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Distressed debt analysis: strategies for speculative investors

Author: Moyer, Stephen G. Publisher: JRoss, 2005.Language: EnglishDescription: 448 p. : Graphs ; 24 cm.ISBN: 1932159185Type of document: BookBibliography/Index: Includes bibliographical references and index
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Item type Current location Collection Call number Status Date due Barcode Item holds
Book Asia Campus
Main Collection
Print HG3761 .M69 2005
(Browse shelf)
900180894
Available 900180894
Book Europe Campus
Main Collection
Print HG3761 .M69 2005
(Browse shelf)
001230907
Available 001230907
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Includes bibliographical references and index

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TABLE OF CONTENTS Distressed Debt Analysis Distressed Debt Analysis ... Notes on Style ........................................................................................... xi11 Acknowledgments ........................................................................................xiv xv About the Author ........................................................................................ Web Added ValueTM .................................................................................. xvi ............................................................................... 1 .................................................. 2 What Is Distressed Debt? ................................................................................ 6 Investing in Distressed Debt ........................................................................... 8 An Example of a Distressed Debt Situation Chapter I . Introduction Chapter 2. The Distressed Debt Investment Opportunity ........................ 13 Financial Restructurings in the 2000-2003 Era ........................................ 14 Precursors to Default .................................................................................... 22 Economic Performance .............................................................................23 Relative Quantity of Low-Rated Bonds ..................................................25 Capital Markets Liquidity ......................................................................... 28 Market Conditions That Permit Superior Returns ....................................... 32 Equal Access to Information .................................................................... 33 Rational Behavior .................................................................................. 35 Low Transaction Costs ........................................................................ 39 Summary .........................................................................................................41 Chapter 3. Conceptual Overview of Financial Distress and the Restructuring Process ............................................................................43 A Simple Model of the Firm .....................................................................43 Extensions of the Basic Model ...................................................................... 45 A Conceptual View of Financial Distress ............................................... 49 How Restructurings Attempt to "Fix" the Distress ..................................... 52 Summary ......................................................................................................... 53 Chapter 4. Legal Overview of Distressed Debt Restructurings ................. 55 Out-of-Court Restructurings: The Preferred Option When Effective and Feasible ................................................................................................... 56 The Financial Effects of an Out-of-Court Restructuring ........................ 56 The Out-of-Court Restructuring Process ................................................. 59 Parties Involved .................................................................................... 59 Strategic Considerations in Participating on the Bondholder Committee ............................................................................................. 61 Beginning the Process .......................................................................... 64 Implementing the Restructuring ............................................................... 67 Feasibility: The Holdout Problem ......................................................... 68 Summary ...................................................................................................... 70 In-Court Restructurings: An Overview of the Bankruptcy Process ........... 71 Declaring Bankruptcy ................................................................................ 72 Jurisdiction of Filing ............................................................................ 73 Timing of Filing ................................................................................... 73 The Goal: The Plan of Reorganization .................................................... 76 The Role of Exclusivity and Prefiling Coordination ......................... 76 Content and Structure of the Plan ....................................................... 78 Operating Under Chapter I I .................................................................... 80 Stabilizing Operations ........................................................................... 80 Developing a Going-Forward Business Plan ...................................... 83 Determining the Assets and Liabilities ........................................ 84 Determining the Valuation and the New Capital Structure ............... 87 Voting on and Confirming a Plan of Reorganization ............................89 Summary .................................................................................................... 92 Chapter 5. Overview of the Valuation Process ........................................ 95 The Basics of Cash-Flow-Based Valuation ................................................. 96 Using EBITDA as a Measure of Cash Flow .......................................... 96 Understanding and Adjusting EBITDA ............................................... 97 Limitations of EBITDA ..................................................................... 102 Comparing Discounted Cash Flow and EBITDA Multiple Approaches .............................................................................................. 103 Comparable Company Analysis Based on Enterprise Value ............... 104 Calculating Enterprise Value .................................................................. 105 Determining the Correct Multiple ..................................................... 109 Using Comparable Company Analysis .............................................. 112 Alternatives to the EBITDA Multiple Approach ....................................... 1 14 Revenue-Based Valuations ...................................................................... 115 Asset-Based Valuations ........................................................................... 115 Customer-Based Valuations .................................................................... 116 Liquidation Valuations ............................................................................ 117 Summary ................................................................................................. 117 Chapter 6. Leverage and the Concepts of Credit Support and C a p a c i ~.............................................................................................. 119 The Interrelationship of Credit Risk and Credit Support ..........................119 Credit Risk .............................................................................................. 120 Credit Support ......................................................................................... 120 Credit Capacity ........................................................................................ 121 Credit Capacity as Measured by Debt Repayment Ability ....................... 123 Stable Cash Flow Scenarios ................................................................... 123 Volatile Cash Flow Scenarios ................................................................ 126 Debt Capacity Under Alternative Criteria .................................................. 129 Asset Coverage .................................................................................. 129 Ability to Refinance ........................................................................... 132 Interest Expense Coverage ...................................................................... 133 Capital Instruments Designed to "Avoid Credit Capacity Criteria ......... 134 Exchangeable Preferred Stock .............................................................. 135 Convertible Bonds ................................................................................... 135 Discount Notes and Payment-in-Kind Notes ......................................... 135 Summary ....................................................................................................... 136 Chapter 7. Capital Structures and the Allocation and Management of Credit Risk ................................................................................................... 139 Using Corporate and Capital Structures to Allocate Credit Risk ............. 141 Grants of Collateral ................................................................................. 142 Contractual Provisions ............................................................................ 142 Maturity Structure ...................................................................................144 Corporate Structure .................................................................................146 How Capital Structures Manage Credit Risk .............................................149 Leverage ................................................................................................... 151 Priority .................................................................................................. 151 Restricted Payments ............................................................................ 151 Negative Pledge Clauses .................................................................. 156 Time ......................................................................................................... 157 Performance Covenants ......................................................................157 Put Rights ............................................................................................ 158 Forced Call in the Event of a Downgrade ....................................... 158 Performance-Linked Pricing Provisions ........................................... 159 Summary ....................................................................................................... 160 Chapter 8. Causes of Financial Distress and the Restructuring implications ............................................................................................. 163 Indicators of Financial Distress ..................................................................163 Debt Ratings ............................................................................................ 164 Predictive Models .................................................................................... 166 Market Prices ........................................................................................... 167 Causes of Financial Distress ......................................................................168 Performance Materially Below Expectation .......................................... 169 Economic Downturn ........................................................................... 169 Uncompetitive Product or Service .................................................... 170 Unrealistic Business Plan ...................................................................172 Poor Management ............................................................................... 174 Near-Tern Liquidity lssues ......................................................................... 177 Bank Debt Scenarios ........................................................................... 177 No Bank Debt Scenarios .......................................................................178 Unexpected Liabilities ................................................................................ 180 Tort Claims .............................................................................................. 180 Contract Liabilities ................................................................................ 181 Crisis of Confidence: Fraud and Other Events That Create Financial Uncertainty ................................................................................. 183 Reliability of Historical Financial Data and Valuation Issues ............. 184 Liquidity and the Likelihood of Bankruptcy ......................................... 185 Summary ......................................................................................................... 187 Chapter 9. Options for Alleviating Financial Distress: The Company's Perspective ........................................................................ 189 Properly Assessing the Distressed Firm's Likely Actions Is Key to Assessing the lnvestment Outcomes ...................................................... 190 Example 1: Playing the Waiting Game ................................................ 190 Example 2: Between a Rock and a Hard Place ................................... 194 Summary ............................................................................................. 198 Strategic Options to Resolve Financial Distress Outside Bankruptcy ...... 200 Raise Additional Capital ......................................................................... 200 Asset Sales .......................................................................................... 201 Secured Financings ............................................................................ 202 Salekeaseback Financings ................................................................ 204 Equity Sponsors ................................................................................. 204 Reducing Leverage .................................................................................. 207 Open Market Repurchases ................................................................. 207 Direct Purchases from Holders .......................................................... 207 208 Cash Tender Offers ............................................................................. Exchange Offers ................................................................................. 211 Coercive Exchange Offers ........................................................... 211 Noncoercive Exchange Offers ...................................................... 212 Constraints on the Range of Options ......................................................... 213 Liquidity ................................................................................................... 213 .......................................................................... Time-to-Liquidity Event 213 Magnitude of Problem ............................................................................ 214 Complexity of Capital Structure ............................................................ 214 Severability of Business Units ............................................................... 215 Cause(s) of Financial Distress ................................................................ 215 Strategies When Bankruptcy Appears Necessary ...................................... 215 Maintaining Liquidity .............................................................................. 215 Preplanned Filings ................................................................................... 216 ....................................................................................................... Summary 217 Chapter 10. Profiting from Financial Distress: The Investor's Perspective .......................................................................... 219 Defining the Investment Objectives ........................................................... 220 Tailoring a Strategy to the Investment Objectives .................................... 221 222 Non-Chapter 1 1 Situations ...................................................................... Passive Involvement ........................................................................... 222 Active Involvement ......................................................................... 224 Chapter 1 I Situations .............................................................................. 228 Feasibility Considerations ............................................................................ 238 238 Capital Structure ...................................................................................... Market Versus True Valuation ............................................................... 240 Market LiquidityIConcentration of Holdings ......................................... 241 Other Distressed Investors .................................................................. 241 Bank Debt .......................................................................................... 242 242 Large Block Holders of Public Debt ............................................... 242 Hedging and Capital Structure Arbitrage ................................................... Return Potential of Capital Structure Arbitrage .................................... 243 Common Capital Structure Arbitrage Trades ........................................ 249 Pari Passu Securities with Different Maturities ................................ 250 Senior Versus Junior Securities ....................................................... 252 254 Bonds Versus Equity .......................................................................... ......................................................................................................... Summary 256 Chapter I 1 . Practical Aspects of the Investment Process and Due Diligence ....................................................................................... 257 Practical Realities of the Investment Analysis Process ............................. 258 Screening Situations to Prioritize Opportunities ................................... 258 Reacting to Volatile Situations ............................................................... 260 A Time-Efficient Valuation Methodology ............................................. 260 Performing Due Diligence ........................................................................... 262 Diligence Cost-Benefit Analysis ........................................................ 262 Prioritizing the Diligence Issues ............................................................ 263 Financial Due Diligence .............................................................................. 267 Basic Goals of Financial Due Diligence .................... ................... 267 Obtaining Publicly Available Financial lnformation ............................ 268 Accessing Management ........................................................................... 270 Special Valuation Considerations in Financially Distressed Contexts .................................................................................................272 Business Deterioration During a Reorganization .............................. 272 Reorganization Costs ............................................................................ 273 Critical Vendor Payments .................................................................. 273 Cash Accumulation During the Reorganization .................................... 275 Tax Issues ................................................................................................ 276 Liquidity Implications of a Distressed Firm's Current Tax Status ........................................................................................... 277 Potential Value from Carryforward of Net Operating Losses ......... 279 Priority Status of Tax Claims ......................................................... 284 Legal Due Diligence ..................................................................................... 284 Obtaining the Relevant Documents ....................................................... 285 Checklist of Legal and Bankruptcy-Related Issues to Consider .......... 286 Voidable Preferences ..........................................................................287 Substantive Consolidation .................................................................. 287 Structural Advantages ......................................................................... 288 Equitable Subordination .....................................................................289 Zone of Insolvency ............................................................................ 292 Special Considerations When Investing in Claims That Are Not Negotiable Lnstruments ............................................................ 292 Recent Developments Under the Sarbanes-Oxley Act of 2002 ........... 295 Mechanics of Accumulating the Investment ................... ...................... 296 Investment Strategy and Market Environment Drive Accumulation Approach .......................................................................... 297 Consummating the Trade ........................................................................ 300 Firm Market ........................................................................................ 302 No Market or Above-Market Offering .............................................. 303 . . . . Settling the Trade ............................................................................... 304 Bank Debt ................................................................................................ 305 Holder Identity ....................................................................................305 Settlement ........................................................................................... 305 Special Considerations for Revolving Loans .................................... 306 Summary ....................................................................................................... 307 Chapter 12 . Dynamics of the Workout Process: The Endgame ............... 309 The Parties ...................................................................................................310 The Debtor ............................................................................................. 310 Debtor's Bankruptcy Counsel ................................................................. 311 Debtor's Financial Advisor ..................................................................... 311 The Committee ................................................................................... 311 Committee Legal Counsel .................................................................... 313 Committee Financial Advisor .................................................................314 The Secured Creditors ............................................................................ 314 The Bankruptcy Judge ............................................................................ 315 Types of Chapter 1 1 Cases ......................................................................... 316 Preplanned Restructuring ...................................................................... 318 Full Prepack ....................................................................................... 318 Prenegotiated Filings .......................................................................... 320 Asset Sales ................................................................................................. 321 Sales Intended to Enhance Recoveries by Maximizing Estate Value ........................................................................................ 322 Sales Designed to Maximize Creditor Recoveries ...........................326 Free-Fall and Contested Chapter 11 Reorganizations ........................... 326 Sources of Leverage in the Chapter 11 Process ................................... 327 Delay .................................................................................................... 328 Management and the Right of Exclusivity ................................... 329 Creditors and the Threat of Litigation ........................................ 331 Priority ................................................................................................. 332 Secured Creditors ...........................................................................335 Valuation ............................................................................................. 336 Voting and Confirmation ............................................................................. 339 Voting ..................................................................................................... 339 Confirmation ............................................................................................ 341 Summary ................................................................................................... 346 Chapter 13. Postreorganization Considerations ........................................ 349 Postreorganization Equities ......................................................................... 350 Size of Expected or Probable Market Capitalization ............................ 350 Postreorganization Trading Float ............................................................ 352 Forced Sellers .......................................................................................... 353 Company Profile ...................................................................................... 354 Postconfirmation Lockups ....................................................................... 355 Tax-Based Trading Restrictions ............................................................. 356 Warrants ................................................................................................. 356 Trading Performance of Back-End Equities .......................................... 356 Postreorganization Debt Securities ............................................................. 359 Liquidating Trusts ...................................................................................... 360 365 Summary ....................................................................................................... Endnotes ....................................................................................................... 367 Literature Survey and Selected References ................................................ 405 ......................................... 433 . 435 437 Appendix: Chess Notation and Game Moves Disclosure of Possible Conflicts of Interest Index ............................................... ..........................................................................................................

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