Comments on Distressed Debt Investing: Distressed Debt Case Study

2009-08-03T19:20:51.895-04:00

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This Bloomberg article shows what is currently going on in the DIP market.

In relation to the 364(d) issue, the article notes that the unsecured Lyondell DIP is trading at almost half of the price of the secured DIP (identified in the article as the "DIP roll-up" versus "portion of the DIP that wasn’t rolled up").

The court cannot and will not prime a lien that is...

2009-07-30T01:28:56.903-04:00

The court cannot and will not prime a lien that is not adequately protected because of 364(d). If the full value of all of a debtor's assets are liened, the court can only provide super priority administrative status.

Super priority administrative status provides a DIP lender with the right to be paid at the end of the case (or at the end of the loan term), but if there are not enough assets to pay the super priority administrative claims (for example, no exit financing), they do not prime the secureds.

If the exit is to a continuing operation, an unsecured DIP lender can roll over the loan (or take some other form of continuing interest - equity, etc.) - of course the existing secureds wouldn't be paid in that case either, but their standing relative to their liens wouldn't change (except in very unusual circumstances). If it's a liquidation, then the DIP lender takes the chance that there may not be sufficient assets to pay the DIP after satisfying the secured claims.

Section 364(d) gives the court NO DISCRETION and requires that the trustee (or debtor in possession) prove that there is adequate protection before a lien can be primed.

The Delphi plan that included Platinum would have paid the unsecured DIP lenders only 20% of their principal. That's an unusual case, but it's an unusual situation.

If you look at the Dayton Superior case, the unsecured bondholders challenged the roll-up offered by the secured lender - but eventually settled. Prior to the settlement, the debtor's argument was that a priming fight would be futile and costly, leading them to select the less attractive economic terms offered by GECC (as opposed to the bondholders' proposal).

A debtor that has no assets left to offer as security is at the mercy of their existing secured lenders - if they can convince them to provide a roll-up.

The lack of exit financing has made DIP loans, where there are no assets to provide security, almost solely the province of the existing lenders (secured and, sometimes, parties further down in the capital structure looking to increase their leverage). This is why the courts have accepted roll-ups, which they generally frown against.

An existing secured lender who participated in the roll-up is in a better position than a non-participant, but only because they would be first in line to get paid upon a successful exit.

ITDC may not need a DIP, that is why I said absent...

2009-07-30T00:46:05.881-04:00

ITDC may not need a DIP, that is why I said absent the cash. However, with respect to the comment about the DIP. The court can grant super-priming liens on the debtor's existing collateral for a DIP, regardless or whether the pre-petition is undersecured. Since the adequate protection payments and liens (to the extent there is secuirty for them) are not going to have super-priority or administrative status, a roll-up is a better strategy for the creditor.

I leave for a few days, and you guys are having al...

2009-07-28T00:33:53.722-04:00

I leave for a few days, and you guys are having all the fun. The question remainds, does ITDC need a DIP in bankruptcy? Maintenance capex is quite light relative to run rate cash flows.

Actually, the DIP lender can only get security if ...

2009-07-27T23:13:15.990-04:00

Actually, the DIP lender can only get security if there are assets that haven't been secured or if there is excess value in the existing secured assets. The debtor must provide proof that there is "adequate protection" for the existing secured claims before the DIP can be secured against the same assets, let alone prime the secured creditors (see Section 364(d)).

Of course, if the value of the loan is greater than the value of the security, then the excess is unsecured.

This is why so many DIPs have been roll-ups by existing secured creditors (judges usually frown on the practice) and why, under Delphi's plan with Platinum some of the DIP lenders were to recover only 30% (they had adminstrative status but insufficient security).

Absent the cash which could be used in lieu of a D...

2009-07-27T23:02:47.415-04:00

Absent the cash which could be used in lieu of a DIP loan to fund operations in chapter 11, I would be less sanguine about this name. In these situations the pre-petition bank debt can get screwed by a DIP that quickly forces a 363 a la Foamex. You have to control collateral post petition, and if you don't you are at the mercy of the DIP lender. IF the DIP lender is the stalking horse he is going to collude with management and get the company. Pre-petition creditors would have to either step-up and take out the DIP or face getting nothing.

Ronagt, you have a good eye. Follow the name much...

2009-07-26T00:48:05.684-04:00

Ronagt, you have a good eye. Follow the name much? Anyhow, I agree with everything you said, but I think adding the cash to the market cap is a bit of a leap of faith (it implies your assuming that money goes to pay down debt, no?). I don't doubt the FY will be better than $75 mm, but at our fund I always like to show downside, call me a sandbagger if you must. In any event we both can agree the debt is undervalued. If 13% is low in today's market, what would you consider a sufficient return given the run-up in the high-yield market?

Anon in the post on 7/24 makes several errors and ...

2009-07-25T23:26:19.963-04:00

Anon in the post on 7/24 makes several errors and also shows a tolerance for chasing returns that is not well suited for investing in small, distressed situations where liquidity can dry up very quickly. But if you are going to chase, do so to win (hence the equity call).
The cap lease is $11M not $11MM or $19MM; Even if they wanted to, the first lien limits them to $7.5MM. In addition, the draw on the revolver is $8.5MM, with $600M in availability after LCs. The cash balance is actually $1.1MM higher when you include the payout received on the First Reserve cash (listed as a portion of the ST investment on BS). The first lien is $226.5MM (real #, not just pulling from balance sheet without reading notes)
75MMx5=375mm-310mm+67.3MM=132.3MM mkt cap, or $1.63/sh. However, they did over $22MM in EBITDA in March and continue taking out cost, so even if did just $80MM in EBITDA during this miserable year (7% better), the stock @ 5x is just shy of $2/sh (20% higher) - demonstrating the huge leverage in this business.

As for the comment about why not to buy equity if ...

2009-07-24T19:43:59.065-04:00

As for the comment about why not to buy equity if 5x is the appropriate multiple: At 5x our Enterprise Value is $375 mm (using the conservative $75 mm). Subtract out our 1st lien of $224.6 mm,capital leases of $11 mm second lien of $75 mm, you get implied equity of $64.4 mm. Divided by their outstanding shares of 80.9 mm, your implied trading value is $0.80. The equity is currently at about $1.20 last I checked, meaning it's overvalued if we think its 5x. There is a disconnect between the equity and the debt, the equity is giving an implied 5.4-5.5, and the 1st lien is implying 2.1-2.2 at the current run rate EBITDA

Ronagt: "Middling" IRR, given the genera...

2009-07-24T19:18:27.168-04:00

Ronagt: "Middling" IRR, given the general performance chase that is just now abating, is probably not quite accurate. The cash balance is mentioned in the conclusion paragraph at the end. I spoke to the CFO and asked why they didn't go out and purchase the Term Debt when it was at 59 cents a few months back, they said they were restricted by their covenants and before I could rebuttle followed with "but we can always seek to amend", which is what they should have done unless there is some plans for the cash. The only thing they told me is that their customers liked them having a large cash balance,however I'm sure their securities holders would prefer they do something with it.

As per the most recent 10-Q, there is $75 mm out under the 2nd lien. However you are right on the cap leases, they should be 11 not 19, that was a bust left from the 10-K.

Anon: The 1st lien recovery is just a simple calculation it's not meant to show what would happen in an actual restructuring, just if you get full recovery. It's simply cash available to 1st lien divided by 1st lien. If this was an 11, yes, the secured would get taken out at par and the balance would go to the 2nd lien in either cash, new notes, equity, or a mix.

I don't understand your calculation of the 1st...

2009-07-24T18:47:37.310-04:00

I don't understand your calculation of the 1st lien recovery in the 4.0x EBITDA multiple case: why wouldn't the 1st lien get paid back at par (you have them getting 114) and the second lien get equity?

Low current yield, middling IRR and inability to ...

2009-07-24T14:02:10.515-04:00

Low current yield, middling IRR and inability to put on size will clearly limit appetite for distressed players. $75MM EBITDA is very conserviative given they had best quarter since Telecom Bubble burst in Mar09; also an oligopoly competing against sleepy Bells who don't know how to sell to SME, though competing on price isn't an advantage to get too excited about. The analysis neglected to mention the company is sitting on $67MM in cash and has $20MM less in secured debt (less cap leases and 2d lien, more firs when inc unamortized discount). If you're the type you like leverage to juice returns, its a good safe bet. Then again, if you think 5x is the right multiple, just buy the equity which has much more upside.

Hey Hunter, there's something wrong with the l...

2009-07-24T07:30:02.414-04:00

Hey Hunter, there's something wrong with the links in your posts. Like in this one, the link to Mark's distresed debt example points to the blog's frontpage. I've seen this several times in your blog.

Anyway, thanks for a great and informative blog with truly unique content. Way too few of those in the world.

Given that you have two funds controlling the comp...

2009-07-24T02:22:37.227-04:00

Given that you have two funds controlling the company, one of which is pumping money into the public equity (and which you say is a well managed fund), and there is no imminent prospect of default, it seems like the first lien should be pretty safe.

The threat of IP telephony could be a problem, but I'm not an expert in the field.

Forgetting the quant analysis for the moment, insiders putting new money in; no default prospect; and the ability to put new money in should there be a short term squeeze seems to limit your downside.

I am concerned with the IRR, however. Was the 13.4% IRR based on a price of 74? If so, isn't that a bit low for a distressed investment?

The risk/return may be aligned, but the return profile would seem unattractive without leverage, which you would tend to avoid in a distressed strategy (right?).