A M&a Boom in Busted Companies

8/10/2019 A M&a Boom in Busted Companies

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BUSTED

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J une 2001 Vol. 36 No.

The Dealmak ers J ourna

LEGALAFTERSHOCKS

IN KEYDIVESTITURES

A NASTYPOSTCRIPT

TO THEBROKEN DEAL

An M & A

C O M P A N I ES

A NASTYPOSTCRIPT

TO THEBROKEN DEAL

LEGALAFTERSHOCKS

IN KEYDIVESTITURES

BUSTEDBOOMBOOMINC O M P A N I ES


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www.ceoknowledge.com

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C OVERSTORY

By Brent Shearer

Doing a distressed m&a deal is like

tying to sell an ice cube before itmelts, says Henry F. Owsley, a prin-cipal at boutique investment bank theGordian Group in New York. That

being the case, there are a lot of ice cubes on theblock in todays sagging economy and a lot of deal-makers struggling to unload them before interme-diaries, investors, management, and debtors are leftwith little but a puddle to divvy up.

During the economic boom of the mid- and late1990s, distressed m&a was a sideshow populated bysuch firms as Dresdner Kleinwort Wasserstein (the

former Wasserstein Perella & Co.), Lazard Freres &Co., Houlihan Lokey Howard & Zukin, BlackstoneGroup, Rothschild Inc., and a few others. Most ofWall Streets powerhouse financial institutions donttake on distressed m&a work for a number of rea-sons ranging from the potential clients financialconstraints to conflicts of interest with creditors.

Few people outside of the fraternity of distressedm&a specialists paidmuch attention tothe restruc-

When BadThings

Happen toGood

Companies,Find a BuyerThe distressed sector of them&a market is growing rapidly

as acquirers see value incorporate wreckages.

When BadThings

Happen toGood

Companies,Find a Buyer


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turing activities of firms that specialize in distressed situa-tions which often include m&a when the Nasdaq wasbooming and the chase for IPOs and technology invest-ments was the preferred path to riches. But this former

wallflower of a sector now is enjoying its most robust levelof activity since the economic slump of the early 90s.

The increase in distressed m&a is a continuation of atrend weve been seeing for some time now, says BarryW. Ridings, co-head of restructuring at Lazard. Thetrend is linked to the slowing of the economy, the tight-ening of credit, and a confluence of other events thatmake it close to a perfect storm.

In the film Ridings is referring to just about everythingwent wrong for a ships crew. If you translate that kind ofstormy weather into the adverse business conditions facedby many companies today, you have a picture of what is

driving distressed companies to consider restructuringoptions. And m&a is an increasingly attractive option forrestructuring distressed companies. While it may be hardto appreciate this perfect storm if your company is the onebeing battered and forced into Chapter 11, it has meantan up-tick in activity at firms that specialize in restructur-ing. But one difference this time around is that there is alarger group of potential acquirers.

Were seeing a lot of more-traditional companies tak-ing a look at buying troubled businesses, says David L.Resnick, who heads up Rothschild North America Inc.srestructuring practice. In addition to this new class ofpotential acquirers kicking the tires of ailing companies,you also have the traditional bottom-fishers, or distressedinvestors, who see new opportunities as the number ofdistressed companies increases.

Can you say credit crunch?

The foundation for the distressed m&a revival is thetightening of the purse strings by lenders in the face of thehighest rate of defaults on corporate debt since the lasteconomic dip the slump of the early 1990s. Accordingto Moodys Investor Services, default rates on corporate

debt have risen to levels not seen for nearly a decade, andthey are projected to rise even further this year. The glob-al default rate on high-yield bonds rose to 6% in 2000from 5.1% in the preceding year. The rating agency fore-casts a 9.1% default rate for 2001.

One result of this heightened default rate is an increasein pressure on lenders to get their money out of the weakercompanies in their portfolios as quickly as possible. In addi-tion to a sale, options for a sputtering company include refi-nancing the debt load, reorganization, and a workout plan.

Because of the pressure that lenders are under, wereseeing that companies in trouble are often choosing to optfor a sale because lenders increasingly dont have thepatience for any other restructuring option such as a reor-

ganization, which can take as much as a year or longer,Resnick says.

One choice that distressed dealmakers say is out offavor now is the option to issue new equity in a stumblingcompany. Reorganized equity is not as attractive as itonce was as an exit strategy, says Andrew Rahl, a bank-ruptcy attorney at the law firm of Anderson Kill & Olickin New York.

However, an interesting wrinkle in todays distressedm&a market is that the tightness of credit cuts both ways.Not only are lenders short on patience but potentialacquirers can also have trouble rounding up cash. Finan-

cial buyers are at a disadvantage in todays distressed m&amarket, says Andrew Miller, head of restructuring atHoulihan Lokey. Many of them are being forced to equi-tize their deals more than they have in the past.

Tight credit has also led to an increased level of anxi-ety among bondholders in many cases. In the last 12 to24 months, weve seen an increase in the debt-holdingcommunitys willingness to get organized earlier in theprocess, notes H. Roy Stroube, III, a bankruptcy lawyerat Akin, Gump, Strauss, Hauer & Feld in Houston. Hesays hes seeing the formation of ad hoc debtors groupseven before the company goes into Chapter 11.

See you in Chapter 11

As more companies report earnings disappointmentsand other operational snafus, Chapter 11 becomes eithera reality or at least a possibility for many companies thatmay be targets for a distressed deal. Indeed, Miller notesthat most distressed deals get done in Chapter 11.

In conversations with a number of distressed m&aexperts, Mergers & Acquisitions has heard many opinionsabout the advantages and disadvantages of selling a com-pany while it is under the umbrella of court protection.

Without belaboring readers with Bankruptcy Sales 101, anumber of practitioners were willing to add their tips tothe body of knowledge that exists on negotiating therapids and shoals of Chapter 11 and ending up with a sale.

Stroube says that due diligence is vital in evaluatingcompanies that are candidates for a distressed m&a deal,but added that the process differs from normal due dili-gence. You have to be able to drill down deeper to deter-mine the true going concern value of the enterprise, hesays. Stroube cautions that since failing companies have


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far more gremlins and goblins on their books thanhealthy companies, getting a clear picture of a distressedcompany is harder.

Stroube also states that the due diligence process

should include a going-forward component so that poten-tial acquirers form a reasonable expectation of the relia-bility and the value of the company after it is sold.

In distressed m&a, time isnt on your sideIts all well and good to recommend thorough due dili-

gence, but as a number of distressed specialists point out,you dont have much time in most distressed transactions.After all, the ice cube is melting.

Ridings says that these companies all have chronic liq-uidity problems so everyone is in a rush to get a deal done.The afflicted company,

usually one in Chapter 11,already is probably havingtrouble meeting its creditobligations. It may haveimpaired relationshipswith customers and maybe faced with a rash ofemployee departures. Asthese negatives snowball,only quick and decisiveaction can get a deal done.

In about one-third toone-half of our assign-ments, we get called in torescue a deal after thingshave gone wrong, Millersays. A lot of these com-panies are bleeding cashand we have to sell themquickly. We try to get thedeals done in 60 to 90days, he says.

The necessity of a short-term focus in most distressed

situations means that the highest bid isnt necessarily thebest one. You fit your strategy to the circumstancesyoure dealing with, says Peter S. Kaufman, a principal atthe Gordian Group. Sometimes the certainty of gettingthe deal done is more important than holding out for themost money.

Miller noted that common failings of dealmakers whoare new to the distressed arena include a lack of experi-ence with bankruptcy law and creditor rights. As the par-ties try to structure the deal, management will be unlikely

to have experience in selling assets from a distressed situ-ation, so the need for experienced dealmakers to handlethe process is vital.

But having said that, there is some overlap between

what bankruptcy expert Rahl calls regular m&a guys anddistressed specialists. The best distressed m&a people aregetting busy and we expect to see another wave of thesedeals coming to the fore this year, he says. Some deal-makers can swing in and out of this area as it heats up.

But Rahl cautions that working in a bankruptcy envi-ronment, where most distressed deals occur, requiresknowledge of a number of special rules that overlay therest of the m&a world. Unless the people on the dealknow these rules and the people involved in enforcingthem, they will have trouble working in this environ-

ment, he says.

A more crowded table fordistressed deals

Whether a dealmaker isa distressed specialist or ageneralist, he can expectone complicating factorwhen doing a distresseddeal: more interested par-ties around the table. Inmost regular m&a deals youhave the buyer and the sell-er only. In a distressed deal,you have those two partiesplus representatives of dif-ferent creditor groups. Insome deals, there may beadditional constituents.And if it is a Chapter 11sale, the court will have tookay the results.

The biggest difference between distressed m&a andregular m&a is that you have multi-party negotiations,

Resnick says. Resnick adds that valuation is a key issue inthese talks and determining it is not easy given the differ-ent viewpoints and interests of the multiple parties thatare involved in the talks.

While valuation may be relatively cut-and-dried for asuccessful business, Miller says that it is much more sub-jective a measure for companies that are on the skids.Because there is not enough value to go around, you haveinherent conflicts of interest. Equity holders will have adifferent perspective than bondholders, management will

Top 10 Ways to Screw Up

A Distressed Transaction10. Lousy, rushed due diligence

9. Inaccurate valuation

8. Paying too much for the asset

7. Lack of understanding of bankruptcy law

6. Lack of understanding of m&a basics

5. Inability to craft a pact that creditors can support

4. Selling common stock in a deal where the company

is worth less than the underlying claims

3. Failure to account for liability overhang from

previous operations

2. Putting in new capital and allowing it to be

used for past sins

1. Selling healthy assets to try to save

underperforming ones


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Why not pull the plug?The payoff for acquirers in distressed m&a situations

is that they can pick up assets cheaply. For debtors, agood sale is one that gets them out of the company with

as much of their investment as possible intact. For thecompany, if the sale allows it to reorganize and start lifeover under new management, it will be deemed asuccess.

Rothschilds Resnick pointed to two transactions hewas involved in as good examples of the value that can becreated by distressed m&a. The acquisition by Schlum-berger Inc. of Cell Net Data Systemswas done at asignificant discount to what Cell Nets assets had beenworth. Cell Net produces electronic metering systemsfor the reading of utility service. In the deregulating util-ity industry environment, the concept had seemed

promising, but the company failed to execute its businessplan. Now Schlumberger has been able to broaden itsofferings in its utility services sector by offering Cell Netproducts.

Resnick cites a distressed deal by a financial buyer asanother example of a transaction that added value for both

parties. Key Plastics LLC was able to continue opera-tions and emerge from Chapter 11 after Carlyle Man-agement Groupbought it. Key Plastics, a maker of plas-tic components and subsystems for the auto industry, will

be run by Carlyle.An interesting aspect of the Key Plastics deal was that

the acquirers status as a financial buyer was an advantage.Resnick and other distressed specialists say that a strategicbuyer usually is in a better position to do a distressed deal.But in the Key acquisition, this general rule was reversed.Sometimes a financial buyer can be more flexible,Resnick says. Strategic buyers are more likely to want aclean balance sheet, while in the Carlyle Management/KeyPlastics transaction, it was the private equity investorswho put together the most compelling purchase plan.

But for both strategic and financial buyers, distressed

transactions will continue to offer significant opportuni-ties as long as credit remains tight and companies fail toexecute their business plans. Given the pressures onlenders and companies, we see distressed m&a takingplace on a more accelerated timetable for the foreseeablefuture, Resnick says.

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