Presentation on theme: "Course Layout: M&A & Other Restructuring Activities"— Presentation transcript:
1 Chapter 16 Alternative Exit and Restructuring Strategies: Reorganization and Liquidation
2 Course Layout: M&A & Other Restructuring Activities Part IV: Deal Structuring & FinancingPart II: M&A ProcessPart I: M&A EnvironmentPayment & Legal ConsiderationsPublic Company ValuationFinancial Modeling TechniquesM&A IntegrationBusiness & Acquisition PlansSearch through Closing ActivitiesPart V: Alternative StrategiesAccounting & Tax ConsiderationsBusiness AlliancesDivestitures, Spin-Offs & Carve-OutsBankruptcy & LiquidationRegulatory ConsiderationsMotivations for M&APart III: M&A Valuation & ModelingTakeover Tactics and DefensesFinancing StrategiesPrivate CompanyValuationCross-BorderTransactions
3 Learning ObjectivesPrimary Learning Objective: To provide students with an understanding of alternative strategies for failing businessesSecondary Learning Objectives: To provide students with an understanding ofCriteria for choosing strategy for failing firmsProcess for filing for bankruptcy, voluntary and involuntary settlements inside and outside of court, and voluntary and involuntary liquidation
4 Rule of Law and Corporate Asset Allocation The smooth functioning of capital markets requires rapid and fair resolution of disputes involving the legal rights of borrowers and lendersStudies show that borrowing costs are lower and access to credit easier in countries which enforce credit rights.Total cost of financial distress (i.e., inability to meet financial obligations) includes the following:--Employee layoffs--Firm under-investment--Eroding community tax base and blight--Customer dissatisfaction with declining product quality and increasing delivery times--Delayed payments to suppliers (including lenders)--Higher borrowing costs--Declining shareholder valueBankruptcy plays key role in minimizing these costs by providing a process for resolving these issues in a timely manner.
5 Bankruptcy Applicable to failing firms A firm is technically insolvent if it is unable to pay its liabilities as they come dueA firm is legally insolvent if a firm’s liabilities exceed the fair market value of its assetsDesigned to protect failing firms from lawsuits by its creditors until decision made to shut-down or to continue operating the firmA firm not considered bankrupt until it or its creditors petition the federal bankruptcy court
6 Signs and Risks of Distress¹ Ratings downgradesNear scheduled expiration of credit linesComplex capital structuresPending regulatory investigationsAuditor discord or qualified opinionChange of lender representativesDebt reduction programsCost reduction initiatives – layoffs, concessionsUnexpected changes in management¹ Ball and Kane, A Practical Guide to Distress M&A, The M&A Lawyer
7 Examples Los Angeles Dodgers Prince Sports Kodak Hostess MF Global LehmanGeneral MotorsDelphi – formerly GM supplier.
8 Voluntary Reorganization Outside of Bankruptcy Court Generally offers best chance for owners to recover a portion of their investmentUsually, initiated by debtor firm by requesting relief from creditorsSuch relief often consists of the following:An extension: Creditors agree to lengthen period during which debtor firm can repay its debt. May also include a temporary suspension of both interest and principal repaymentsA composition: Creditors agree to settle for less than the full amount they are owedDebt for equity swap: Creditors surrender a portion of their claims in exchange for an ownership position in the firm
9 Voluntary Liquidation Outside of Bankruptcy Court If creditors conclude insolvent firm’s situation cannot be reorganized, liquidation may be only course of actionIf insolvent firm is willing to accept liquidation and all creditors agree, legal proceedings not necessaryCreditors normally prefer liquidations to avoid lengthy and costly litigationSignificant issue: liquidation vs. going concern
10 Reorganization and Liquidation in Bankruptcy In absence of out-of-court voluntary settlement, debtor firm mayseek protection from creditors by petitioning the bankruptcy court orbe forced into bankruptcy by its creditorsBankruptcy allows creditor firm to stop all principal and interest payments and prevents secured creditors from taking possession of their collateral StayU.S. Bankruptcy Code:Chapter 11 deals with reorganization and provides for the debtor to remain in possession, unless court rules otherwiseChapter 7 deals with liquidation and defines priority in which creditors will be paidChapter 15 addresses insolvency issues involving assets, lenders, and other parties in various countries
11 Chart 16-1. U.S. Chapter 11 Filings By Fiscal Year (Public and Private Companies) Source: Administrative Office of the United States Courts
13 Chapter 11 – Statistics Public record but difficult to identify Approximately 1% of total filings –September 2011 and September 2010Filings 1,596, ,467,732Terminations 1,496, ,461,896Pending 1,659, ,664,393Conclusion: Increase 2.75 X 2008
14 Procedures for Reorganizing in Bankruptcy Filing with the Bankruptcy CourtAppointment of Debtor in Possession or Court TrusteeDevelop and Present Reorganization PlanAcceptanceofReorganization Plan by All PartiesPayment of Court Approved Expenses
15 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) Pre-BAPCPA:Debtor in possession (DIP) had exclusive right for first 120 days to file a reorganization plan before creditors could submit their own planCourt could at its discretion provide extensionsLeases could be extended indefinitely as long as payments madePost-BAPCPA: “Stop the foot dragging”Caps DIP exclusivity period at 18 months with an additional 2 months to win creditors’ acceptance of reorganization plan, effectively giving DIP a maximum of 20 months before creditors’ can submit their plan“Good cause” lease extensions limited to 90 daysPayments to management employees cannot be more than 10 times amount paid to non-management employeesChapter 11 Success ?¹ Warren & Westbrook, The Success of Chapter 11: A Challenge to The Critics, Michigan Law Review Vol. 107:603
16 Liquidation in Bankruptcy If the bankruptcy court determines reorganization not feasible, failing firm may be forced to liquidatePriority in which claims are paid (per Chapter 7 of U.S. Bankruptcy Code)Past due property taxesSecured creditors up to proceeds of the sale of pledged assetsLegal feesExpenses incurred after involuntary case begun but before trustee appointedWages not to exceed $2000 per workerUnpaid employee benefit plan contributions up to $2000Unsecured customer deposits of $900 or lessIncome taxes owed federal, state, or local governmentsUnder-funded pension liabilities up to 30% of the firm’s book valueUnsecured creditorsPreferred shareholders, up to par value of their stockCommon shareholders, paid out of remaining funds
17 Prepackaged Bankruptcies Debtor negotiates reorganization plan with major creditors well in advance of filing for Chapter 11Subsequent Chapter 11 reorganization averages a few months as court only has to approve the planMinority creditors may be required to accept the plan by the court “Cram Down”Debtor may lose NOLs if out of court settlement reached in which creditors exchange their debt for equity and original shareholders own less than 50 percent of firm. In bankruptcy, debtor may claim NOLs. Unless GMBeechcraft – 5/3/12 – swap debt for equity¹ Fitzgerald & Beaudette, Hawker Beechcraft Files for Chapter 11, WSJ, May 3, 2012
18 Choosing Appropriate Restructuring Strategy: Failing Firms Choice heavily influenced by the following:Going concern value of debtor firmSale value of debtor firmLiquidation value of debtor firmImplications:If sale value > going concern or liquidation value, sell firmIf going concern value > sale or liquidation value, reach out of court settlement with creditors or seek bankruptcy protection under Chapter 11If liquidation value > sale or going concern value, reach out of court settlement with creditors and liquidate or liquidate under Chapter 7
19 Examples – 2011-2012 Borders – February 2011 Assets $1.28B; Liabilities $1.2bGE Capital provided DIP financing $550MSales down double digit each quarter from 20086,100 staff, 508 stores including WaldenbooksLiquidation sale $700M in July
20 A123 Bankruptcy October 2012 Bankruptcy Presidential election issue -$249M/$120MAwaiting court approval – 12/11/12 – 2PMOther suitors – Johnson Controls & NECAlso CFIUS approval – Treasury may stopOriginal deal – Wanxiang – 80% -$450MNow gets 100% (less US govt. deal) $260MMilitary/industry – businesses too similar
21 Examples – 2011-2013 MF Global – November 2011 – 8th largest Firm began 1783 by James Man12/8/11 – Corzine – Sgt. Schultz defense.Ongoing hearings today as CH 11 proceedsFormer FBI head Louis Freeh, TrusteeOctober 30 – “material shortfall”; $7B in AugustOctober 31 – accounts frozen; petition filedInvested $6B in European sovereign bondsMixed customer and firm assets; loss > $1BCannot be primary dealerAssets: $41B; liabilities $40B
22 Examples – 2013 Atari – cleared Ch 11. No game buyers Building 19 Gallup NM Catholic DioceseCity of Detroit (Chapter 9)BlockbusterCengage – PUBLISHERBebo – Former AOL subsidiary
23 Discussion QuestionsWhy should corporate bankruptcy be considered a potential business strategy?Under what circumstances is the bankruptcy court likely to decide that a “failing firm” should be liquidated?What are the primary options available to a “failing firm?” What criteria should be used to select the best option? Be specific.When is a prepackaged bankruptcy an appropriate option?
24 Things to Remember…Bankruptcy process supports smooth functioning of capital markets by protecting creditor and debtor rightsGenerally offers best chance for owners to recover a portion of their investmentBankruptcy allows creditor firm to stop all principal and interest payments and prevents secured creditors from taking possession of their collateralA failing firm’s options are to merge with another firm, reach an out-of-court voluntary settlement with creditors, or file for Chapter 11 bankruptcy protection