Distressed Debt Slides_Melissa Brady

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<ul><li><p>2016 RSM US LLP. All Rights Reserved. 2016 RSM US LLP. All Rights Reserved. </p></li><li><p>2016 RSM US LLP. All Rights Reserved. 2016 RSM US LLP. All Rights Reserved. </p><p>VALUATION METHODOLOGIES OF VARIOUS DEBT PRODUCTS</p><p>Melissa Brady, CFA</p><p>Phone: 212-372-1296</p><p>Email: Melissa.Brady@RSMUS.com</p><p>Website: www.RSMUS.com</p><p>September 26, 2016</p><p>mailto:Melissa.Brady@RSMUS.comhttp://www.rsmus.com/</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Distressed Debt Overview </p><p> What is distressed debt?</p><p> How does distressed debt differ for the middle market?</p><p> What are the underlying factors that cause inefficiencies in the distressed market?- Complexity- Illiquidity- Stigma- Information asymmetries- Investor disqualifications</p><p>2</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Causes</p><p> 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</p><p>3</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Distressed Debt Valuation</p><p> Traditional models breakdown and tend to overestimate value. </p><p> Valuation Approaches - Income approach using distressed rates of return</p><p>- Net recovery approach in assessing collateral coverage</p><p>- Weighted approaches with going concern and liquidation</p><p>- Simulation / scenario approach</p><p>4</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Recovery Rates </p><p>5</p><p> Academic papers Studies</p><p> CEPRES Data Private Debt &amp; Mezzanine Market Report</p><p> S&amp;P Global Market Intelligence &amp; LSTA Moodys Annual Default &amp; Recovery Studies Other</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Academic Study: Recovery By Instrument</p><p>6</p><p>Instrument Type # of Obs. Mean Recovery Rate</p><p>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%</p><p>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 Moodys Ultimate Recovery Rate Database. </p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Syndicated Loan Study: Recovery Rates</p><p>7</p><p>Instrument Type Recovery Rate</p><p>Weighted Recovery Rate</p><p>First Lien Term Loans 76.6% 80.7%Second Lien Term Loans 36.9% 57.6%</p><p>All Term Loans 74.4% 80.1%</p><p>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%</p><p>Source: S&amp;P Capital IQ LossStats &amp; LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCDs database.</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Recovery Rates by EBITDA</p><p>8</p><p>EBITDA Level First Lien Term Loan Recoveries by EBITDA (Approximate)</p><p>Negative 60%</p><p>Positive 77%</p><p>Source: S&amp;P Capital IQ LossStats &amp; LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCDs database.</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Recovery Rates by Industry</p><p>9</p><p>Industry RecoveryPrinting &amp; Publishing 64.8%Telecom 68.1%Gaming &amp; Hotel 68.2%Chemicals 68.8%Healthcare 69.9%Utilities 72.9%Computers and Electronics 73.8%Automotive 85.8%Entertainment &amp; Leisure 89.2%Radio 91.0%Source: S&amp;P Capital IQ LossStats &amp; LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCDs database.</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Distribution of Recovery Rates</p><p>10</p><p>Distribution of First Lien Recoveries</p><p>Recovery</p><p>&lt; 50% 25.4%</p><p>50% to 70% 12.9%</p><p>70% to 90% 11.5%</p><p>90% or More 50.2%</p><p>Source: S&amp;P Capital IQ LossStats &amp; LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCDs database.</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Recovery Rates for Balance Sheet Assets</p><p>11</p><p>Example: Cash 100% recoverable</p><p> Accounts Receivable 75% to 85% recoverable</p><p> Inventory 50% to 80% recoverable</p><p> Fixed assets 50% recoverable</p><p> Intangible assets 0%</p><p> Prepaid assets 0%</p><p> Other assets 0%</p><p>The rates above are for illustrative purposes only. Recovery rates vary by industry and by company. </p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Example 1 Plant Nursery Business</p><p>12</p><p>Balance Low High Low HighCurrent Assets:</p><p>Cash &amp; 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% - - </p><p>Total Current Assets 261,495$ 39,620$ 64,943$ </p><p>Net Fixed Assets 18,368 40% 60% 7,347 11,021 </p><p>Intangible Assets 12,667 0% 0% - - Total Other Assets 12,667$ -$ -$ Total Assets Supporting Debt 292,530$ 46,967$ 75,963$ </p><p>Less: Revolver 31,035 31,035 31,035 </p><p>Collateral Supporting First Lien 261,495 15,932 44,928 </p><p>First Lien Term Loan A 75,000$ 75,000$ 75,000$ First Lien Coverage 21.2% 59.9%</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Example 2: Sun Block Retail (Part I of II)</p><p>13</p><p>($ in thousands) Low Range High RangeValuation Valuation</p><p>Balance Adjustments Adjustments Low HighCurrent Assets:</p><p>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% - - </p><p>Total Current Assets 15,153$ 10,739$ 11,438$ </p><p>Net Fixed Assets 1,445$ 45% 55% 650$ 795$ </p><p>Intangible Assets 16,564 0% 0% - - Brands - N/A N/A 12,496 14,995 Other Assets 964 0% 0% - - </p><p>Total Other Assets 17,528$ 12,496$ 14,995$ </p><p>Total Assets 34,126$ 23,885$ 27,228$ </p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Example 2: Sun Block Retail (Part II of II)</p><p>14</p><p>($ in thousands)Low -- High</p><p>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 -$ -$ </p><p>Subordinated Debt Coverage 59.2% 77.9%</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Considerations</p><p> Factors behind market approach limitations. </p><p>- Choosing only distressed firms may be problematic if there is few available.</p><p>- Adjust multiple for distress (highly challenging)</p><p> Factors behind income approach limitations. </p><p>- Using distressed discount rates of 30% or higher may overestimate value.</p><p> Use multiple methods, if possible.</p><p>15</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Example 3: Market Approach Service Co.</p><p>16</p><p>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 </p><p>Subordinated Debt Coverage 42% 60%</p><p>Valuation Range</p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>Example 3: Income Approach Service Co.</p><p>17</p><p>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%</p><p>Concluded Price of Debt (% of Par) 63.2% -- 69.6%</p></li><li><p>2016 RSM US LLP. All Rights Reserved. 2016 RSM US LLP. All Rights Reserved. </p></li><li><p>2016 RSM US LLP. All Rights Reserved. </p><p>This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services. This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. RSM US LLP, its affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person. Internal Revenue Service rules require us to inform you that this communication may be deemed a solicitation to provide tax services. This communication is being sent to individuals who have subscribed to receive it or who we believe would have an interest in the topics discussed.</p><p>RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. </p><p>RSM and the RSM logo are registered trademarks of RSM International Association. The power of being understood is a registered trademark of RSM US LLP. </p><p> 2016 RSM US LLP. All Rights Reserved.</p><p>RSM US LLP</p><p>1185 Avenue of the AmericasNew York, New York 10036+1 212 372 1000www.rsmus.com</p><p>Slide Number 1Valuation Methodologies of Various Debt ProductsDistressed Debt Overview CausesDistressed Debt ValuationRecovery Rates Academic Study: Recovery By InstrumentSyndicated Loan Study: Recovery RatesRecovery Rates by EBITDARecovery Rates by IndustryDistribution of Recovery RatesRecovery Rates for Balance Sheet AssetsExample 1 Plant Nursery BusinessExample 2: Sun Block Retail (Part I of II)Example 2: Sun Block Retail (Part II of II)ConsiderationsExample 3: Market Approach Service Co.Example 3: Income Approach Service Co.Slide Number 19Slide Number 20</p></li></ul>