distressed debt slides_melissa brady


VALUATION METHODOLOGIES OF VARIOUS DEBT PRODUCTS

Melissa Brady, CFA

Phone: 212-372-1296

Email: [email protected]

Website: www.RSMUS.com

September 26, 2016

mailto:[email protected]

http://www.rsmus.com/

©2016 RSM US LLP. All Rights Reserved.

Distressed Debt Overview

• What is distressed debt?

• How does distressed debt differ for the middle market?

• What are the underlying factors that cause inefficiencies in the distressed market?- Complexity- Illiquidity- Stigma- Information asymmetries- Investor disqualifications

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Causes

• Aggressive lending (weak terms)• Macro conditions• Company performance• Accounting vs. Reality• Fraud / negative news• Covenants / acceleration• Maturities• Liquidity• Bankruptcy / emergence• Securities prices• Lack of confidence• Forced Sellers

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Distressed Debt Valuation

• Traditional models breakdown and tend to overestimate value.

• Valuation Approaches - Income approach using distressed rates of return

- Net recovery approach in assessing collateral coverage

- Weighted approaches with going concern and liquidation

- Simulation / scenario approach

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Recovery Rates

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• Academic papers• Studies

• CEPRES Data – Private Debt & Mezzanine Market Report

• S&P Global Market Intelligence & LSTA• Moody’s Annual Default & Recovery Studies• Other


Academic Study: Recovery By Instrument

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Instrument Type # of Obs. Mean Recovery Rate

Revolvers 254 82.45%Term Loans 209 70.49%Senior Secured Bonds 218 58.90%Senior Unsecured Bonds 483 52.69%Senior Subordinate Bonds 148 28.79%Subordinate Bonds 120 25.79%Junior Bonds 17 18.36%

Source: Debt Structure, Market Value of Firm, and Recovery Rate by Min Qi and Xinlei Zhao. Office of the Comptroller of the Currency. Economics Working Paper 2011-2, October 2011. Sample is from Moody’s Ultimate Recovery Rate Database.


Syndicated Loan Study: Recovery Rates

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Instrument Type Recovery Rate

Weighted Recovery Rate

First Lien Term Loans 76.6% 80.7%Second Lien Term Loans 36.9% 57.6%

All Term Loans 74.4% 80.1%

Secured Bonds 56.3% 55.4%Senior Unsecured Bonds 43.8% 41.4%Subordinate Bonds 29.3% 28.7%Junior Subordinate Bonds 22.8% 26.8%

Source: S&P Capital IQ LossStats & LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCD’s database.


Recovery Rates by EBITDA

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EBITDA Level First Lien Term Loan Recoveries by EBITDA (Approximate)

Negative 60%

Positive 77%



Recovery Rates by Industry

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Industry RecoveryPrinting & Publishing 64.8%Telecom 68.1%Gaming & Hotel 68.2%Chemicals 68.8%Healthcare 69.9%Utilities 72.9%Computers and Electronics 73.8%Automotive 85.8%Entertainment & Leisure 89.2%Radio 91.0%Source: S&P Capital IQ LossStats & LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCD’s database.


Distribution of Recovery Rates

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Distribution of First Lien Recoveries

Recovery

< 50% 25.4%

50% to 70% 12.9%

70% to 90% 11.5%

90% or More 50.2%



Recovery Rates for Balance Sheet Assets

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Example:• Cash – 100% recoverable

• Accounts Receivable – 75% to 85% recoverable

• Inventory – 50% to 80% recoverable

• Fixed assets – 50% recoverable

• Intangible assets – 0%

• Prepaid assets – 0%

• Other assets – 0%

The rates above are for illustrative purposes only. Recovery rates vary by industry and by company.


Example 1 – Plant Nursery Business

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Balance Low High Low HighCurrent Assets:

Cash & Cash Equivalents 3,040$ 0% 0% -$ -$ Accounts Receivable 2,973 70% 80% 2,081 2,378 Prepaids 5,225 0% 0% - - Inventory 250,257 15% 25% 37,539 62,564 Other Current Assets - 0% 0% - -

Total Current Assets 261,495$ 39,620$ 64,943$

Net Fixed Assets 18,368 40% 60% 7,347 11,021

Intangible Assets 12,667 0% 0% - - Total Other Assets 12,667$ -$ -$

Total Assets Supporting Debt 292,530$ 46,967$ 75,963$

Less: Revolver 31,035 31,035 31,035

Collateral Supporting First Lien 261,495 15,932 44,928

First Lien Term Loan A 75,000$ 75,000$ 75,000$ First Lien Coverage 21.2% 59.9%


Example 2: Sun Block Retail (Part I of II)

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($ in thousands) Low Range High RangeValuation Valuation

Balance Adjustments Adjustments Low HighCurrent Assets:

Cash 80$ 100% 100% 80$ 80$ Accounts Receivable 6,990 75% 85% 5,243 5,942 Inventories 6,018 90% 90% 5,416 5,416 Other Current Assets 2,065 0% 0% - -

Total Current Assets 15,153$ 10,739$ 11,438$

Net Fixed Assets 1,445$ 45% 55% 650$ 795$

Intangible Assets 16,564 0% 0% - - Brands - N/A N/A 12,496 14,995 Other Assets 964 0% 0% - -

Total Other Assets 17,528$ 12,496$ 14,995$

Total Assets 34,126$ 23,885$ 27,228$


Example 2: Sun Block Retail (Part II of II)

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($ in thousands)Low -- High

Available for Paydown 23,885$ 27,228$ Less: Senior Debt 13,322 13,322 Residual Coverage 10,563$ 13,906$ Less: Subordinated Debt 17,854 17,854 Residual Value to Common -$ -$

Subordinated Debt Coverage 59.2% 77.9%


Considerations

• Factors behind market approach limitations.

- Choosing only distressed firms may be problematic if there is few available.

- Adjust multiple for distress (highly challenging)

• Factors behind income approach limitations.

- Using distressed discount rates of 30% or higher may overestimate value.

• Use multiple methods, if possible.

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Example 3: Market Approach – Service Co.

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Low -- HighAdjusted EBITDA 5,355$ 5,355$ EBITDA Multiple 6.5x 7.0xImplied Enterprise Value 34,808$ 37,485$ Plus: Sponsor Committed Equity Infusion 2,500 5,000 Plus: Cash 248 248 Available for Paydown 37,556$ 42,733$ Less: Senior Debt 25,249 25,249 Residual Value For Subordinated Debt 12,307 17,485 Less: Subordinated Debt 29,045 29,045

Subordinated Debt Coverage 42% 60%

Valuation Range


Example 3: Income Approach – Service Co.

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Sensitivity Analysis - Implied Price of Debt Based on Following Concluded Yields27.00% 28.00% 29.00% 30.00% 31.00% 32.00% 33.00%71.3% 69.6% 67.9% 66.3% 64.7% 63.2% 61.7%

Concluded Price of Debt (% of Par) 63.2% -- 69.6%


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distressed debt slides_melissa brady

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