12.27.2010

Accuride and Rule 2019

Last week, the Wall Street Journal ran an article entitled: "For Accuride Investors, a Big Payday: Big Bondholders Parlayed Position at Negotiating Table During Bankruptcy Into $132 Million Gain." (subscription required). A number of people emailed me the above article and asked me my thoughts on it. But first some background.


For those interested, the Accuride docket can be found here: Accuride bankruptcy docket

In April 2010 (docket #968), Dow Jones & Company (publisher of the WSJ) submitted a motion to unseal the Accuride's ad hoc note holder's groups Rule 2019 disclosures which at that point had been sealed. What is Rule 2019 you ask? From the same motion:
"Rule 2019(a) requires that unofficial committees or ad hoc groups disclose, inter alia, (1) the nature and amount of their claims or interests; (2) the date of acquisitions of their claims or interests acquired in the year prior to the filing of the bankruptcy case; (3) the amount paid; and (4) any subsequent sales of claims or interests."
In other words what / when they paid for certain securities...

Eventually, after objections from the ad hoc group, the judge ruled to release the 2019 disclosures. The below document is where all the details can be found:



There was a very interesting quote from the aforementioned Dow Jones motion to release the 2019 disclosures:
"Chapter 11 proceedings have emerged as the preferred venue for mergers and acquisitions, where private investors quickly buy, trade, and break up companies. These investors may attempt to force a company into bankruptcy."
What is this? Pretty Woman?

In the article mentioned above, another interesting quote emerged. This time from Deirdre Martini, a managing director at Wells Fargo Capital Finance and former U.S. Trustee:
"The evolution of distressed investing has made a mockery of the underpinnings of our bankruptcy process, which is total transparency," said Deirdre Martini, a managing director at Wells Fargo Capital Finance and former U.S. Trustee, the government watchdog for cases in federal bankruptcy courts. Chapter 11 was created decades ago as a way to give ailing companies a chance to fix their balance sheets and operations, and reimburse supportive creditors as much as possible, she said.

"The bankruptcy code's focus was never intended to garner profits for distressed investors," she said.
Now that I completely disagree with. Whether it be the blanketed releases the code has ALWAYS allowed to the 2005 changes which has made pre-packs basically inevitable, the code has been welcoming to investors with fresh capital to rehabilitate debtors and capture a profit on that investment. Do you truly think anyone is going to put up $140M of capital and expect a mid single digit return on that capital for a bankrupt company?

The WSJ quote above, as it relates to the bankruptcy as the preferred M&A route for investors - of course it is. Have you ever actually read the releases involved in a confirming disclosure statement and plan? No one is liable for anything. Furthermore, given the litany of legacy liabilities and trial lawyers that profit from any ailment under the sun, why would any investor pursue M&A OUTSIDE of the Chapter 11 process.

Yes - The purpose of Chapter 11 is to rehabilitate ailing companies. But ailing companies' securities trade at a significant discount to their healthy peers. Would you like me to buy high and sell low?

If anyone is to blame, blame the management teams. No where in the entire WSJ article does the author point to how well management teams have profited from Equity Incentive plans granting management teams anywhere from 6-15% of the post-re org company.

And because the code allows a company the exclusive right to file a plan for the first 18 months after the petition date, distressed investors HAVE to work with management teams and offer them a very large carrot to ensure their plan is accepted. Is this collusion at the expense of pre-petition junior creditors and equity holders? Not in my opinion. Remember - always look at the incentives of every party in an investing situation - It really can tell you a lot about how the chips will fall.



4 comments:

Anonymous,  12/27/2010  

For those who don't hold WSJ subscriptions, you can google "For Accuride Investors, a Big Payday: Big Bondholders Parlayed Position at Negotiating Table During Bankruptcy Into $132 Million Gain" and click the article link there to gain free access.

WSJ gives access to google so the articles are searchable and appear in the search engine.

Ken Barkett,  12/28/2010  

Thanks for posting on the article I emailed you about, its too funny because you pointed out the exact same two quotes that shocked and disgusted me the most. I was hoping you would write a rebuttal to their nonsense :)

Ken Barkett,  12/28/2010  

Correction* I meant to say the second comment is what shocked and disgusted me, not the first too

persistentone 12/29/2010  

For disclosure, I invested in the Accuride bonds based on research I started after first reading articles here on DDI. Needless to say that investment was the gift that keeps on giving, and I held through the recent conversion offer. Thanks for that gem Hunter.

There are several things that struck me from the WSJ article, as someone who studied this deal a lot and had something at stake in the transaction:

1) "On Nov. 30 and Dec. 1, respectively, Sankaty sold $3 million of bonds for 76 cents on the dollar and $16 million of bonds for 75.5 cents, court filings show." What was amazing to me was that a sophisticated investor with a seat at the table liquidated half their position at far below the real value simply as a trade, taking a tax hit at short term capital gains rates when they could have held and doubled their money again.

2) There is one part of the Accuride transaction that I found obscene, and it is touched on in the article. This "backstop" arrangement that gave away over 25% of the new equity in the company was criminal. The new convertible bond that was "backstopped" was a money making machine that most investors would have paid over par to participate in. No one should have been offered a penny - let alone 25% of the company - to backstop an investment that nearly guarantees a 50%+ return on the day you buy it.

3) The real lesson from the Accuride deal was to look for Chapter 11s where all of the equity is going to a single stakeholder. In this case there was a single bond, and all of the company was going to that one group of bondholders. That made it possible for the best deal to get negotiated since there were not a lot of conflicting interests all grabbing for the value in the newly organized company.

Email

hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.