Valcon 2010 Playing To Win: Effective Valuation Analysis And Strategies For Restructurings, Reorganizations, Distressed Sales And Auctions Donald S. Bernstein Partner Davis Polk & Wardwell, LLP New York, NY J. Scott Victor Managing Director SSG Capital Advisors, LLC Philadelphia, PA Kaaran E. Thomas Of Counsel McDonald Carano Wilson, LLP Reno, Las Vegas, NV D. Bobbitt Noel, Jr. Partner Vinson & Elkins, LLP Houston, TX George Angelich Partner Arent Fox LLP 1675 Broadway New York, NY February 2010 Barry M. Monheit Senior Managing Director FTI Palladium Partners Phoenix, AZ
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Valcon 2010 Playing To Win: Effective Valuation Analysis And Strategies For Restructurings, Reorganizations, Distressed Sales And Auctions Donald S. Bernstein.
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Valcon 2010
Playing To Win: Effective Valuation Analysis And Strategies
For Restructurings, Reorganizations,
Distressed Sales And Auctions
Donald S. BernsteinPartnerDavis Polk & Wardwell, LLPNew York, NY
J. Scott VictorManaging DirectorSSG Capital Advisors, LLCPhiladelphia, PA
Kaaran E. ThomasOf CounselMcDonald Carano Wilson, LLPReno, Las Vegas, NV
D. Bobbitt Noel, Jr.PartnerVinson & Elkins, LLPHouston, TX
George AngelichPartnerArent Fox LLP1675 BroadwayNew York, NY
February 2010
Barry M. MonheitSenior Managing DirectorFTI Palladium PartnersPhoenix, AZ
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Overview
Current Restructuring Landscape
The Distressed Company’s Options: Out of Court Restructuring v. Chapter 11 Alternatives
Valuation Dynamics In Chapter 11
Resolving The “Battle of the Experts” Without Litigation
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The Current Restructuring Landscape
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Senior Loan Volume 1999 – 1H 2009
Source: Standard & Poor’s LCD M&A Stats
Note: This chart reflects the estimated primary volume to the US and European loan markets. The US Market includes tranches denominated in non-USD currencies as well as US dollars. The European Market includes tranches denominated in non-Euro or Sterling currencies as well as Euros and Sterling. Exchange rates from non-USD currencies are based upon date of launch of the individual transactions.
Initial Institutional Defaults Loan Amounts by QuarterInitial Institutional Defaults Loan Amounts by QuarterComprises Institutional Loans closed between 1995 - 3Q 2009 for Issuers that File PubliclyComprises Institutional Loans closed between 1995 - 3Q 2009 for Issuers that File Publicly
Fraudulent transfer attacks on leveraged transactions
Use of “collective action” to bind minority holders
Developing case law and practice in each area
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The Distressed Company’s Options: Out of Court Restructuring v. Chapter
11 Reorganization
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Out of Court Restructuring
Types Of Restructurings
• Debt for Equity Exchanges
• Debt Buybacks
• Sale of Assets/Company
• Standstills, forbearances, overrides
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Out of Court Restructuring (Cont.)
Obstacles
• Recalcitrant Creditors – asset grabs. How to punish hold outs and reward cooperation
• Squeamish buyers –inability to provide warranties, bonds, indemnities
• Inability to control/manage assets due to creditor interference, lawsuits, threats of foreclosure
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Out of Court Restructuring (Cont.)
Lender Obstacles
– Reluctant bank group agents
– Recalcitrant bank group members
– Inability to deleverage overleveraged assets – Inability to reach lender consensus – especially with
perception that recession is ending, values increasing
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Out of Court Restructuring (Cont.)
Statutory Obstacles– Fraudulent transfer laws– Bulk Sales laws– Challenges to buyer if insiders of seller remain active,
get special consideration– No binding determination of value of assets being
sold, refinanced – Exposure to second guessing after the fact. See, e.g.,
Tousa Official Committee of Unsecured Creditors v. Citicorp North America, et.al. Case 08-01435 Bankr. S.D. Fla., Oct. 30, 2009 (on court website)
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Out of Court Restructuring (Cont.)
Advantages of Out of Court Restructuring
• Cost – but may be offset by cost of controlling parties and replacing assurances available in bankruptcy
• Time – Chapter 11 cases require (pre GM) time for procedural safeguards. (May not be true today)
• Less Scrutiny, fewer procedural hurdles
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Out of Court Restructuring (Cont.)
Chapter 11 Alternative -- Prepak
– Prepak combines out of court + bankruptcy – Approach out of court solution as potential Chapter 11
– Addresses holdout problem – Begin Chapter 11 process pre-filing like out of court
workout
– Build in protections of Chapter 11 as last resort – or as conclusion to out of court efforts
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Valuation Strategy for Out of Court Restructurings
• Obtain supportable valuation for each party’s interest• Seek creditor approval for the valuation – attempt to
resolve any valuation disputes• Identify each party’s claim in Chapter 11 and their most
likely distribution in a liquidation• Estimate Chapter 11 costs; compare to out-of-court costs• Hire reputable advisor/credible valuation firm to use as go-
between (remember that their work will not be privileged in litigation)
• Be prepared to file if pre-defined triggers occur (cost, assets at risk, etc.)
• Negotiate “amend and extend” (aka “amend, pretend, extend”) provisions to defer valuations
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Criteria Guiding Selection
Debtor’s Viewpoint
• What is debtor’s goal? Reorganize? Sell? Other?• Do operations need to be restructured or just debt?• Value of Debtor’s assets – going concern vs. fair
market vs. liquidation• Allies – senior secured? Junior secured?
Investor? Trade?• How cooperative are the parties in interest• Liquidity and available funds• Prospect of holdouts
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Criteria Guiding Selection (cont.)
• Senior Secured Lender Viewpoint– Preference between sale and reorganization
• Value of collateral – going concern vs. fair market vs. liquidation• Possibility of credit bidding
– View of management - need for a change?– Available buyers, investors– Liquidity to reorganize - provide defensive DIP?– Lien priority issues (e.g. mechanics liens)– Potential for litigation claims– Lending group issues – first/second lien? dissidents?– Status of junior classes
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Criteria Guiding Selection (cont.)
Junior Creditor/Unsecured Viewpoint
– Legal issues – developing interpretation of ability to sell free and clear of junior liens under Section 363 (c)(2) outside of a plan
– 9th Circuit, Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008). In single asset real estate case failure to obtain a stay does not render moot appeal of order approving sale to senior lender for credit bid free and clear of junior liens. The Panel held that § 363(m) applies only to protect the portion of sale orders issued under § 363(b) or (c), but not to the "free and clear" relief under § 363(f). reversed order approving sale. No showing of a justification for eliminating junior liens under 363(c)(2).
– Contra: In re Nashville Senior Living, LLC,407 B.R. 222(6th Cir.BAP (Tenn.),2009). (363(m) applies to “free and clear “ section of 363(c)).
– Sale free and clear outside plan also discussed in In re Gulf Coast Oil Corp.,404 B.R. 407(Bkrtcy.S.D.Tex.,2009.)
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Criteria Guiding Selection (cont.)
Junior Creditor/Unsecured Viewpoint (cont.)
• Valuation Issues– Going concern vs. fair market vs. liquidation value
• Liquidity
• Value of claims against secureds
• Strategic issues– Value to constituents of keeping Debtor alive
(contractors, landowners, customers)
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Criteria Guiding Selection (cont.)
Dissident Lender Viewpoint
– “Dissident Lender” means participant in loan who disagrees with decision of majority of other participants and agent.
– Under credit documentation, dissident lender is generally bound by the vote of majority regarding exercise (or forbearance from exercise) of remedies.
• Recent developments under state law regarding “collective action” to bind dissident lenders in restructuring. Beal Savings Bank v. Sommer, 865 N.E.2d 1210 (N.Y. 2007)
– In bankruptcy dissident lenders are “parties in interest” entitled to be heard
• But can’t ignore agreements – “collective action” can apply in bankruptcy as well.
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Criteria Guiding Selection (cont.)
Dissident Lender Viewpoint (cont.)
– Valuation scenario – define lender’s ability to align with group that will provide highest recovery or best leverage
• Bankruptcy clarifies the various parties in interest and their positions
• Easier to evaluate options
– Valuation strategy• Review participation/agency agreements for leverage
– Limits on agent powers– Controls/sanctions on dissident lender – Indemnity agreements, hold harmless, etc
– Evaluate which party in interest supports dissident’s position and align with that party
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Valuation Dynamics in Chapter 11
Valuation Alternatives• Negotiated value (required for consensual plan or
prepak)– The parties determine the ultimate value.– Required for any consensual plan, including a prepack.
• Market value (usually 363 sale)– If parties cannot agree to reorganize
• Reorganization value – valuation by the court– Valuation to satisfy best interests test (liquidation)– “Cram down” value in order to apply absolute priority rule
• obtain competent liquidation analysis• identify market and possible buyers• construct realistic alternative for key parties
– Avoid bluffing
• Threatened sales/competing plans need buyers, take out financing, • Litigation requires funds, experts, witnesses
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Market Value
“Testing the Market”
• Possible alternative to negotiated value if parties cannot agree
Pursuing sale concurrently with restructuring
• Sales establishes value and provides options
• Parties may be stuck with bad offers as valuation
• Evidence for all valuation purposes
• Sales of some assets deleverage estate
• Sale may remove dissidents, troublemakers
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Market Value (cont.)
Quick 363 Sale
– GM: US government orchestrated 363 sale to US Treasury sponsored entity to be owned by US Government, pre-bankruptcy bondholders, UAW union healthcare fund and the Canadian government (Conventional?)
– Chrysler: US government orchestrated 363 asset sale to a company to be owned by Fiat, a UAW union retirement plan and the US government (Conventional?)
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Market Value (cont.)
• Caveat to “Quick Sales”
– Ability to sell “free and clear” See e.g., Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008).
– Ability to sell outside plan – See e.g., In re Gulf Coast Oil Corp.,404 B.R. 407 (Bkrtcy. S.D.Tex., 2009.)
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Reorganization Value
Traditional Reorganization
– Requires liquidity to finance the Chapter 11• DIP Financing• Cash Collateral• Unencumbered Cash
– Requires consensus -- “Dividing up the pie” or cramdown - risky
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Reorganization Value (cont.)
Cram Down Value
– Determined at trial
– Requires valuation experts
– Risky – judge is least knowledgeable person in the room
– Wide variations in testimony• In re Mirant Corp., 334 B.R. 800 (Bankr. N.D. Tx. 2005)
– Market vs. Expert Testimony • In re Exide Technologies, Case No. 02-11125 Bankr. Delaware
– Court appointment of expert under FRE 706?
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Negotiations: Role of the Experts
• Identifying Experts– Problem Using Same Expert For Negotiation And
Litigation– Negotiating expert vs. testifying expert
• Presenting Each Side’s Case
• Debating Assumptions– Reconcile differences in valuations, if possible– Identifying differences in assumptions
• Business plan• Valuation methodology
• Finding Ways To Bridge The Gap
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Negotiations: Bridging The Valuation Gap“Parallel Track” Sale Process
• Simultaneously pursuing sale and reorganization – In re Adelphia Communications Corp., Case No. 02-41729 Bankr.
S.D.N.Y.
• Sale in lieu of reorganization – In re Chrysler LLC, Case No. 09-B 50002 Bankr S.D.N.Y. Appeal of
sale order: In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009)– In re General Motors Corp. Case No. 09-50026 Bankr S.D.N.Y.– In re Delphi Corp. Case No. 05-44481 Bankr. S.D.N.Y.(“Delphi”)– Possibility of credit bid to keep the process honest (Delphi)
Third party intervention
– Mediators and Examiners
Rights Offerings
– “Put your money where your mouth is.”– Rights offerings are viable way to bring valuation negotiations
to a close.
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Negotiations: Rights Offerings
Opportunity to “buy in” to restructuring
– Provides a form of consideration for potentially out-of-the money classes
– A way to avoid a contested confirmation hearing.
There is typically a backstop
– Underwritten by an existing creditor/investor (hedge fund).
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Negotiations: Contingent Value Plans
Reallocation of consideration based on future valuation
Allocation Formulas For Contingent Assets, Contingent Distributions
– Classic example: In re Penn Central Transp. Co., Case No 70-347 Bankr. E.D. Pennsylvania
• Litigation claims against United States were valuation variable
Securities With Option Features– Allow future market value to determine plan allocations– Warrants– Convertible securities– Valuation of options
• Negotiating over Black-Scholes valuations (“VAR”) • See, e.g., In re Conseco, Inc., Case No. 02 B 49672 (Bkr. N.D.