More online at www.dbr.dowjones.com
Viewpoint
ONE OF A SERIES OF OPINION COLUMNS BY BANKRUPTCY PROFESSIONALS
Déjà Vu: Some Companies Face Fresh Restructurings
By Mark Joachim and Jeffrey Rothleder
During the past few years, restructuring professionals who focus on middle market companies have felt
a bit like amateur seismologists—we know that the
“Big One” is coming, but it is nearly impossible to
pinpoint exactly when it will come and what it will
look like when it gets here. One inescapable fact
remains, however: a handful of key tectonic shifts
have made it much more difficult for many
companies to execute comprehensive deleveraging
strategies, as opposed to short-term “quick fixes,”
such as asset sales, that simply delay the inevitable.
Hundreds of middle-market companies that implemented “amend and extend” transactions during
2009 and 2010 will soon be back at the negotiating
table with key creditor constituencies, and since the
economy has not rebounded as quickly as we all
hoped that it might, these negotiations are likely to
present significant challenges.
Anyone who studies earthquakes will tell you that
the best way to predict what will happen in the
future is by reference to the past. When analyzing
how we got here, the first thing that comes to mind
is the dramatic increase in the use of senior secured
debt in leveraged buyout structures during the most
recent acquisition boom. Those of us old enough to
recall when second-lien debt was reserved for
marginal borrowers that needed small “stretch
loans” to bridge short-term liquidity needs can see
the difference between what post-LBO capital structures looked like in 2007 and 2008 and what they
looked like after historical buyout frenzies. To be
sure, secured debt has always been one component
of the capital structure of a “going private” transaction, but not nearly to the same extent as was the
case in the early to mid-2000s. Traditionally, debt
structures were comprised of some secured debt
and a large component of unsecured debt that was
often subordinated and had limited rights in an insolvency scenario. When private equity firms and other
borrowers retreated from expensive unsecured debt
in favor of lower-priced secured debt, this fueled a
dramatic expansion of the second-lien market from
roughly $300 million in total outstanding debt during
the late 1990s to tens of billions of dollars during the
mid-2000s. While the short-term cost of second-lien
debt appeared attractive when compared to subordinated mezzanine debt at the time, the true cost may
have been underestimated. Starting in 2007, when
many highly leveraged companies hit liquidity walls,
they found that well-worn deleveraging strategies
Wednesday, May 23, 2012 | dbr.dowjones.com
Copyright © Dow Jones & Company, Inc. All Rights Reserved.
(such as coercive exchange offers, prepackaged
Chapter 11 plans, and lengthy interest-free breathing
spells in Chapter 11 followed by massive conversions of debt to equity) were not nearly as achievable when saddled with layers of secured debt that
had not contractually and/or structurally waived their
enforcement rights when confronted with default or
maturity. This important shift found many borrowers
struggling with an unsatisfying menu of “restructuring” options: either agree to a quick sale under
Section 363 of the Bankruptcy Code with lien
holders standing by with credit bids, or simply kick
the can down the road a few years by amending and
extending, with the hope that other options will
somehow reveal themselves before the bills come
due again. Even in the rare case where a company
filed for Chapter 11 relief without a pre-planned
emergence strategy mandated by its secured
creditor constituencies, the lack of any real equity
cushion or unencumbered collateral that would
foster a third-party debtor-in-possession financing
alternative often meant that the prepetition secured
lenders would remain comfortably ensconced in the
driver’s seat even after a Chapter 11 filing.
So, if the increased reliance on secured debt can
be analogized to the slow but methodical sliding of
one side of the San Andreas fault, the change to
the nature of distressed-debt holders would be the
other side. For the most part, the first- and
second-lien debt that was placed during the past
decade has been freely tradeable (and even where
restrictions did exist, those restrictions typically
were lifted once a default occurred). What this has
meant is that distressed debt is now often held by
activist and nimble private investment funds rather
than the more reactive investors, who historically
controlled this debt. Today’s holders of distressed
debt are extremely savvy when it comes to the
restructuring process, are willing and able to
aggregate investments up and down the capital
structure of a troubled company in order to control
their destinies, and are capable of executing any
number of outcomes in order to maximize their
return on debt investments. With these investors in
the driver’s seat and with borrowers looking at a
much shorter list of restructuring options, it is no
surprise that many of the Chapter 11 cases and
out-of-court restructurings implemented during
2009 and 2010 were engineered, at least in part, by
senior lien holders. The result is that much of the
see Viewpoint on page 11
10
Viewpoint
continued from page 10
stress built up by overleveraging remains, as
opposed to being eased by conversions to equity
and other extinguishments of debt.
bankruptcy courts suddenly remember that there
used to be a general rule against 363 sales that
were tantamount to sub rosa Chapter 11 plans, the
next restructuring cycle will not look like the earthquake that many of us have been bracing for.
This brings us back to the big question: will the
ground shift, and what will happen when it does?
Tens of billions of dollars worth of corporate debt
that was either “amended and pretended” or
replaced with new high yield issuances is
scheduled to mature again over the next four years.
Assuming that all of that secured debt will not
somehow become magically unsecured, and that
activist distressed-debt holders will not lose their
resolve and will remain flush with ready capital, it is
likely that the next set of tremors will look much like
the previous one. Either maturities will be kicked
down the road again or assets will be sold as
quickly as possible. Unless the economy vastly
improves (yielding vast quantities of excess cash
flow with which to pay down secured debt), or
Opinions expressed are those of the author,
not of Dow Jones & Company, Inc.
Mark Joachim is a partner with Arent Fox,
based in Washington, D.C. He is part of the
firm’s corporate group and its bankruptcy and
financial restructuring group. He can be
reached at [email protected].
Jeffrey Rothleder is a partner in the financial
restructuring and bankruptcy practice group at
Arent Fox based in Washington. He can be
reached at [email protected].
Born from Necessity
Dow Jones Private Equity Analyst
INNOVATIVE STRATEGIES FOR SUCCEEDING IN THE DOWNTURN
Private equity investors and fund managers are in dire need of new ways to finance and execute lucrative deals.
The smart professionals know they have the edge with Private Equity Analyst, the industry’s voice of reason for
more than 20 years.
STAY AHEAD OF THE MARKET WITH:
• Comprehensive monthly print issue featuring robust fundraising & deal numbers
• Weekly “breaking news” e-newsletter with timely insights from top LPs & GPs
• Subscriber-only Web portal with latest headlines from other Dow Jones publications
• Complete, custom-searchable archive of past deals, stories & features
FOR MORE INFORMATION:
Online: www.privateequity.dowjones.com | Phone: 877-633-8663
E-mail: [email protected]
© Copyright 2009 Dow Jones & Company, Inc.
Wednesday, May 23, 2012 | dbr.dowjones.com
Copyright © Dow Jones & Company, Inc. All Rights Reserved.
11