Bankruptcy is like… “Open heart surgery – the longer you stay under the knife, the lower the chance of success… “
GM warns it may be forced into bankruptcy Thu Mar 5, 2009 7:39am EST DETROIT (Reuters) - General Motors Corp on Thursday said its auditors had raised "substantial doubt" about its ability to survive outside bankruptcy if it fails to stem its losses and stop burning cash. The "going concern" warning from the struggling U.S. automaker had been expected, but underscored the stakes for GM as it seeks up to $30 billion in U.S. government aid to restructure outside a court-supervised bankruptcy process. GM had warned late last month that it expected its auditors would question its viability at the same time that it reported a loss of nearly $31 billion for 2008.
Biggest Bankruptcies… $613B in debtWorld markets continue to tumble over the September 15, 2008 bankruptcy filing of Lehman Brothers. Once a global financial services firm, Lehman Brothers fell victim to the subprime mortgage crisis and couldn’t recover its losses. The company’s stock plummeted in the first half of 2008 and attempts to secure a potential buyer failed. The company’s fate was sealed after the U.S. Federal Reserve Bank refused to bail them out. Lehman’s cited $613 billion in bank debt and $155 billion in bond debt when it declared bankruptcy. On September 16, Barclays acquired Lehman’s investment banking and trading devisions.
Worldcom… $5.7B in debtThe one-time second-largest U.S. phone company, WorldCom came under fire in 2002 after it was discovered that company officials were cooking the books to hide declining earnings. They were accused of using fraudulent accounting methods to increase the price of the company's stock. The U.S. Securities and Exchange Commission launched an investigation and it was estimated that WorldCom’s assets had been inflated by about $11 billion. The company filed for bankruptcy in July 2002 but emerged under the name MCI. Verizon Communications acquired MCI in 2005.
Nortel… Over 95,000 employees, market value of $366B at its peakOnce an industry giant, telecom equipment manufacturer Nortel filed for bankruptcy protection Jan. 14 after years in a downward spiral following the tech bust. Despite attempts to restructure over the last few years, Nortel is the latest victim of the global credit crisis and recession. In December 2008, Nortel stocks were valued at just $1 per share. On Jan. 13, the company's stock closed even lower at 38.5 cents per share. At their highest worth before a more recent consolidation, Nortel shares were listed on the TSX at $124.50 in July 2000.
Barings… Bought in 1995 for £1Even the bank’s storied history couldn’t save it from a gutsy employee. Singapore-based employee Nick Leeson managed to go unnoticed over a three year period speculating on futures contracts. By the time his fraudulent activities were discovered, Lesson had lost £827 million (US$1.4 billion) - about double of Barings trading capital - and the bank was declared insolvent. Leeson tried to escape but was captured and given a jail sentence. His book, “Rogue Trader” was made into a movie.
Bre-X Total capitalization hit $6BA mining company based in Calgary, Bre- X stock soared in 1995 after the company reported that gold was discovered at one of its sites in Indonesia. Formally a penny stock, Bre-X skyrocketed to $286 on the Toronto Stock Exchange as speculation swirled around how much gold was at the site. In fact, there wasn’t any gold and investors were scammed. The company’s collapse in 1997 rendered its shares worthless. The scandal is reported to be one of the biggest in Canadian history.
Bear Stearns Bought for $10 a share - traded as high as $133.20The collapse of global investment bank Bear Stearns is attributed to a lack of investor confidence after rumours swirled about its liquidity crisis. Unlike Lehman Brothers, however, the U.S. Federal Reserve tried to save it from collapse in March 2008 with an emergency loan that came too late. JPMorgan Chase bought Bear Stearns for a meagre $10 per share, significantly lower than its 52-week high of $133.20 per share.
ENRON… Claims revenues hit $111BEnjoying the notoriety that came with being named “America’s Most Innovative Company” by Fortune magazine six times, U.S. energy company Enron had a reported 22,000 employees and revenues of $111 billion in 2000. The bubble burst in 2001 after it was discovered that the company’s finances were fraudulent and Enron filed for bankruptcy protection late that year. Some of Enron’s directors settled lawsuits with personal money and in 2007 the company changed its name to Enron Creditors Recovery Corporation.
Global Crossing CEOs received $13.5M signing bonusesLavish executive spending – from private jets and exorbitant property deals to multi-million dollar bonuses and a $15 million Picasso painting – is where the trouble started for telecommunications company Global Crossing. The company’s stock fell to $5 per share in November 2001 as investors lost confidence and Global Crossing filed for bankruptcy protection in early 2002, becoming the seventh largest bankruptcy filing in U.S. history. It has since been bought by Singapore Technologies Telemedia for $750 million.
Will the government safe you? Bailout Lockheed, Bear Stearns, Chrysler Maintain competition in industry Safe employment Maintain technology, knowledge Etc…..
Failures that trigger reorganization Economic failure: LT Revenue market value of the assets Legal bankruptcy: firm has filed for bankruptcy with the court
Dun&Bradstreet Inc. There is a whole industry out there checking on companies’ credit worth…
The largest bankruptcies Enron Worldcom Tyco Texaco Airlines… The down fall of companies often trigger the downfall of some of their customers and suppliers….
Current cases of potential bankruptcy The car industry in the US The airline industry Rover…Roewe… Company Bankruptcy Date Total Assets Filing Court Distric t (click for more info)Pre-Bankruptcy Worldcom, Inc.07/21/02$103,914,000,000NY-S Enron Corp.*12/02/2001$63,392,000,000NY-S Conseco, Inc.12/18/02$61,392,000,000IL-N Texaco, Inc.04/12/1987$35,892,000,000NY-S Financial Corp. of America 09/09/1988$33,864,000,000CA-C Global Crossing Ltd.1/28/2002$30,185,000,000 NY-S UAL Corp. 12/09/2002 $25,197,000,000IL-N Adelphia Communicati ons 6/25/2002 $21,499,000,000 NY-S Pacific Gas and Electric Co. 04/06/2001$21,470,000,000CA-N MCorp3/31/1989$20,228,000,000TX-S Mirant Corporation7/14/2003$19,415,000,000TX-N First Executive Corp.5/13/1991$15,193,000,000CA-C Gibraltar Financial Corp. 02/08/1990$15,011,000,000CA-C Kmart Corp.1/22/2002$14,600,000,000IL-N
Who is next ? GM Ford Daimler Chrysler North West Airlines Altria
The firm in distress; first signs The firm can not meet its scheduled payments due to cash flow problems The firm starts to wonder if this is temporary or a more structural issue The firm starts to think if its worth more dead or alive The firm considers filing under chapter 11 protection against creditors who will chase the firm’s assets The firm starts to think of the new management that should take care of the turnaround…
Informal reorganization Creditors work with the firm to find a solution for its problems These problems are temporarily The debtor is perceived as a good moral risk The debtor must present a reasonable plan to solve its problems General business conditions must be favourable for recovery Creditors postpone payments (extensions) or reduce their claims (compositions)
Informal liquidation The firm is seen to be of more value if it liquidates The firm may still agree to partly repay its creditors Since this is not a formal procedure a lot of costs and interests are saved…to benefit the remaining creditors The debtors assets are assigned to a trustee who sells the assets in a private sale or public auction The proceeds are distributed among the creditors
Federal Laws on bankruptcy Chapters 1,3,5,7,9, and 11 US Bankruptcy Laws Chapters 1,3,5: general provisions Chapter 7: procedures of liquidation Chapter 9: financially distressed public bodies Chapter 11: protection under law avoiding creditors to chase assets of the firm
Filing under chapter 11 The company seeks protection against creditors The company works on a reorganization plan or regulation for creditors The company has the flexibility to negotiate with its creditors and stockholders
Reorganization Bankruptcy Informal procedures are less costly and offer most chances of quick solutions Two problems arise: 1) common pool problem: if a creditor waits for the other creditors the firm has to share between the creditors if the firm forecloses on the debtor it can get priority and hold the chance of getting all what is owed back! 2) hold out problem: only if all creditors agree on getting less then what is owed they will agree not if some will hold 100% right to their credits…
Further provisions of chapter 11 Interest and principal on delayed payments may be delayed without penalty The firm can issue Debtor In Possession financing (DIP) this is borrowing for short term liquidity purposes The firms managers get 120 days after filing to come up with a reorganization plan plus another 60 days to obtain agreement (the court may extend these dates) Sharing the pie with creditors…
Absolute priority doctrine: Creditors should be compensated for their claims in a rigid hierarchical order; Senior claims must be paid in full junior claims may not receive a single dime
Is the reorganization viable Future sales to be estimated Operating conditions to be analyzed Future earnings and cash flows to be analyzed Company value to be estimated Capital structure after chapter 11 period to be determined Firm’s securities should be allocated to the various claimants in a fair manner
Measures taken Debt maturity is lengthened New management team in control Obsolete inventories to be replaced Modernized production equipment to improve competing strength Stronger operations and marketing approach… Develop and enter new markets and products…
Pre-packaged bankruptcy Hybrid form of bankruptcy between formal and informal workout Informal: debtor negotiates restructuring with its creditors Formal; restructuring under chapter 11 Prepack: debtor gets creditors to agree to the reorganization plan prior to the filing for bankruptcy
Time and expense Typical bankruptcy case takes 2 years under chapter 11 until final plan is approved by all creditors In the meanwhile sales suffers Good employees leave the company In the meanwhile all other employees worry about their jobs rather then work Good bankruptcy lawyers charge 250 USD per hour; all other costs of creditors will be imposed on the firm as well… At some point parties may just want to settle some deal…to stop the bleeding.
Liquidation in bankruptcy The company is worth more dead then alive: chapter 7 explains how to share the assets over the creditors: Secured creditors (pledged/ collateral) Legal fees Expenses incurred before trustee is appointed Wages to workers up to 3 months prior to the filing Payments for contributions to pension plans Claims for customer deposits (max $900 pp.) Taxes (federal, state ) General creditors Preferred stockholders Common stockholders
Predicting the likelihood of bankruptcy Multiple Discriminant Analysis (MDA) Discriminant function is described as: Z= a+b1(current ratio)+b2(debt ratio) Z=z score; multiple regression based on data of the book gives; Z= -0.3877-1.0736(current ratio)+.0579(debt ratio) Discriminant analysis defines a boundary between current ratio and debt ratio defining high and low probabilities of bankruptcy The lower the Z score the less likely bankruptcy Financial Institutions use their own criteria for the value of Z
Multiple regression Z score Regression Analysis: Z-score versus current ratio, debt-asset ratio The regression equation is Z-score = - 0.388 - 1.07 current ratio + 0.0579 debt-asset ratio Predictor Coef SE Coef T P Constant -0.387856 0.000233 -1664.66 0.000 current ratio -1.07371 0.00009 -11572.58 0.000 debt-asset ratio 0.0578922 0.0000044 13253.17 0.000 S = 0.000282689 R-Sq = 100.0% R-Sq(adj) = 100.0% Analysis of Variance Source DF SS MS F P Regression 2 18.0043 9.0022 1.12649E+08 0.000 Residual Error 16 0.0000 0.0000 Total 18 18.0043 Source DF Seq SS current ratio 1 3.9679 debt-asset ratio 1 14.0364
Altman’s MDA Z= 1.2X 1 +1.4X 2 +.33X 3 +0.6X 4 +0.999X 5 Where: X 1 =Net working capital/total assets X 2 =retained earnings/total assets X 3 = Ebit/total assets X 4 =market value of all shares/book value of debt X 5 =sales/total assets Zones of Discrimination: Z > 2.99 -“Safe” Zone 1.8 < Z < 2.99 -“Grey” Zone Z < 1.80 -“Distress” Zone The higher the Z score the less probability of bankruptcy Altman’s model is a reasonable predictor for bankruptcy within a period of 2 years…
When using MDA Collect your own data from the industry in question Run your model/use Altman’s predictors Test for significance and fit Define critical zone… Predict future for case on hand…
Assignment: Z-score and Altman’s MDA Calculate the Z-score for your company using Altman’s MDA Calculate similar scores for the main competitors Based on your findings which competitor is relatively most likely to go bankrupt earlier than the others…in the industry of your team’s company? Show your calculations