Post edited 7:41 pm – March 14, 2011 by stormam
Bankruptcy is a very very different process than you would expect. It is not intuitive. Forming a committee is hands down the most important things to do because each ‘stakeholder’ gets a trustee to represent it and the trustees are completely useless. A stakeholder is each layer of debt (HY bonds, secured loans, A/R, shareholder). Forming a group requires a meaningful ownership position which is a prohibitive requirement for an individual. Debt is almost always held by funds, many of which have the wherewithal to take a significant position and implement their view. They also have the ability to hire lawyers and advisors who spend all day in court fighting for them.
A few things to understand that may help you going forward. First, judges have a meaningful preference for keeping the company intact and preserving jobs. Judges generally put a lot of weight on the advice of the board and management. This is ridiculous, but they do. Valuation by a bankruptcy court is one of the most disappointing processes I’ve ever seen. It is often done with ‘peer multiples’ and generally an investment bank prepares a valuation analysis that does not really look into long-term earnings power, normalized margins, etc… It instead considers today and where the market is. So if you file for bankruptcy Jan ’09 as earnings are tanking, you get valued based on historically low peer multiples, historically low margins and historically low revenue. Visteon, Smurfit Stone and several other equity holders were initially valued at 0 until the markets (and peer multiples) came back giving the shares support in their court arguments. Others weren’t so lucky.
If you look at the process, there tends to be some sort of agreement reached between debtors and managements. Management almost always makes out well (which is criminal) in bankruptcy. They get to emerge with equity in a new, less levered entity. Of course they want existing shareholders wiped and the exit valuation low. That’s what their ownership is based on. Debtors are highly incentivized to get the process going so the value doesn’t erode. Bankruptcy is very expensive, costing on average 1% of assets a year. Also, debt funds are often sold based on their yield and sitting on non-performing assets is painful. This is why a debt fund will try to emerge with some debt still on the balance sheet, where it owns new debt and part of the equity. That allows it to recapture some losses while regaining income-producing assets. So the clocks ticking and judges listen to managements and boards => a deal gets done. How the deal is struck depends on the company, its current situation and who is negotiating at the table. Some companies can exit with debt (CHTR, SIX, COSH) and some can’t (Spansion). It comes down to durable earnings and FCF.
I think the point I would emphasize is that bankruptcy is not the cleanest operation and it is extremely difficult to follow unless you’re doing it full time. You are at a massive disadvantage as a retail equity holder. You no longer have a board charged to do what is in your best interest. Often, they don’t do it even when required, so expect even less when the onus is no longer on them.
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