Download - Distressed Debt Slides_Melissa Brady
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VALUATION METHODOLOGIES OF VARIOUS DEBT PRODUCTS
Melissa Brady, CFA
Phone: 212-372-1296
Email: [email protected]
Website: www.RSMUS.com
September 26, 2016
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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
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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.
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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.
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Recovery Rates by EBITDA
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EBITDA Level First Lien Term Loan Recoveries by EBITDA (Approximate)
Negative 60%
Positive 77%
Source: S&P Capital IQ LossStats & LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCD’s database.
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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.
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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%
Source: S&P Capital IQ LossStats & LCDRecoveries for 410 leveraged syndicated term loans that defaulted between 1998 and 2015 based on LCD’s database.
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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.
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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%
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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$
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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%
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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
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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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