capital structure

What is a cram down?

. Requires that in the event that not all impaired classes accept the plan the court may still confirm if it does not discriminate unfairly and it is fair and equitable with respect to those nonaccepting classes. Cram downs are quite rare as it obviously involves the court taking a tough stand against someone who is impaired.

I take your point about optionality and how the 2L would likely trade above 50, but what if we saw the debt trading in the market at 45 (even though we think the recovery value will be 50)? How would that make sense?

1) Could have forced selling dynamic from insitutional funds 2) Recovery Values are predicated on an estimate of EV, which is not some immutable, objective reality. Rather, like most things in finance, it can change and until a POR is agreed upon exactly what the recovery value for any class will be is not guaranteed per se Distressed debt is an erratic and opaque market. Things aren't necessarily as "efficient" as in equity markets for large, healthy companies. Spreads are wide and markets are illiquid (especially when trying to transact in large size).

Why does Efficient Market Theory (EMT) not apply to distressed debt?

1. All counterparties do not have access to the same info (information asymmetry) 2. Many investors may have forced liquidations during highly volatile periods (e.g. the fallen angel phenomenon), which is objectively irrational but done because of their mandate 3. Have large transaction costs (bid/ask spreads wider than in IG or equity) with much worse liquidity

How to talk about accounting case

1. Company overview 2. Financials and Current Situations (what caused it etc.) 3. Current cap structure and how it was planning on being resolved. 4. How the workout was progressing and what I thought were the interesting points of the workout.

Why Evercore

1. Culture (MD's not leaving, looking after junior staff) 2. Boutique feel but exposure to large scale global deals which supports why I went to McGill 3. Shaun finnie said its closest thing to meritocracy 4. Analysts have exposure to everything instead of just crunching numbers, they attend meetings compared to bb's and some other eb's

Basic acquisition effects

1. Foregone interest on cash: buyer loses interest income, reduces pretax income/NI/EPS 2. Additional interest on debt: interest expense increases, reduces pretax income/NI/EPS 3. Additional shares outstanding: reduces EPS b/c there are more shares outstanding 4. Combined financial statements: after acquisition the seller's statements are added to the buyers', with a few adjustments 5. Creation of goodwill and other intangibles: these represent the premium over the sellers' shareholder's equity that was paid, need to have these to balance the balance sheet

What options to creditors have to recover their capital in a distressed situation

1. Lend more capital or grant equity to the company 2. Conditional financing -- only agree to lend if the company cuts expenses, stops losing money or agrees to other terms/covenants 3. Sale -- force the company to hire an investment bank and sell itself or parts of itself 4. Foreclosure -- the bank seizes collateral and forces a bankruptcy filing

Why RX

1. Mix of law and finance 2. strategic aspect 3. different every case instead of plain vanilla m&a

In a bankruptcy, what is the order of claims on a company's assets?

1. New debtor-in-possession (DIP) lenders (see explanation above) 2. Secured creditors (revolvers and "bank debt") 3. Unsecured creditors ("high-yield" bonds) 4. Subordinated debt investors (similar to high-yield bonds) 5. Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK) 6. Shareholders (equity investors) "Secured" means that the lender's claims are protected by specific assets or collateral; unsecured means anyone who has loaned the company money without collateral. For more on the different types of debt, see the LBO section where we have a chart showing the differences between everything.

So, a company files for Chapter 11 and then must come up with a POR. What's that include?

1. Plan must designate classes of claims and classes of interest (e.g. must provide a detailed cap structure). 2. Plan must specify any class of claims or interest that are not impaired under the plan (e.g. classes that have full asset coverage thus will not be able to vote) 3. Plan must specify the treatment of any class of claims or interest that are impaired under the plan (e.g. what are you offering them in the re-organized company upon emergence from bankruptcy since they are impaired) 4. Plan must provide the same treatment for each claim or interest of a particular class unless by requisite vote holders agree to a less favorable treatment 5. Plan must provide the adequate means for the implementation of the plan (meaning, the plan must be feasible and achievable).

What are the advantages and disadvantages of each option?

1. Refinance - Advantages: Least disruptive to company and would help revive confidence; Disadvantages: Difficult to attract investors to a company on the verge of going bankrupt. 2. Sale - Advantages: Shareholders could get some value and creditors would be less infuriated, knowing that funds are coming; Disadvantages: Unlikely to obtain a good valuation in a distressed sale, so company might sell for a fraction of its true worth 3. Restructuring - Advantages: Could resolve problems quickly without 3rd party involvement; Disadvantages: Lenders are often reluctant to increase their exposure to the company and management/lenders usually don't see eye-to-eye 4. Bankruptcy - Advantages: Could be the best way to negotiate with lenders, reduce obligations, and get additional financing; Disadvantages: Significant business disruptions and lack of confidence from customers, and equity investors would likely lose all their money

What options are available to a distressed company that can't meet debt obligations?

1. Refinance and obtain fresh debt / equity. 2. Sell the assets or company(either as a whole or in pieces in an asset sale). 3. Restructure its financial obligations to lower interest payments / debt repayments or issue debt with PIK interest to reduce the cash interest expense. Do an exchange of old debt coming due for new debt, ▪ Extend out current maturities 4. File for bankruptcy and use that opportunity to obtain additional financing, restructure its obligations, and be freed of onerous contracts. File for Chapter 11 with a pre-pack (a pre-done Plan of Reorganization that allows the company to get through Chapter 11 in just a few months File for Chapter 11 without a pre-pack (and then right-size while in Chapter 11, which can take years)

Can you walk me through how you use comps and precedent transactions?

1. Select the comparable companies/transactions based on industry, financial metrics, and geography 2. Determine the relevant metrics and multiples for each set -- for example revenue, revenue growth, EBITDA, EBITDA margins, and revenue and EBITDA multiples and calculate them for all of the comparable companies and precedent transactions 3. Calculate the minimum 25th/50th/75th percentiles and maximum for each set 4. Apply those metrics to our target company to value it -- ex. If median EBITDA is multiple 7x EV and we have $100m in EBITDA, we have an implied eV of $700m. We also calculate value at other multiples in the range too, not just at median value

Let's say a distressed company approaches you and wants to hire your bank to sell it in a distressed sale - how would the M&A process be different than it would for a healthy company?

1. Timing is often quick since the company needs to sell or else they'll go bankrupt. 2. Sometimes you'll produce fewer "upfront" marketing materials (Information Memoranda, Management Presentations, etc.) in the interest of speed. 3. Creditors often initiate the process rather than the company itself. 4. Unlike normal M&A deals, distressed sales can't "fail" - they result in a sale, a bankruptcy or sometimes a restructuring.

determining debt priority

4 ways to distinguish priority: grants of collateral, term structure, contractual provisions and corporate structure

debt capacity

= ebitda * valuation multiple + cash

Levered beta

= unlevered beta (1+((1-t)(total debt/equity)))

What's the difference between Chapter 7 and Chapter 11 bankruptcy?

A Chapter 7 bankruptcy is also known as a "liquidation bankruptcy" - the company is too far past the point of reorganization and must instead sell off its assets and pay off creditors. A trustee ensures that all this happens according to plan. Chapter 11 is more of a "reorganization" - the company doesn't die, but instead changes the terms on its debt and renegotiates everything to lower interest payments and the dollar value of debt repayments. If we pretend a distressed company is a cocaine addict, Chapter 7 would be like a heart attack and Chapter 11 would be like rehab.

Cramdown

A bankruptcy court can approve a plan of reorg even if some creditor groups haven't approved it if the court decides it makes everyone better off

What is a cap table?

A cap table (capitalization table) shows all the debt securities that the company has issued along with their maturity, coupon rate, credit rating, market price (if relevant), and normally leverage and interest coverage ratio.

If a company does file for bankruptcy, what precipitates that?

A company almost always declares bankruptcy itself. This is because the company wants to draw down revolvers, miss certain payments strategically, prepare a list of critical vendors, and try to get in the best position to come through the Chapter 11 process quickly. Occasionally you'll have a company forced into bankruptcy "involuntarily" by creditors as a result of a technical default (technical defaults mean something that doesn't involve missing an interest payment). A company ultimately files for bankruptcy because it just can't refinance its maturities coming due, no matter what it tries, or can't meet its cash interest payments. It therefore needs to figure out a fundamentally new capital structure to continue.

Why would company go bankrupt in the first place?

A company cannot meet its debt obligations / interest payments. Creditors can accelerate debt payments and force the company into bankruptcy. An acquisition has gone poorly or a company has just written down the value of its assets steeply and needs extra capital to stay afloat (see: investment banking industry). There is a liquidity crunch and the company cannot afford to pay its vendors or suppliers.

Term loan characteristics

A loan that has a specified repayment schedule, fixed or floating rates term loans amortize over time. Typically funded straight from a bank's balance sheet, have lower rates due to being higher in the capital structure, usually are secured and come with maintenance covenants

What's a liquidity roll forward?

A projection of where liquidity will be in a year. We will assume that the revolver gets drawn (or cash is diminished) by the amount of decrease in FCF next year. We make the projection on how much FCF will decline by just making assumptions about revenue declines, EBITDA margin contraction, and capex spend based off of what the company has done in the past year (remember, this is restructuring, not M&A, so there is rarely an in-depth model for a one-year projection).

What is the end goal of a given financial restructuring?

A restructuring does not change the amount of debt outstanding in and of itself - instead, it changes the terms of the debt, such as interest payments, monthly/quarterly principal repayment requirements, and the covenants.

Credit bid

A right that secured creditors have in bankruptcy sales -- when collateral that secures a lien is being sold in a bankruptcy, the secured creditor is allowed to bid up to the amount of its debt as a credit bid This gives undersecured creditors the right to control their collateral when it is worth less than the face value of their debt This right is guaranteed under section 363 of the bankruptcy code

How would you adjust the 3 financial statements for a distressed company when you're doing valuation or modeling work?

Adjust Cost of Goods Sold for higher vendor costs due to lack of trust from suppliers. Add back non-recurring legal / other professional fees associated with the restructuring and/or distressed sale process. Add back excess lease expenses (again due to lack of trust) to Operating Income as well as excess salaries (often done so private company owners can save on taxes). Working Capital needs to be adjusted for receivables unlikely to turn into cash, overvalued/insufficient inventory, and insufficient payables. CapEx spending is often off (if it's too high that might be why they're going bankrupt, if it's too low they might be doing that artificially to save money).

Types of covenants

Affirmative, negative and financial -- all are basically what they sound like, affirmative means that the debtor needs to do something (provide audited financial statements, etc), negative prevents the debtor from doing something, financial are things such as maintaining a certain debt or coverage ratio

Keeping with the last question, why is one tranche of these pari Senior Notes trading higher anyway? If you're considering buying one tranche of these pari Senior Notes, what would you need to consider?

As to why one tranche of pari Notes would trade higher than the others, the answer is that some market participants must believe that the Notes coming due in two years should be able to be refinanced, or be dealt with in some way, but it's much less certain that five years from now the two other tranches of Senior Notes (totaling a billion in face value) can be refinanced. Holding the 60-Notes is riskier in so far as you're assuming more risk that the company may keep faltering, or can't turn things around sufficiently, by the time the two latter tranches need to be dealt with (plus they're double the size of the 80-Notes).

What are the 2 different "sides" of a Restructuring deal? Do you know which one we usually advise?

Bankers can advise either the debtor (the company itself) or the creditors (anyone that has lent the company) money. It's similar to sell-side vs. buy-side M&A - in one you're advising the company trying to sell or get out of the mess it's in, and in the other you're advising buyers and lenders that are trying to take what they can from the company. Note that the "creditors" are often multiple parties since it's anyone who loaned the company money. There are also "operational advisors" that help with the actual turnaround. You need to research which bank does what, but typically Blackstone and Lazard advise the debtor and Houlihan Lokey advises the creditors (these 3 are commonly as the top groups in the field).

negative covenant example

Barring the issuer from taking on additional debt; • Imposing a maximum acceptable debt ratio (such as leverage or gearing ratios) or a minimum acceptable interest coverage ratio; Restricting asset disposals, distributions to shareholders, or engagement in (risky) investments; or Explicitly ruling out mergers and acquisitions of any form unless certain conditions are met.

What are bondholder committees and their rights?

Basically, in an out-of-court scenario you'll have bond-holders band together in what's called a bondholder committee in order to negotiate with the company as to what they will accept in an out-of-court restructuring scenario. This committee will often hire a bank to help them do analysis, coordinate, etc. and this is how RX shops get creditor mandates!

What is best interest test?

Basically, what the best interest test is saying is that by accepting the Chapter 11 POR you won't be worse off than if the company just did a Chapter 7 liquidation now

What's original issue discount?

Bonds issued below par (100) at origination. Essentially a form of yield enhancement. The cash interest is still the same for the company, as there is a set coupon rate, but the yield for the buyer of bonds is higher as they're only putting in (for example) $90 at issuance, but getting $100 back at maturity.

Who are the kind of clients we deal with?

Broadly speaking there are two kind of clients on the debtor side: companies in distress (either private or public) and companies in distress owned by sponsors (PE funds).

What would be the bankruptcy payout structure for Company X's given debt hierarchy in Company X's capital structure and covenants?

Calculated it based on the hierarchy but struggled on the covenants which are as follows: New debtor-in-possession (DIP) lenders (see explanation above) Secured creditors (revolvers and "bank debt") Unsecured creditors ("high-yield" bonds) Subordinated debt investors (similar to high-yield bonds) Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK) Shareholders (equity investors)

Cost of equity can be increased by

Can be increased by higher risk free rates and equity risk premiums Can be increased by having more debt in the capital structure (makes being an equity holder riskier)

Why would a company go bankrupt to begin with

Can't meet debt obligations or interest payments Creditors accelerate debt payments and force the company into bankruptcy -- this usually can happen if there's some kind of 'acceleration clause' in a loan doc that can be triggered once some sort of covenant or condition is violated An acquisition has gone poorly or a company has written down the value of its assets steeply and needs extra capital to stay afloat There is a liquidity crunch and the company can't afford to pay its vendors or suppliers

What things would you expect to change most for a distressed company on the three financial statements?

CapEx is often too high and should be lowered moving forward Working capital will decrease as you have write downs on inventory and accounts receivable may decline One time legal, RX, etc. fees

Other items that are "debt like" and may be added to EV

Capital leases, some operating leases, unfunded pension obligations, restructuring and environmental liabilities

What kind of recovery can we expect for different assets in liquidation

Cash: 100%, investments ~100% if liquid but could be much less if illiquid, a/r would be less than cash b/c a lot of customers just won't pay, inventory would be less than both cash and a/r, PP&E would be similar to cash for land/buildings but less than that for equipment, intangibles will usually get 0%

When does GAAP require restructuring costs to be filled?

Charged against income in the year in which the decision to restructure is made even though the actual expenditures will take place over time. Liability reserve is created and the actual expenses are charged against this reserve.

What is an amend and extend?

Company negotiates with the banks to agree to keep in place the basic terms of the bank agreement, but with a longer maturity. This will require bumping their interest payments or paying a consent fee or doing a term loan pay down.

What's a tender?

Company offers to purchase securities. If the company wanted, for example, to change a covenant it could buy 51% of the bonds outstanding (if it is a non-money clause, like subordination). Could do exchange offer instead if the company had limited cash (offer to exchange the bonds for a new set of bonds with perhaps a higher interest rate).

Why might a distressed company not be able to raise fresh debt/equity

Debt: investors won't want to lend if they don't think there will be a viable turnaround plan and credit support might already be limited Equity: same as above but even worse b/c equity is lower in the capital structure

How to determine accretion/dilution for all deals

Cost of cash = foregone interest on cash * (1 - buyer tax rate) Cost of debt = interest rate on debt * (1 - buyer tax rate) Cost of stock = reciprocal of the buyer's p/e multiple, ie e/p or net income/equity value Yield of seller = reciprocal of seller's p/e multiple (ideally the p/e multiple at the purchase price for the deal) To calculate accretion/dilution, determine the weighted cost for the buyer. If this cost is greater than the yield of the seller the deal is dilutive, if it is less than the yield of the seller the deal is accretive This method doesn't account for synergies, D&A changes, tax rates, transaction costs, etc. but it is a good back of the envelope approximation. NOTE: we need to use the purchase share price of the seller that the buyer is paying in the acquisition, not the current market price

What's critical vendor payments risk?

Critical vendors, as the name implies, are those who are essential to the company being an on-going concern. In other words, without them the company wouldn't survive so you need to have cash available to pay them. All non-critical vendors have the automatic stay leveled against them, precluding them from the ability to collect on their debts in the shortterm

Capital structure

DIP > Revolver (paid off based on the working capital that backs it i think) > term loan A (secured) > term loan B (secured) > senior notes (unsecured) > sub notes (unsecured) > mezz/preferred (convertibles, convertible prefered, preferred stock, PIK) > equity ^each progressive type of debt in this waterfall will usually have higher interest rates

What do NOLs become after a Chapter 11?

Deferred tax assets for a reorganized company.

UFCF formulas

EBIT(1-t)+D&A and non cash charges-capex - change in net operating working capital CFO + tax adjusted net interest expense - capex Net income + tax adjusted net interest expense + non cash charges - change in operating assets/liabilities - capex

How would a DCF analysis be different in a distressed scenario?

Even more of the value would come from the terminal value since you normally assume a few years of cash flow-negative turnaround. You might also do a sensitivity table on hitting or missing earnings projections, and also add a premium to WACC to make it higher and account for operating distress.

How is a DCF different for a distressed company

Even more value comes from terminal value b/c we might assume a few years of cash flow-negative turnaround, might also do sensitivities based on hitting or missing earnings projections, could also add a premium to WACC to account for operating distress

What are fallen angels? Why do they matter?

Fallen angels are those bonds rated at the cusp of investment grade (BBB- or Baa3) that then get downgraded one notch or more, making them high yield or distressed (depending on your favored verbiage). This matters because many mutual funds, pension funds, life insurers, etc. have mandates to hold investment grade credit, but not high yield credit

Let's say that a PE firm acquires a $200M EBITDA company for 10x with 60% debt. The company's EBITDA, over a five-year hold period, grows to $300M. All cash is swept out to pay down debt, which at year five totals $400M. No cash is left at the time of exit, which is for a 10x multiple. What's the IRR?

First, the EV at initiation will obviously be $2,000M (or $2B). $1,200M of the acquisition will be funded by debt, and we can assume the remaining $800M will be funded by equity. The EV at exit will be $300M*10x or $3,000M. Since debt of $400M was paid down, with no cash being left over, that leaves us with $800M of debt remaining at exit. At exit the equity proceeds will just be the $3,000M minus the debt remaining of $800M or $2,200M. So $800M of equity was put into the company, $2,200M is taken out at exit five years later, which gives a 2.75x return. You should know rough IRR calculations for various multiples like 2x, 3x, and 4x. A 2x return over five-years is 15% and a 3x return over five-years is 25%. Thus, we can guess the IRR as being in the low twenties.

What's grid pricing?

For example, a revolver could have L+250- 350 where L+250 is the rate if only X% of the revolver is drawn, but if more than X% is drawn then it goes up to L+350.

What does EBITDA/debt tell you about the coverage ratio?

For example, if it's 250/1500 = 0.17 so if company had a 17% interest rate its interest coverage ratio would be 1x.

. Outcomes of a distressed sale other than a conventional/asset purchase

Foreclosure (official or unofficial) When creditors seize assets General assignment (faster alternative to bankruptcy) Section 363 asset sale (a faster, less-risky version of an asset sale) According to divestopedia, this is exactly the same as a stalking horse sale where we have a stalking horse purchaser and then have a sort of auction process where other purchasers send in their offers Chapter 11 Chapter 7

Let's say you're a hedge fund analyst. Assuming that everything returns par, would you rather invest in a bond trading at 90 with a maturity of one year or a bond trading at 50 maturing in five years? What kind of factors would you need to consider?

Fundamental side: First, what's the coupon rate on each of these? Let's assume we have a capital structure with just the two tranches of debt mentioned in the question. If one tranche is trading at 90 and the other at 50, then the 90 will be more senior and almost certainly have a lower coupon. Second, what is the seniority of this debt Third, what is the years left to maturity Fourth, YTM operates under the assumption we are reinvesting coupon income at the prevailing yield. In other words, your YTM can look great, but it assumes that all the cashflows you're clipping off can be reinvested back at an analogous great rate. Institutional side: First, what is our investment mandate? Do we like holding credits in lower parts of the capital structure? Are we assuming we need to hold either of these until maturity?

Difference between bank debt and high yield debt

HY has higher interest rates, has fixed interest rates (bank debt has floating rates based on LIBOR or other rate spreads), HY has incurrence covenants (bank debt has maintenance covenants) (incurrence covenants prevent you from doing things, like buying a factory or selling an asset) (maintenance covenants require you to maintain minimum financial performance like a certain leverage or coverage ratio), bank debt usually amortized (principal is paid off over time) but HY debt is not amortized

Exclusive period to file plan of reorganization once Chapter 11 filed?

Have a 120-day exclusive period and 180-day period to solicit acceptances

How can you block a POR

Hold 33.4% of bonds in an impaired class. Can still have cram down if at least one impaired class voted yes and if judge deems deal to be equitable.

What are restricted payment covenants?

Holder of a bond or loan would want the company to meet certain goals before it can use money to either pay dividends on the equity, do stock buybacks, or be able to retire securities that are more junior

How would you adjust the 3 statements for a distressed company when we're doing valuation/modeling work?

How would you adjust the 3 statements for a distressed company when we're doing valuation/modeling work?

What are some trends in RX?

IP Transfers Non pro rata Uptiers from serta case Cov Light loans

What are "maturity walls"?

If a company has poor ratios, poor FCF, poor liquidity, etc. and has large amounts of its capital structure coming due soon it faces an issue: it needs to either extend those maturities out, so it can then have time to turn the company around, or it needs to refinance them

Do secured creditors always get treated as secured?

If their claim is larger than the value of their collateral the amount of the excess is deemed an unsecured claim (technically called a "general unsecured claim").

Why would we use the gordon growth method

If we have no good comparables If we think multiples might change significantly down the road, like in a cyclical industry

Let's say that I tell you that we have a bond with a YTM of 20%. Ask me some questions to figure out how it's priced.

If we're trying to figure out how a bond is priced, we need three details: YTM (which we've been given), coupon rate, and years to maturity.

Let's say we're doing a Liquidation Valuation for a distressed company. Why can't we just use the Shareholders' Equity number for its value? Isn't that equal to Assets minus Liabilities?

In a Liquidation Valuation you need to adjust the values of the assets to reflect how much you could get if you sold them off separately. You might assume, for example, that you can only recover 50% of the book value of a company's inventory if you tried to sell it off separately. Shareholders' Equity is equal to Assets minus Liabilities, but in a Liquidation Valuation we change the values of all the Assets so we can't just use the Shareholders' Equity number.

Let's say a company wants to sell itself or simply restructure its obligations - why might it be forced into a Chapter 11 bankruptcy?

In a lot of cases, aggressive creditors force this to happen - if they won't agree to the restructuring of its obligations or they can't finalize a sale outside court, they might force a company into Chapter 11 by accelerating debt payments.

What do you think an analyst does within RX? What's the work entail?

In a more structured sense, though, an analyst will be expected to run industry screens, create profiles, and then be involved in pitches and live deals. Pitches and live deals always have an analyst on them, along with usually an associate, VP, and of course MD. The day-to-day work varies a great deal, but will involve things like creating cap tables, pro forma cap tables, ensuring proper formatting in all materials, et

The 2 basic ways you can buy a company are through a stock purchase and an asset purchase. What's the difference, and what would a buyer in a distressed sale prefer? What about the seller?

In a stock purchase, you acquire 100% of a company's shares as well as all its assets and liabilities (on and off-balance sheet). In an asset purchase, you acquire only certain assets of a company and assume only certain liabilities - so you can pick and choose exactly what you're getting. Companies typically use asset purchases for divestitures, distressed M&A, and smaller private companies; anything large, public, and healthy generally needs to be acquired via a stock purchase. A buyer almost always prefers an asset purchase so it can avoid assumption of unknown liabilities (there are also tax advantages for the buyer). A (distressed) seller almost always prefers a stock purchase so it can be rid of all its liabilities and because it gets taxed more heavily when selling assets vs. selling the entire business.

How do we measure cost of debt for a company that is too distressed to issue more debt?

Look at the yields of bonds or the spreads of credit default swaps of comparable companies (similar industry and ebitda/fcf/revenue and leverage/coverage ratios and other metrics). We could also use the current yield's on the company's existing debt, but this is hard if the debt is very illiquid

Changes that increase IRR in an LBO

Lower purchase price, less equity (cash) used, higher revenue growth, higher ebitda margins, lower interest rates, lower capex, higher exit multiple

A company has a high debt balance and is paying off a significant portion of debt principal each year. How does that impact DCF value?

In an unlevered DCF we wouldn't account for this at all b/c we ignore interest/principal payments, so nothing would change In a levered DCF we would factor this in by reducing interest expense every year as debt goes down and by reducing FCF by the amount of principal debt repaid. Whether implied equity value increases or decreases depends on the interest rate and principal repayment percentage each year, but in most cases the principal repayments exceed the net interest expense, so equity value will most likely decrease b/c levered FCF will be lower each year

What did the Fed do for credit markets in 2020?

In mid- to late-March of 2020 credit markets were grinding to a halt, spreads across the investment grade and high yield universe were exploding, and debt capital markets activity all but halted. A seizure of the credit markets ran the risk of causing massive financial disruption and so the Fed stepped in by necessity. My personal view is that in actuality, the Fed didn't do much in practice, but them saying they planned to do something was enough for credit markets to calm. This was a win-win for the Fed. They got their desired result (calming the credit markets), without having to do much of the actual heavy lifting (of fully utilizing or expanding their novel programs that they announced). Chances are you know broadly how the rest of the story unfolded. Credit markets within a month of the Fed's announced plans were nearing the levels they were prior to the crisis (in terms of yields) and by late-2020 / early-2021 credit markets are quite literally as tight as they ever have been, and debt issuance is absolutely booming.

Will the adjusted EBITDA of a distressed company be higher or lower than the value you would get from its financial statements?

In most cases it will be higher because you're adjusting for higher-than-normal salaries, one-time legal and restructuring charges, and more.

If debt goes up by X does EV change?

In theory, no, because cash goes up by the same amount so the effect cancels out

Examples of incurrence and maintenance covenants

Incurrence -- company can't take on more than 2 billion in total debt, proceeds from any asset sales must be used to repay debt, company can't make acquisitions over 200m in size, company can't spend over 200m in capex each year Maintenance -- total debt/ebitda can't exceed 3.0x, senior debt/ebitda can't exceed 2.0x, (total cash payable debt + capitalized leases) / EBITDAR can't exceed 4.0x, EBITDA/interest expense can't fall below 5.0x, EBITDA / cash interest expense can't fall below 3.0x, (EBITDA-capex) / interest expense can't fall below 2.0x

When you can't make interest coverage what can you do from an out-of-court perspective?

Issue discount notes or PIK notes. Under GAAP interest expense is still recorded on the income statement, but each structure is essentially allowing the cash payment on the interest to be deferred until maturity.

Limitations of EBITDA as a measure of cash flow

It fails to reflect changes in working capital It doesn't reflect capex -- a better metric would be EBIT (using D&A as a proxy of maintenance/required capex) or EBITDA-capex (probably the best metric to use) EBITDA often needs to be adjusted to reflect "one-time" charges, and in the context of a distressed firm "one-time" charges can constitute a huge variety of things -- thus, unless adjusted, EBITDA might understate the true cash flow generating potential of a firm

What is debtor-in-possession (DIP) financing and how is it used with distressed companies?

It is money borrowed by the distressed company that has repayment priority over all other existing secured/unsecured debt, equity, and other claims, and is considered "safe" by lenders because it is subject to stricter terms than other forms of financing. Theoretically, this makes it easier for distressed companies to emerge from the bankruptcy process - though some argue that DIP financing is actually harmful on an empirical basis. Some DIP lending firms are known for trying to take over companies at a significant discount due to the huge amount of collateral they have. One reason companies might choose to file for (Chapter 11) bankruptcy is to get access to DIP financing. only available to those who have filed, that has super-priority over all existing elements of the capital structure. Roughly 70% of the time this DIP financing comes from those who have already given the company loans

What are reasonable leverage and coverage ratios in terms of how much debt the company can take on?

It really depends on the company and the industry, and the leverage and coverage ratios for comparable transactions. We'll usually look at previous transactions that were similar or look at the leverage and coverage ratios of other similar companies with the same size/industry. In general having a coverage ratio close to 1 is dangerous, so we'd probably want over 2-3x interest coverage ratio. For leverage, generally 4-6x ebitda or higher is considered pretty high

PIK toggle

Lets a company choose if it wants to pay cash or PIK interest for debt, some types of debt have PIK toggles (probably mezz debt?)

What do we mean by leveraged vs. unleveraged loans?

Leveraged are those with BBB- or Baa3 or lower. Leveraged just means that the credit rating is below investment grade (IG). In other words, rated high yield.

What are convertible bonds? How can they be issued in an out-of-court restructuring to get around asset coverage issues?

Like preferred stock, convertible bonds are issued by distressed companies to get around asset coverage issues. Feature allowing the holder to convert the face amount of the bond into specified number of shares. Share price to convert is significantly above the share price at the time the bond is issued. Expected for stock to increase above the issue price and then convert and can cash out gain. Of course, if stock declines in value then the convertibility option become worthless, but the debt is still valid, and coupons can be clipped and hopefully principle will be repaid (called busted converts when this occurs).

What are the characteristics of a distressed company in need of restructuring?

Limited liquidity High leverage ratios throughout the capital structure (including at senior secured positions) ▪ "Maturity walls" upcoming that are unlikely to be able to be re-financed ▪ Decreasing equity price if public ▪ Butting up against covenants ▪ Low secondary pricing across the capital structure ▪ Recent downgrades, in particular for credit trading low in the capital structure ▪ Declining interest coverage ratios ▪ Increasing amount of distressed debt hedge funds buying up classes that could potentially be impaired Limited secured basket space o Often there will be covenants around how much money can be raised in the secured section of the capital structure preventing new issuance there, which puts a company in a bind if it can't refinance existing secured debt Litigation Industey downfall Recession

What two valuations are done in confirmation process of a plan of reorganization (POR)?

Liquidation analysis and going concern enterprise value (EV).

Other valuation methods

Liquidation valuation - value of assets after being sold off minus value of liabilities Useful in bankruptcies or to get a floor value LBO - determining how much a PE firm would pay to hit a target IRR Sum of the parts - valuing each division of a company separately and adding at the end to get the value Useful when a company has many unrelated businesses, like General Electric

A company has $25mm in EBITDA, trading at 8x. It has a $100 mm revolver, $75 mm 2nd lien term loan, $50 mm in bonds maturing in 2019, $50 mm bonds maturing in 2021, and $50 mm in equity, what are their market values?

Make sure to take into account that bonds have different maturity dates, but still share same tranche in capital structure. I am assuming the value of assets can be distributed according to seniority and that there is no contractual sub.

Why do asset sales under section 363 instead of Chapter 7?

Management keeps control of process.

Who wouldn't like a pre-pack (pre-packaged bankruptcy)?

Management, out of the money creditors, and equity holders. Management may have significant equity

How would a distressed company select its Restructuring bankers?

More so than M&A or IPO processes, Restructuring / Distressed M&A requires extremely specialized knowledge and relationships. There are only a few banks with good practices, and they are selected on the basis of their experience doing similar deals in the industry as well as their relationships with all the other parties that will be involved in the deal process. Remember that a Restructuring involves many more parties than a normal M&A or financing deal does - there are lawyers, shareholders, debt investors, suppliers, directors, management, and crisis managers, and managing everyone can be like herding cats. Lawyers can also be a major source of business, since they're heavily involved with any type of Restructuring / Distressed scenario.

What kind of companies would most likely enact debt buy-backs?

Most likely over-levered companies - ones with too much debt - that were acquired by PE firms in leveraged buyouts during the boom years, and now face interest payments they have trouble meeting, along with excess cash.

What makes mezzanine debt uniqu

Much smaller in notional value and are almost always privately placed, highly illiquid, and bought with the expectation of being held to maturity.

NOLs

NOLs can only apply for refunds 2 years backwards If we have excess tax savings we should get from losses that are greater than the tax paid in the previous two years, we get NOL carryforwards These carryforwards can be applied to make an equal amount of future income tax-free However, they don't apply if there's a change in ownership (change in ownership happens when any major holder, defined as a holder of 5% or more equity, has their stake increase by over 50% compared to any point in the last 3 years) This is particularly significant in a reorganization where all of the equity might switch hands If there is a change in ownership the NOL amount to be used per year is limited to a certain percentage * the pre change of ownership market cap of equity

Other items that are "cash like" and may be subtracted from EV

NOLs, short/long term investments, equity investments (from 20%-50% ownership of a company) (depending how liquid they are)

LFCF formulas

Net income + non cash charges - change in operating working capital - capex - mandatory debt repayments (EBIT - net interest expense)*(1-t) + non cash charges - change in operating working capital - capex - mandatory debt repayments CFO- capex - mandatory debt repayments

How do the 3 statements link together

Net income from the income statement become the top line of the CFS Then add back non-cash charges, adjust for changes in operational balance sheet items, investing and financing activities (ex. Changes in PP&E or debt/equity) to eventually get your net change in cash Cash goes up (or down) by this amount on the ending period balance sheet, and on the other side net income flows into shareholder's equity to make the sides of the sheet balance

Flaws with public comps

No company is 100% comparable to another Market is "emotional", multiples could be dramatically higher or lower on some given dates Share prices for small companies w/ thinly traded stocks may not reflect true value

Would we use LFCF for a distressed company since it might be encumbered with debt

No, in fact we should use UFCF precisely because the company is probably encumbered w/ higher than usual debt expense

Would you use Levered Cash Flow for a distressed company in a DCF since it might be encumbered with debt?

No. In fact, with distressed companies it's really important to analyze cash flows on a debt-free basis precisely because they might have higher-than-normal debt expenses.

What does a typical prepackaged (pre-pack) POR do?

Obtain new exit financing from banks (primarily DIP loans) ▪ Reinstate or repay old bank loans Reinstate trade creditors ▪ Reinstate leases and other executory contacts Issue 90 and 95% of common stock to former bond holders (they may get pieces of new debt issuance as well) Issue 5-10% of common stock to former junior creditors, former preferred stockholders, and/or former common stockholders If there is litigation pending, set up and finance a litigation trust and give the common stock a small participation in lawsuit recoveries, if any ▪ Issue options on 6 to 12% of the common stock outstanding to management to incentive them to stay around (despite probably having lost a great deal on their prior stock holdings in the company)

If debtor wants to provide some little value to equity holders what does it need to get from all impaired classes?

Obtain the consent of, or provide full recoveries for, all impaired creditors or the plan will fail as violation of absolute priority rule.

Let's say there's a company that has a first-lien Term Loan (1L TL) of $100 and a second-lien Term Loan (2L TL) of $100. The company has an EV of $150. Where would you think each tranche of debt trades?

Obviously, in the event of default, the 1L will be made whole and there will be $50 leftover for the 2L. So, one would expect the recovery value to be 50 and thus the 2L to trade at roughly fifty cents on the dollar today. It's perfectly fine to say that one would think that the 2L would trade at 50 but may trade higher due to the embedded optionality of the 2L. There's no need to elaborate further unless you are prompted to In reality, one might expect the 2L to actually trade at a little over what it's recovery value alone would dictate. In other words, you'd expect the 2L to probably trade a bit over fifty cents on the dollar. The reason for this is optionality. If the company has not yet filed for Chapter 11 - as the question implies - then there is still the possibility that the company somehow turns things around. Maybe the company is able to raise some junior debt, maybe the company is owned by a sponsor and the sponsor injects some fresh cash for equity, maybe a big contract comes the company's way and they're suddenly flush with cash, etc.

What is feasibility test?

Once restructured, the debtor will not likely liquidate or will not experience the need for further financial reorganization in the future

A company decides to do a $100 write-down of debt. Assuming a 20% tax rate, walk me through the three financial statements

Pretax income is up by $100, net income is up $80. Then you subtract it out on the cash-flow statement because it's a non-cash charge. This leaves you with a -$20 net change in cash. BS: cash down $20, debt down $100, RE up $80

Sometimes a distressed sale does not end in a conventional stock/asset purchase - what are some other possible outcomes?

Other possible outcomes: • Foreclosure (either official or unofficial) • General assignment (faster alternative to bankruptcy) • Section 363 asset sale (a faster, less risky version of a normal asset sale) • Chapter 11 bankruptcy • Chapter 7 bankruptcy

Affirmative covenant example

Outlining what the issuer can do with the proceeds from the bond issue; Obligating the issuer to promising to return the principal of a loan at maturity; or Obligating the issuer to comply with laws and regulations, insure assets adequately, or deliver timely audit reports. comply with law pay taxes

What are the three legal tests for the confirmation of the POR?

Plan confirmation has three tests: feasibility, best interest, and cram down.

What's one way to add debt when there is insufficient asset coverage?

Preferred equity. Can be converted, at the issuer's option, into true debt. Mandatory redemption features (have to be repaid) and blur the line with debt. Failure to make a dividend or redemption payment has limited repercussions so some argue not true debt (for example, can't have a technical default with preferred debt). Usually issued when leverage very high. Also, could do convertible bonds.

What are the four major valuation methodologies

Public comps, precedent transactions, DCF and LBO

Strategic options available to a distressed company

Raise more capital through asset sale, secured financings (more common for IG companies that previously only had unsecured debt b/c other companies likely already have assets encumbered, although they could do second lien), sale/leaseback, equity sponsors (investors) Reducing leverage - through open market repurchases, direct repurchases from holders, cash tender offers, exchange offers

Equitable subordination

Refers the the legal action by which the court postpones payment to one creditor/creditor group until others are paid -- traditionally has been limited to cases of fraud, illegality or breach of fiduciary duty

What are examples of non-recurring charges we need to add back to EBIT or EBITDA when analyzing financial statements?

Restructuring charges Goodwill impairment Asset write-downs Bad debt expense One-time legal expenses Disaster expenses Changes in accounting policies ***Note: to count as an add-back or nonrecurring expense, something has impact EBIT (operating income) in the balance sheet. If it is 'below the line' then we don't add back for it

What are four major steps in Chapter 11?

Restructuring of the debtor's operations by asset sales and contract assumptions and rejections The development and dissemination of a proposed plan (POR) A vote on the plan by the claim and interest holders Confirmation of the plan by the bankruptcy court

What do we do here in RX?

Restructuring really comes down to helping a company right-size (or restructure) their capital structure to ensure they can succeed well into the future. The role of a RX banker is to understand the capital structure of a company, who holds their debt, and then come up with creative solutions that can ensure the company's longterm sustainability in the easiest, cheapest way possible Out of court: Exchange offerings, ammend and exten terms, raising equity, Liability Management, Recap'z In court: Ch 11

Why does Third Avenue (and many other distressed funds) try to get 50% of any issue?

Revolves around fact that in the indentures for almost all publicly traded bonds, any nonmoney provision in the indenture can be modified or abrogated by the consent of 50% of the outstanding issue. So, for example, if you want to block the capacity to be primed (have new money put in front of you in the capital structure) you can if you own 50% of a certain class of bond.

Revolving credit

Revolving credit (i think the same as a working capital line of credit) A line of credit where the debtor pays a commitment fee and then can use the funds as needed. It is usually used as a sort of "credit card" for operating purposes You basically get a credit limit which you can draw on, pay back and then draw on again, so it really does operate like a credit card Often but not always secured by working capital assets, typically a/r and inventory For example, a revolver's capacity (borrowing base) might be up to 85% of a/r and inventory value, with the entirety of a/r and inventory acting as security The theory is that there will always be enough collateral to pay back the loan

How to qualify for section 382 election for NOLs (allowing NOLs to be carried forward into the newly reorganized company)?

Shareholders and creditors of the company must end up owning at least 50% of reorganized debtor's stock. ▪ Shareholders and creditors must receive their 50 percent stock ownership in discharge of their interest and in claims against debtor. ▪ Stock received by creditors can be counted toward the 50% test only if it is received in satisfaction of debt that: o Had been held by the creditor for at least 18 months on the date of bankruptcy filing, or... o Arose in the ordinary course of the debtor's business and is held by the person who at all times held the beneficial interest in that indebtedness.

Downside of being on bondholder committee?

Sign confidential agreement and will then have to disclose when selling or buying securities of the firm. Also, can't tell others about nonpublic info (of course!). The bondholder can't be unrestricted until filing of nonpublic info to public via 8-K, 10-Q, or 10-K.

What's priming?

So priming is just when a new piece of the capital structure is added to above existing pieces.

A company has had positive EBITDA for years but just went bankrupt. How could this happen?

Spending too much on capex High interest expense Facing a credit crunch b/c they can't refinance and debt has all matured Significant one time charges that aren't part of ebitda (ex. litigation)

3. Walk me through an LBO model

Step 1 is making assumptions about the purchase price, debt/equity ratio, interest rate on debt, and other variables; we may also make assumptions about revenue growth or margins Step 2 is to create the sources and uses section, which shows how the transaction is financed and what the capital is used for; it also tells the investor how much equity (cash) is required Step 3 is to adjust the company's balance sheet for the new debt and equity figures, allocate the purchase price, and add in goodwill and other intangibles on the Assets side of the BS to make everything balance Step 4 is to project out the company's three statements, and determine how much debt is paid off each year based on the available cash flows and required interest repayments Step 5 you make assumptions about the exit after several years, usually using an EBITDA exit multiple, and calculate the return based on how much equity is returned to the PE firm

Benefits of filing for chapter 11

Stop accruing post-petition interest on unsecured debt Opportunity to reject uneconomic leases or contracts Tax savings due to liquidity implications of tax status (may get cash tax refund) and the value of NOLs going forward

What is substantive consolidation risk?

Substantive consolidation is when liabilities of separate legal entities are treated as being merged into one entity. Changes value of creditor claims through invalidation of any priority a claim may have had due to corporate structure and thus affect the potential recoveries of certain creditors. Kmart had this happen to them.

Gordon growth formula

TV = final year FCF * (1+g)/(r-g)

Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?

Technically, the answer is "it depends" but practically speaking most of the time the answer is "no." If a company is truly distressed, the value of its debts and obligations most likely exceed the value of its assets - so equity investors rarely get much out of a bankruptcy or distressed sale, especially when it ends in liquidation.

If the market value of a distressed company's debt is greater than the company's assets, what happens to its equity?

The SHAREHOLDERS' EQUITY goes negative (which is actually not that uncommon and happens all the time in LBOs and when a company is unprofitable). A company's EQUITY MARKET CAP (which is different - that's just shares outstanding * share price) would remain positive, though, as that can never be negative.

We have a small group of bonds (let's call them the Unsecured Notes) coming due in a year. They're only $50m and the company has $70m in liquidity. Nothing else matures before these Unsecured Notes. Yet these Unsecured Notes are trading at 60 cents on the dollar. What's going on here?

The Unsecured Notes can't be paid off in full using liquidity (because the liquidity primarily comes from a revolver that has certain terms precluding further draw downs) • The Unsecured Notes can't be refinanced because of the overall poor financial performance of the firm (despite the appearance of having ample liquidity) • The company does not have a year to figure things out, but rather has 6-9 months because of a springing maturity on a much larger, more senior piece of the capital structure exists Therefore, these Unsecured Notes are trading down significantly because time is running out for the company to figure out how to reconfigure their capital structure and in the event of a Chapter 11 the Notes will be impaired and perhaps only deemed to be worth 50-60 (or an out-of-court will occur where the Notes will be asked to take a big haircut) r, perhaps the company has declining EBITDA, poor FCF, etc. making it impossible to go out and raise new debt to roll over these Unsecured Notes (despite the appearance of ample liquidity)

Forced liquidation value

The amount of money a company would get if it sold its assets in an auction immediately. This is basically an absolute worst case scenario (worst case of liquidation too) Assumes sale period of 60-90 days

A company has the same multiple as another. They have the same capital structure, and everything about the two companies is exactly the same except for the industry that they operate in. One company is a biopharmaceutical firm with several drugs in the development pipeline and uncertain cash flows in the future. The other company is a auto manufacturer with very stable cash flows moving forward. Assume that both companies at present rates will be unable to meet their debt obligations in 2 years. Which company's market value of equity is higher?

The firm with more unstable cash flows has greater option value. Therefore, the biopharmaceutical firm has greater potential from its pipeline to generate greater future cash flows. The auto manufacturer has predictable cash flows, and therefore will more than likely continue down the same path and be unable to meet its debt obligations. Same goes for the biopharm firm, but because of the slim chance the firm's equity should trade at a slight premium. Neither firm's equity is necessarily zero (Transaction costs).

Let's say we have two distressed companies with the same EV and debt (where debt is substantially greater than EV). Let's say that Company A has a market cap of $1M and Company B has a market cap of $5M. Which company has more volatility?

The key to this question is understanding that for distressed companies equity trades like a call option (as we discussed above). Therefore, all else being equal, what this question is really saying is that the call options on Company B are worth more than the call options on Company A. The more volatility that an underlying has, the more a call option is worth (because more volatility means a higher chance a call option expires ITM). Therefore, Company B must be more volatile as its equity is worth more and its equity is essentially a call option.

What's fulcrum security?

The most senior class of debt that is impaired and not paid in full.

Recently, there has been news of distressed companies like GM "buying back" their debt for 50 cents on the dollar. What's the motivation for doing this and how does it work accounting-wise?

The motivation is simple: use excess balance sheet cash to buy back debt on-the-cheap and sharply reduce interest expense and obligations going forward. It works because the foregone interest on cash is lower than whatever interest rate they're paying on debt - so they reduce their net interest expense no matter what. Many companies are faced with huge debt obligations that have declined significantly in value but which still have relatively high interest rates, so they're using the opportunity to rid themselves of excess cash and cancel out their existing debt. Accounting-wise, it's simple: Balance Sheet cash goes down and debt on the Liabilities & Equity side goes down by the same amount to make it balance.

Let's say we have a company with a $500M term loan trading at par. The company also has three tranches of $500M Senior Notes (all pari with each other and totaling $1.5B in aggregate). One tranche of Senior Notes is trading at 80, the other two are trading at 60. All have a YTM of 20%. What explains how the YTM is the same?

The only way to explain how the YTM is the same is that there must be a difference in maturity date for these tranches of Senior Notes. Because the Notes trading at 80 have the same YTM as those Notes trading at 60, that must mean the maturity date is sooner for the 80-Notes.

What is needed for a POR to be approved?

The plan is accepted if at least 2/3 of the notional amount (meaning dollar amount of bonds or loans agree) and more than half number of the allowed claims of such a class (meaning half the number of bond or loan holders, regardless of how much they hold)

How is an LBO model different for a distressed company

The purpose here is more to see how quickly we can pay off new debt obligations, as well as to see what kind of IRR the new investors can expect Otherwise its basically the same, but we have different types/tranches of debt (might have DIP), and returns might be lower One structural difference is that an LBO for a distressed company is more likely to take the form of an asset purchase than a stock purchase

How would an LBO model for a distressed company be different?

The purpose of an LBO model here is not to determine the private equity firm's IRR, but rather to figure out how quickly the company can pay off its debt obligations as well as what kind of IRR any new debt/equity investors can expect. Other than that, it's not much different from the "standard" LBO model - the mechanics are the same, but you have different kinds of debt (e.g. Debtor-in-Possession), possibly

What are the five inputs of the Black-Scholes Model?

The strike price, current stock price, time to expiration, risk free rate, and volatility.

Let's say that a company has some Senior Notes trading at fifty cents on the dollar and they go and buy back $100 (face value) worth of these Notes. Can you walk me through the three statements?

The way this works is that we need to recognize the spread between where the debt was bought back at ($50) with the par value ($100) on our income statement as a gain. This isn't operating income per se, so would be considered to be an "Other" source of income in the form of a gain on the retirement of debt. So, on the income statement we have this $50 gain (again, this is the spread between the level the debt was bought at and the face value). We'll apply a 40% tax rate (you can apply a 20% rate to be more current, I'll just use 40% here) and get to $30. On the cash flow statement, under CFO, we have net income up $30, but had the non-cash gain of $50, so we're down $20 on the CFO. Under cash flow from financing, we reflect the retirement of the debt (-$50), so our net change in cash is -$70. On the balance sheet, we have cash down $70. On the flip side, we have debt down $100 (since we retired $100 face value of debt) and retained earnings is up by $30.

What are the two-sides of a restructuring? Who do we advise?

There's the "debtor" side, which is the company, and the creditors side, which is the bond holders or loan holders. Debtor mandates involve just dealing with one party: the company. Creditor mandates usually involve dealing with a large number (it can be three or it can be ten or more) bond or loan holders within a certain class who band together.

From the perspective of the creditors, what different strategies do they have available to recover their capital in a distressed situation?

These mirror the options that are available to the company itself in a distressed scenario: 1. Lend additional capital / grant equity to company. 2. Conditional financing - Only agree to invest if the company cuts expenses, stops losing money, and agrees to other terms and covenants. 3. Sale - Force the company to hire an investment bank to sell itself, or parts of itself. 4. Foreclosure - Bank seizes collateral and forces a bankruptcy filing.

Why are credit ratings not that great of an indicator for distress?

They are lagging indicators.

How are Restructuring deals different from other types of transactions?

They are more complex, involve more parties, require more specialized/technical skills, and have to follow the Bankruptcy legal code - unlike most other types of deals bankers work on. The debtor advisor, for example, might have to work with creditors during a forbearance period and then work with lawyers to determine collateral recoveries for each tranche of debt. Also, unlike most standard M&A deals the negotiation extends beyond two "sides" - it's not just the creditors negotiating with the debtors, but also the different creditors negotiating with each other. Distressed sales can happen very quickly if the company is on the brink of bankruptcy, but those are different from Bankruptcy scenarios.

What happens to Accounts Payable Days with a distressed company?

They rise and the average AP Days might go well beyond what's "normal" for the industry - this is because a distressed company has trouble paying its vendors and suppliers.

How are restructuring deals different from other types of deals

They're more complex, involve more parties, follow a legal framework, require more specialized knowledge, negotiation isn't just two-sided like in M&A and involves the debtor as well as all the different creditor groups and equity holders and other stakeholders

Normally M&A processes are kept confidential - is there any reason why a distressed company would want to announce the involvement of a banker in a sale process?

This happens even outside distressed sales - generally the company does it if they want more bids / want to increase competition and drive a higher purchase price.

Why might a creditor might have to take a loss on the debt it loaned to a distressed company?

This happens to lower-priority creditors all the time. Remember, secured creditors always come first and get first claim to all the proceeds from a sale or series of asset sales; if a creditor is lower on the totem pole, they only get what's left of the proceeds so they have to take a loss on their loans / obligations.

What kind of recovery can you expect for different assets in a Liquidation Valuation?

This varies A LOT by industry, company and the specific assets, but some rough guidelines: • Cash: Probably close to 100% because it's the most liquid asset. • Investments: Varies a lot by what they are and how liquid they are - you might get close to 100% for the ones closest to cash, but significantly less than that for equity investments in other companies. • Accounts Receivable: Less than what you'd get for cash because many customers might just not "pay" a distressed company. • Inventory: Less than Cash or AR because inventory is of little use to a different company. • PP&E: Similar to cash for land and buildings, and less than that for equipment. • Intangible Assets: 0%. No one will pay you anything for Goodwill or the value of a brand name - or if they will, it's near-impossible to quantify.

How is a distressed m&a process different from one for a healthy company?

Timing is quick We might produce fewer upfront marketing materials in the interest of speed Creditors might initiate the process and not the company itself Distressed sales can't "fail" like normal m&a deals -- they'll either result in a sale, a liquidation/bankruptcy or restructuring We might need more bidders to get a half-decent price for our company While a lot of M&A processes are kept confidential, we might publicize distressed sales to get more interested buyers and bid up the price

Signs on the financial statements that a firm is in distress

Too little capex on the cash flow statement a/p and accrued expenses higher than normal on the balance sheet

How could a decline in a company's share price cause it to go bankrupt?

Trick question. Remember, MARKET CAP DOES NOT EQUAL SHAREHOLDERS' EQUITY. You might be tempted to say something like, "Shareholders' equity falls!" but the share price of the company does not affect shareholders' equity, which is a book value. What actually happens: as a result of the share price drop, customers, vendors, suppliers, and lenders would be more reluctant to do business with the distressed company - so its revenue might fall and its Accounts Payable and Accrued Expenses line items might climb to unhealthy levels. All of that might cause the company to fail or require more capital, but the share price decline itself does not lead to bankruptcy. In the case of Bear Stearns in 2008, overnight lenders lost confidence as a result of the sudden share price declines and it completely ran out of liquidity as a result - which is a big problem when your entire business depends on overnight lending.

What acceptance rate do exchange offers need (for an out-of-court restructuring)?

Typically exchange offer needs 90% acceptance.

What is debt incurrence covenant?

Under what terms a company is allowed to add to its debt. Based on leverage ratio debt/EBITDA. Sometimes (although rarely) EBITDA/interest expense used.

PIK interest

Usually issued on mezz debt. PIK interest is where the interest accrues to the loan's principal balance, so if we have 100 in debt and 10% yearly PIK interest, after year 1 we now have 110 in outstanding principal debt. The loan principal will keep going up over time. PIK is a risky form of debt and carries a higher interest rate than bank or HY or other traditional debt. We include this as an interest expense on the income statement, but we have to be sure to add it back on the cash flow statement since it's a non-cash expense. The idea is that by the time the PIK debt matures, the company will have grown or stabilized enough to pay it off and pay off the accumulated coupons, either through its own cash or through refinancing with fresh debt/equity

Orderly liquidation value

Value we expect to get for sale of hard assets in an auction-style sale. "Orderly" implies enough time to contact all potential buyers and that the seller has control of the process Assumes sale period of 6-9 months

Difference between section 301 or section 303 in Chapter 11?

Voluntary by debtor of involuntarily by creditors or indenture trustee. Meaning that the company voluntarily declares Chapter 11 or creditors do (on the basis of technically defaulting for breaking covenants, missing payments, etc.)

How does valuation change for a distressed company

We use the same 3 main methods, but we make certain accounting adjustments, look at the lower range of multiples, use lower projections for the DCF, pay more attention if the company is EBIT/EBITDA/EPS negative, might look at liquidation value, sometimes we'd look at valuations on an assets-only or a liabilities assumed basis

How do we use an LBO to value a company, and why do we say it sets a "floor valuation" for a company

We would set a targeted IRR and then solve backwards to determine the purchase price the PE firm would have to pay to get the targeted IRR This is called a "floor valuation" b/c PE firms usually will pay less than a strategic buyer

How should we think about optionality for various parts of the capital structure?

What we've been building toward in these questions is that any part of the capital structure that trades below par has some level of optionality embedded in it, but not all parts of the capital structure have the same level of optionality. For example, carrying forward our initial example, the 1L has no real optionality. It's probably trading around par and if the company suddenly turned things around, and didn't have to file, that wouldn't make things much different for the 1L holders (since they would already receive a full recovery in the event of filing).

What's a full prepack?

When a Chapter 11 petition is filed it is accompanied by a complete disclosure statement and a proposed plan of reorganization, together with an agreement to support the plan that is binding on a sufficient number of the class to satisfy the applicable voting tests

Default? Technical default?

When the company that issues a bond or loan fails to make required payment. Technical default occurs when maintenance/affirmative covenants are violated (for example, breaks the required leverage or interest rate coverage ratios)

When does absolute priority rule not apply?

When the plan is accepted by all voting classes by requite majorities. If a class of claims so consents, a class below them can get something even though the consenting class has not been paid in full (made whole). Nothing in the statue says the distributions in a consensual plan need to comply with absolute priority rule.

What's the difference between acquiring just the assets of a company and acquiring it on a "current liabilities assumed" basis?

When you acquire the assets of a distressed company, you get literally just the assets. But when you acquire the current liabilities as well, you need to make adjustments to account for the fact that a distressed company's working capital can be extremely skewed. Specifically, "owed expense" line items like Accounts Payable and Accrued Expenses are often much higher than they would be for a healthy company, so you need to subtract the difference if you're assuming the current liabilities. This results in a deduction to your valuation - so in most cases the valuation is lower if you're assuming current liabilities.

Normally in a sell-side M&A process, you always want to have multiple bidders to increase competition. Is there any reason they'd be especially important in a distressed sale?

Yes - in a distressed sale you have almost no negotiating leverage because you represent a company that's about to die. The only real way to improve price for your client is to have multiple bidders.

Can you change loan covenants if the company gets into trouble?

Yes, for a fee (called a consent fee, often part of a restructuring involving needing the consent of a revolver). It's usually easier to get changes with loans than with bond holders.

How do you determine how much liquidity a company really has?

You take their revolver capacity, subtract the amount currently drawn, and add their current cash or cash equivalents (also minus letters of credit outstanding and minus restricted cash, if relevant)

How do you measure the cost of debt for a company if it is too distressed to issue additional debt (i.e. investors won't buy any debt from them)?

You'd have to look at the yields of bonds or the spreads of credit default swaps of comparable companies to get a sense of this. You could also just use the current yields on a company's existing debt to estimate this, though it may be difficult if the existing debt is illiquid.

What's a springer or "spring forward"?

he Term Loan will often have a springing maturity such that if the Notes are not re-financed significantly (leaving less than $10m left, for example) then the Term Loan maturity springs before the Notes maturity.

financial maintenance covenant example

max leverage ratio min coverage ratio max capex max senior debt/ ebitda

Let's say there's a company that has a first-lien Term Loan (1L TL) of $100 and a second-lien Term Loan (2L TL) of $100. The company has an EV of $150. where would we expect equity to trade in this scenario?

the equity will retain value prior to filing for the same reason as mentioned above with the 2L (just to an even greater extent). The optionality of equity arises from the fact that maybe the company is able to turn things around. Maybe the company can effect some out-of-court solution that delays filing, maybe the company is injected with new cash from the sponsor, etc.

Let's say a distressed company wants to raise debt or equity to fix its financial problems rather than selling or declaring bankruptcy. Why might it not be able to do this?

• Debt: Sometimes if the company is too small or if investors don't believe it has a credible turnaround plan, they will simply refuse to lend it any sort of capital. • Equity: Same as above, but worse - since equity investors have lower priority than debt investors. Plus, for a distressed company getting "enough" equity can mean selling 100% or near 100% of the company due to its depressed market cap.

How would valuation change for a distressed company?

• You use the same methodologies most of the time (public company comparables, precedent transactions, DCF)... • Except you look more at the lower range of the multiples and make all the accounting adjustments we went through above. • You also use lower projections for a DCF and anything else that needs projections because you assume a turnaround period is required. • You might pay more attention to revenue multiples if the company is EBIT/EBITDA/EPS-negative. • You also look at a liquidation valuation under the assumption that the company's assets will be sold off and used to pay its obligations. • Sometimes you look at valuations on both an assets-only basis and a current liabilities-assumed basis. This distinction exists because you need to make big adjustments to liabilities with distressed companies

Can you tell me some of the kinds of projects you'll be working on as an analyst or associate?

▪ Refreshing a screen ▪ Creating a new screen ▪ Creating a profile ▪ Joining an ongoing pitch