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Valcon 2010

Playing To Win: Effective Valuation Analysis And Strategies

For Restructurings, Reorganizations,

Distressed Sales And Auctions

Donald S. BernsteinPartnerDavis Polk & Wardwell, LLP

J. Scott VictorManaging DirectorSSG Capital Advisors, LLCPhiladelphia PA

Kaaran E. ThomasOf CounselMcDonald Carano Wilson, LLPReno Las Vegas NVLLP

New York, NYPhiladelphia, PA Reno, Las Vegas, NV

D. Bobbitt Noel, Jr.PartnerVinson & Elkins, LLPHouston, TX

George AngelichPartnerArent Fox LLP1675 BroadwayNew York, NY

February 2010

Barry M. MonheitSenior Managing DirectorFTI Palladium PartnersPhoenix, AZ

Overview

Current Restructuring Landscapeg

The Distressed Company’s Options: Out of Court Restructuring v. Chapter 11 Alternatives

Valuation Dynamics In Chapter 11

2

Resolving The “Battle of the Experts” Without Litigation

2

The Current Restructuring Landscape

3

Senior Loan Volume1999 – 1H 2009

643.8

762.4

163 2

226.2

$600B

$700B

$800B

251.9192.9

138.5 144.8 165.7

274.4 297.9

480.6536.2

154.5

36.2

54.8

65.7 38.253.7

81.4

147.0

163.2

81.2

15.0

45.6

235.7

288.2

247.7

204.2183.0

219.3

355.8

444.8

$100B

$200B

$300B

$400B

$500B

4

Source: Standard & Poor’s LCD M&A Stats

Note: This chart reflects the estimated primary volume to the US and European loan markets. The US Market includes tranches denominatedin non-USD currencies as well as US dollars. The European Market includes tranches denominated in non-Euro or Sterling currencies as wellas Euros and Sterling. Exchange rates from non-USD currencies are based upon date of launch of the individual transactions.

30.6$0B

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1H09

US Market European Market

3

Second Lien Volume1Q 1997 – 3Q 2009

$12,500

$15,000

$5,000

$7,500

$10,000

$ ,

($ in

milli

ons)

5


$0

$2,500

1Q97

2Q97

3Q97

4Q97

1Q98

2Q98

3Q98

4Q98

1Q99

2Q99

3Q99

4Q99

1Q00

2Q00

3Q00

4Q00

1Q01

2Q01

3Q01

4Q01

1Q02

2Q02

3Q02

4Q02

1Q03

2Q03

3Q03

4Q03

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

Number of Middle-Market Deals By Quarter(Defined as Issuers with EBITDA of $50 Million or Less)

1Q 1997 – 3Q 2009

120

140

40

60

80

100

6


0

20

4

Total US Leveraged Buyout VolumeTotal US Leveraged Buyout Volume1996 1996 –– 3Q 20093Q 2009

By Quarter By Year

433.7$450B

$160B

$180B

70

80

110.8

4.6

233.0

28.933.0

56.752.5

40.519.5 21.9

47.0

93.9

130.3

$0B

$150B

$300B

$0

$20B

$40B

$60B

$80B

$100B

$120B

$140B

0

10

20

30

40

50

60

7

Note: The volume on this page includes the Total Sources (loans, secured debt, unsecured debt, sub debt, and equity) involved in Leveraged Buyouts.


Total Common & Preferred Equity Other Sources

$0B 0

LBO Volume Number of Deals

M&A Leveraged Loan Volume M&A Leveraged Loan Volume 1Q 1997 1Q 1997 –– 3Q 20093Q 2009

$150B

31.5

60.0

39.834.2

51.5

31.726.2

17 0 16 921.4

29.8

41.5

29.035.2 33.6

62.7

70.0

51.7

95.1

105.6

66.6

31.5

64.1

91.2

31.6

18 212 320.8

45.8

32.6

51.251.1

45.2

24.9

32.431.8

$50B

$100B

8


17.0 16.9

10.25.5 4.1 2.04.0

18.214.6

9.89.5

11.1

12.3

10.310.4

4.3

11.0

20.815.6

0.8$0B

Institutional Pro Rata

5

Initial Institutional Defaults Loan Amounts by QuarterInitial Institutional Defaults Loan Amounts by QuarterComprises Institutional Loans closed between 1995 Comprises Institutional Loans closed between 1995 -- 3Q 2009 for Issuers that File Publicly3Q 2009 for Issuers that File Publicly

$25000M

$30000M

$5000M

$10000M

$15000M

$20000M

9


$0M

$5000M

Default Date

Below Investment Grade Debt Maturity ScheduleBelow Investment Grade Debt Maturity Schedule

$250B

$50B

$100B

$150B

$200B

10

Source: DealLogic, Fitch Ratings

Note: Leveraged Loans include term loans, revolvers, and other loans.

$B

2008 2009 2010 2011 2012 2013 2014 > 2014

Leveraged Loans High Yield Bonds

6

Quarterly Corporate Chapter 11 Bankruptcy Filings1Q 2005 - 3Q 2009

3 431

3,9654,000

4,500

1,5211,384 1,310

1,692

1,2911,079 1,192 1,170

1,2831,430 1,410

1,6121,812

1,658

2,485

2,941

3,431

3,060

500

1,000

1,500

2,000

2,500

3,000

3,500

11

Source: American Bankruptcy Institute

0

500

Q1 20

05

Q2 20

05

Q3 20

05

Q4 20

05

Q1 20

06

Q2 20

06

Q3 20

06

Q4 20

06

Q1 20

07

Q2 20

07

Q3 20

07

Q4 20

07

Q1 20

08

Q2 20

08

Q3 20

08

Q4 20

08

Q1 20

09

Q2 20

09

Q3 20

09

Restructuring Today – New Factors

Debt trading – “loan to own”

Credit bidding

Fraudulent transfer attacks on leveraged transactions

Use of “collective action” to bind minority holders

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Use of collective action to bind minority holders

Developing case law and practice in each area

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The Distressed Company’s Options: Out of Court Restructuring v. Chapter

11 Reorganization

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Out of Court Restructuring

Types Of Restructurings

• Debt for Equity Exchanges

• Debt Buybacks

• Sale of Assets/Company

St d till f b id

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• Standstills, forbearances, overrides

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Out of Court Restructuring (Cont.)

Obstacles

• Recalcitrant Creditors – asset grabs. How to punish hold outs and reward cooperation

• Squeamish buyers –inability to provide warranties, bonds, indemnities

• Inability to control/manage assets due to creditor

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• Inability to control/manage assets due to creditor interference, lawsuits, threats of foreclosure


Lender Obstacles

– Reluctant bank group agents

– Recalcitrant bank group members

– Inability to deleverage overleveraged assets

I bilit t h l d i ll ith

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– Inability to reach lender consensus – especially with perception that recession is ending, values increasing

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Statutory ObstaclesFraudulent transfer laws– Fraudulent transfer laws

– Bulk Sales laws– Challenges to buyer if insiders of seller remain active,

get special consideration– No binding determination of value of assets being

sold, refinanced Exposure to second guessing after the fact See e g

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– Exposure to second guessing after the fact. See, e.g., Tousa Official Committee of Unsecured Creditors v. Citicorp North America, et.al. Case 08-01435 Bankr. S.D. Fla., Oct. 30, 2009 (on court website)


Advantages of Out of Court Restructuringg g

• Cost – but may be offset by cost of controlling parties and replacing assurances available in bankruptcy

• Time – Chapter 11 cases require (pre GM) time for procedural safeguards. (May not be true today)

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• Less Scrutiny, fewer procedural hurdles

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Chapter 11 Alternative -- Prepak

Prepak combines out of court + bankruptcy– Prepak combines out of court + bankruptcy

– Approach out of court solution as potential Chapter 11

– Addresses holdout problem

– Begin Chapter 11 process pre-filing like out of court workout

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workout

– Build in protections of Chapter 11 as last resort – or as conclusion to out of court efforts

Valuation Strategy for Out of Court Restructurings

• Obtain supportable valuation for each party’s interest• Seek creditor approval for the valuation – attempt toSeek creditor approval for the valuation attempt to

resolve any valuation disputes• Identify each party’s claim in Chapter 11 and their most

likely distribution in a liquidation• Estimate Chapter 11 costs; compare to out-of-court costs• Hire reputable advisor/credible valuation firm to use as go-

between (remember that their work will not be privileged in liti ti )

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litigation) • Be prepared to file if pre-defined triggers occur (cost,

assets at risk, etc.)• Negotiate “amend and extend” (aka “amend, pretend,

extend”) provisions to defer valuations

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Criteria Guiding Selection

Debtor’s Viewpoint

• What is debtor’s goal? Reorganize? Sell? Other?What is debtor s goal? Reorganize? Sell? Other?• Do operations need to be restructured or just debt?• Value of Debtor’s assets – going concern vs. fair

market vs. liquidation• Allies – senior secured? Junior secured?

Investor? Trade?• How cooperative are the parties in interest

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p p• Liquidity and available funds• Prospect of holdouts

Criteria Guiding Selection (cont.)

• Senior Secured Lender Viewpoint– Preference between sale and reorganizationPreference between sale and reorganization

• Value of collateral – going concern vs. fair market vs. liquidation

• Possibility of credit bidding

– View of management - need for a change?

– Available buyers, investors

– Liquidity to reorganize - provide defensive DIP?

Li i it i ( h i li )

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– Lien priority issues (e.g. mechanics liens)

– Potential for litigation claims

– Lending group issues – first/second lien? dissidents?

– Status of junior classes

12


Junior Creditor/Unsecured Viewpoint

– Legal issues – developing interpretation of ability to sell free and clear ofLegal issues developing interpretation of ability to sell free and clear of junior liens under Section 363 (c)(2) outside of a plan

– 9th Circuit, Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008). In single asset real estate case failure to obtain a stay does not render moot appeal of order approving sale to senior lender for credit bid free and clear of junior liens. The Panel held that § 363(m) applies only to protect the portion of sale orders issued under § 363(b) or (c), but not to the "free and clear" relief under § 363(f). reversed order approving sale. No showing of a justification for eliminating junior liens under 363(c)(2)

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eliminating junior liens under 363(c)(2).

– Contra: In re Nashville Senior Living, LLC,407 B.R. 222(6th Cir.BAP (Tenn.),2009). (363(m) applies to “free and clear “ section of 363(c)).

– Sale free and clear outside plan also discussed in In re Gulf Coast Oil Corp.,404 B.R. 407(Bkrtcy.S.D.Tex.,2009.)


Junior Creditor/Unsecured Viewpoint (cont.)

• Valuation Issues• Valuation Issues– Going concern vs. fair market vs. liquidation value

• Liquidity

• Value of claims against secureds

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• Strategic issues– Value to constituents of keeping Debtor alive

(contractors, landowners, customers)

13


Dissident Lender Viewpoint

– “Dissident Lender” means participant in loan who disagrees with p p gdecision of majority of other participants and agent.

– Under credit documentation, dissident lender is generally bound by the vote of majority regarding exercise (or forbearance from exercise) of remedies.

• Recent developments under state law regarding “collective action” to bind dissident lenders in restructuring. Beal Savings Bank v. Sommer, 865 N.E.2d 1210 (N.Y. 2007)

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( )

– In bankruptcy dissident lenders are “parties in interest” entitled to be heard

• But can’t ignore agreements – “collective action” can apply in bankruptcy as well.


Dissident Lender Viewpoint (cont.)

– Valuation scenario – define lender’s ability to align with group that will provide highest recovery or best leveragegroup that will provide highest recovery or best leverage

• Bankruptcy clarifies the various parties in interest and their positions

• Easier to evaluate options

– Valuation strategy• Review participation/agency agreements for leverage

– Limits on agent powersControls/sanctions on dissident lender

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– Controls/sanctions on dissident lender – Indemnity agreements, hold harmless, etc

– Evaluate which party in interest supports dissident’s position and align with that party

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Valuation Dynamics in Chapter 11

Valuation Alternatives• Negotiated value (required for consensual plan or• Negotiated value (required for consensual plan or

prepak)– The parties determine the ultimate value.– Required for any consensual plan, including a prepack.

• Market value (usually 363 sale)– If parties cannot agree to reorganize

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• Reorganization value – valuation by the court– Valuation to satisfy best interests test (liquidation)– “Cram down” value in order to apply absolute priority rule

Negotiated Value

Negotiating Tactics – Threats (Sale, Conversion, Plan)

– “Be careful what you wish for”– Be careful what you wish for

– Valuation strategy

• obtain competent liquidation analysis• identify market and possible buyers• construct realistic alternative for key parties

Avoid bluffing

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– Avoid bluffing

• Threatened sales/competing plans need buyers, take out financing, • Litigation requires funds, experts, witnesses

15

Market Value

“Testing the Market”

• Possible alternative to negotiated value if parties cannot agree

Pursuing sale concurrently with restructuring

• Sales establishes value and provides options

• Parties may be stuck with bad offers as valuation

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• Evidence for all valuation purposes

• Sales of some assets deleverage estate

• Sale may remove dissidents, troublemakers

Market Value (cont.)

Quick 363 Sale

– GM: US government orchestrated 363 sale to US Treasury sponsored entity to be owned by US Government, pre-bankruptcy bondholders, UAW union healthcare fund and the Canadian government (Conventional?)

– Chrysler: US government orchestrated 363 asset

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– Chrysler: US government orchestrated 363 asset sale to a company to be owned by Fiat, a UAW union retirement plan and the US government (Conventional?)

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Market Value (cont.)

• Caveat to “Quick Sales”

– Ability to sell “free and clear” See e.g., Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008).

Abilit t ll t id l S I G lf

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– Ability to sell outside plan – See e.g., In re Gulf Coast Oil Corp.,404 B.R. 407 (Bkrtcy. S.D.Tex., 2009.)

Reorganization Value

Traditional Reorganization

– Requires liquidity to finance the Chapter 11• DIP Financing• Cash Collateral• Unencumbered Cash

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– Requires consensus -- “Dividing up the pie” or cramdown - risky

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Reorganization Value (cont.)

Cram Down Value

– Determined at trialDetermined at trial

– Requires valuation experts

– Risky – judge is least knowledgeable person in the room

– Requires multiple guesses – correct discount rate, multiple WACC

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p

– A “guess compounded by an estimate”

– An option of last resort

Valuation Dynamics In Chapter 11

34

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Perspective of Debtor’s Financial Advisor

Manage The Parties’ Expectations– Management– Stakeholders

• Public Company• Family Business• Private Equity

Realistic Assessment Of What Company Can DoThe Other Professionals

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– Attorneys– CRO– Investment Banker– Appraiser(s)


Prepare Management, Board for Alternatives

Organizing the Creditors

Who should the debtor “hook up” with in the process– Senior Lenders– Bondholders– Unsecured Creditors

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– Unsecured Creditors– Labor– Trade group – Suitor

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Valuation Preparations And Tactics– Transparency of Information

• Open process• Stop bad information• Stop bad information

– “Sing from the same hymn book”– Need to value assets to see what is available in the

negotiations– Collateral for DIP– Real Estate– Enterprise value

S b idi i

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• Subsidiaries• Business plan assumptions

– Tactical Perspective• ITS ALL ABOUT THE NUMBERS• Choice of Valuation Methods• Usefulness of “valuation ranges”


Debate Over Assumptions

– ITS ALL ABOUT THE NUMBERSITS ALL ABOUT THE NUMBERS– Understand the position of all the parties on

assumptions– The equity split

• Should the debtor care– Proposing alternatives to litigation

• Recovery model• Assumptions regarding causes of action

S ttl ? P ?

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– Settle? Preserve?• Do you really want the judge to decide valuation?

Should the expert who will testify on valuation participate in the negotiation process?

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Perspective of Senior Lender Expert

• Inherent Tensions– Adequate protection and priming risks

Post petition interest– Post-petition interest– Plan of reorganization

• Inclination To Favor Conservative Valuation

• Tendency To “Keep Powder Dry” Early In Case– Settle adequate protection, use of cash collateral, DIP

i i t id l l ti fi ht

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priming to avoid early valuation fight

• Fear: being “held hostage” by out of money junior classes

Perspective of Creditor’s Committee Expert

Avoiding “Out of the Money” Presumption

– Risk in highly leveraged debtors (second lien structures)

Favor Aggressive ValuationFavor Aggressive Valuation

– Higher valuation means a higher proportion of the enterprise value goes to unsecured creditors

– Fight tendency of debtor to take “path of least resistance” favoring senior lenders with a conservative valuation

– Show unsecured creditors will be substantial ongoing stakeholders

– Involvement in business plan critical -- driver of valuation range

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Explore Testing Market To Enhance Credibility Of Valuation

When All Else Fails, Play For Time: “Who knows? Maybe the horse will talk.”

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Resolving The “Battle of the Experts” Without Litigation

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Chapter 11 Valuation Negotiations

• Backdrop: Threat Of Judicial Valuation– Contested confirmation: cram down valuation

Non expert judge must weigh expert testimony & decide– Non-expert judge must weigh expert testimony & decide• Battle Of The Experts

– Valuations are “fuzzy” absent market test– Debatable variables

• Projections• Discount rates• Comparable companies• Replacement cost

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p• Bankruptcy “discount”

– Wide variations in testimony• In re Mirant Corp., 334 B.R. 800 (Bankr. N.D. Tx. 2005)

– Market vs. Expert Testimony • In re Exide Technologies, Case No. 02-11125 Bankr. Delaware

– Court appointment of expert under FRE 706?

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Negotiations: Role of the Experts

• Identifying Experts– Problem Using Same Expert For Negotiation And

LitigationLitigation– Negotiating expert vs. testifying expert

• Presenting Each Side’s Case

• Debating Assumptions– Reconcile differences in valuations, if possible

Id tif i diff i ti

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– Identifying differences in assumptions• Business plan• Valuation methodology

• Finding Ways To Bridge The Gap

Negotiations: Bridging The Valuation Gap“Parallel Track” Sale Process

• Simultaneously pursuing sale and reorganization – In re Adelphia Communications Corp., Case No. 02-41729 Bankr.

S.D.N.Y.

• Sale in lieu of reorganization – In re Chrysler LLC, Case No. 09-B 50002 Bankr S.D.N.Y. Appeal of

sale order: In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009)– In re General Motors Corp. Case No. 09-50026 Bankr S.D.N.Y.– In re Delphi Corp. Case No. 05-44481 Bankr. S.D.N.Y.(“Delphi”)– Possibility of credit bid to keep the process honest (Delphi)

Third party intervention

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– Mediators and Examiners

Rights Offerings

– “Put your money where your mouth is.”– Rights offerings are viable way to bring valuation negotiations

to a close.

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Negotiations: Rights Offerings

Opportunity to “buy in” to restructuring

– Provides a form of consideration for potentially out-of-the money classes

– A way to avoid a contested confirmation hearing.

There is typically a backstop

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– Underwritten by an existing creditor/investor (hedge fund).

Negotiations: Contingent Value Plans

Reallocation of consideration based on future valuation

Allocation Formulas For Contingent Assets, Contingent Distributions

– Classic example: In re Penn Central Transp. Co., Case No 70-347 Bankr. E.D. Pennsylvania

• Litigation claims against United States were valuation variable

Securities With Option Features– Allow future market value to determine plan allocations

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Allow future market value to determine plan allocations– Warrants– Convertible securities– Valuation of options

• Negotiating over Black-Scholes valuations (“VAR”) • See, e.g., In re Conseco, Inc., Case No. 02 B 49672 (Bkr. N.D.

Illinois, Eastern Division

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