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Corporate and Investment Banking
Lecture 10 – Distressed Situations
1
Distressed Situations
Introduction
Distressed M&A Scenario
Sell Side Corporate/Creditor
Buy Side
Legal Issues
2
3
Valuation Deal Initiation Bankruptcy
Process Experience with Potential Buyers
Speed
Current Knowledge of
the Sellers Industry
Global Reach Deal Execution Inherent
Conflicts of Interest
Distressed Situations Definition: Mergers and acquisitions where the target company is “distressed”.
Distress for these purposes generally signifies that a company is having difficulty in dealing with its debt -
either servicing its interest and principal amortization payments, addressing covenant breaches in debt
instruments, paying or refinancing debt at maturity, or raising additional debt to address liquidity needs
Distressed M&A vs. Healthy M&A: key topics to be addressed
Introduction – Definition
4
Distressed M&A is more likely to create value in a downturn than in an upturn. The severity of
the 2008 financial crisis appears to have accentuated the distressed M&A effect, with higher
returns for both acquirers and targets in 2008 than in downturns during the previous 15 years
Returns from distressed M&A for both acquirers and targets 2008 downturn vs. 1992-2007 downturns
Introduction - Returns from Distressed M&A in the
Global Financial Crisis
Source: The Boston Consulting Group, 2009. Be Daring When Others are fearful: Seizing M&A Opportunities While They Last Notes: A downturn year is
defined as one in which worldwide GDP growth was below the average for the period 1990 to 2007. Distressed M&A is defined as a transaction whose
target EBIT margin is below the sample median for targets. (1) Average cumulative abnormal return was calculated over a seven-day window centered
around announcement day (+3/-3).
0.0
(2.4)
Distressed M&Ain 2008
Distressed M&A in Previous Downturns,
1992–2007
50.4
20.3
Distressed M&Ain 2008
Distressed M&A in Previous Downturns,
1992–2007
N = 30 N = 149
2.4%
N = 31 N = 157
30.1%
Acquirers CAR(1) (%) Targets CAR(1) (%)
Typical Challenges
Undercapitalised balance sheet
Inappropriate capital structure
Changing industry conditions
Declining operating performance
Declining cash flow
Risk of losing key management
Significant liquidity constraints
Stretched payables
Management distracted “fire fighting”
Total debt > Enterprise value
Covenant/debt repayment defaults
Stakeholder conflict
Senior lender aggression
Restricted access to existing capital
Limited access to new capital
Threat of insolvency proceedings
5
Time
Lo
wEnti
ty V
alu
eH
igh
Amount of shareholder value
preserved
Deal Timing
Distressed M&A Scenario - Typical challenges and
Deal Timing
Success Stressed Distressed Insolvent
Cash Flow Good Cash Flow Poor
Potential covenant
breach
Credit rating
downgrade
Profit warning
Board still in control
of strategy
Covenant breaches
Creditor pressure
Expensive re
financing
Equity value
negligible
Creditors in control
of strategy
Insolvency
practitioner
appointed
Strategy is to realise
assets and contain
liabilities
6
It is crucial to consider where a distressed company falls on the leveraged pendulum
Distressed M&A Scenario - Focus on Deal Timing
Management &
Employees
Distressed Corporate
Creditors
Distressed
Investor Secured
Unsecured
Operational
Shareholders Regulatory
Pensions
Tax
Listed
Private
Private
Equity
Suppliers
Customers Landlords
Credit
Insurers
7
The stakeholder can be varied in a distressed situation M&A. Depending on the stage of distress, shareholders
may have less influence than in a normal course transaction; management may be accustomed on the buyer’s way
of doing business or have concerns about its role. Furthermore, the buyer should bear in mind the fiduciary duties
of the board, as well as the influence of lenders, key customers, suppliers and trade unions. Indeed, competing
influence are a key issue to deal with in targeting a distressed corporate
Distressed M&A Scenario - The Stakeholders
8
The financial strength of the acquirer
The acquisition is more likely to be a success if the buyer is healthy and has an above average profitability, in order to convince the market that it can turn around a distressed target. This aspect is also crucial if considering the resources and management focus required in the postmerger integration phase
The cause of distress in the target
Targets with financial problems but that have not yet run into operating problems (e.g.: breaking the debt covenants but remaining profitable) are easier to turn around through recapitalization
Even when the target has operating problems, the buyer’s returns from the acquisition will be higher if it also has capital structure problems, that the buyer can sort out. In such cases, the market expectations will be depressed making the target more attractive. In addition, this would facilitate hard restructuring strategies since the alternative -bankruptcy- will be evident to government, labor unions, regulators
The relative size of the acquirer and the target
Bigger buyers acquiring smaller targets will have more success since this carries less risk and is easier to finance – and the market will recognize it in its response to the announcement
The core sectors of the acquirer and the target
Distressed acquisitions outside the acquirers’ core sector are marginally more successful than acquisitions within the same sector. Because of overconfidence, buyers making acquisitions in their own sector are more likely to overpay
Distressed M&A Scenario - Success Factors
Source: The Boston Consulting Group, 2009. Be Daring When Others are fearful: Seizing M&A Opportunities While They Last
9
Timing
Given the diminishing value of a business under distress, the timing of the sale is crucial to preserve the shareholder value
Valuation expectation gap
Seller expectations vs. Buyer offering
Alignment of shareholders – control of equity
Access to capital
Debt market
Refinancing
Equity markets
Public to private transactions
Debt/equity trading during the period
When companies enter a period of financial distress, the original holders often sell the debt or equity securities of the issuer to a new set of buyers: hedge funds, brokerage firms, mutual funds, private equity firms, and specialized debt funds
Investors in distressed securities often try to influence the process by which the issuer restructures its debt, narrows its focus, or implements a plan to turn around its operations
Selling shares vs. Selling business and assets
Managing cash flow / liquidity
Sell Side - Corporate: Acting for Shareholders
10
Key issues
Enhanced value compared to insolvency outcome
Deal structuring:
Debt and/or equity
Pre packs: the assets of a company are sold immediately after it has entered administration, therefore all of the group’s trading subsidiaries will continue to trade with no interruption to their businesses.
Managing “out of the money” creditors / shareholders
Monitoring cash flow and bank exposure
Relative security and tactics for hold out
Perspectives Bank / Secured lender Distressed investor / Creditor committee
Sell Side - The Creditor Perspective
11
Acquisition Strategies
Asset vs. equity purchase: usually buyers prefer asset purchase because it protects them form contingent liabilities and may allow a selection of the assets the acquirers are interested in
Loan-to-own: the investor acquires debt securities in the hopes of emerging from a corporate restructuring in control of the company's equity
Event driven: exploit pricing inefficiencies that may occur before or after the bankruptcy event
Valuation
Valuation of distressed companies is less defined than in normal transactions. Market based methods such as Comps and Compaq are often less relevant, especially where value creation will depend on the turnaround plan
A more reliable valuation is offered by the use of multiple approaches, e.g.: a combination of post closing earnings or free cash flow, valuation of possible synergies and tangible asset backing
Other relevant analysis to be performed include: assessment of the level of distress and impact on enterprise value; funding the turnaround; value-break analysis
Due Diligence focus
Sustainable earnings (and impact of distress)
Pre and post deal cash flows
Post deal funding requirement
Normalized working capital
Identifying debt and debt-like items
Impact of insolvency
Downside risk protection
Buy Side - Key Issues
Legal Issues to Consider
12
Directors’ responsibilities
Fraudulent trading: the company has carried on business with intent to defraud creditors
Wrongful trading: unlike fraudulent trading, wrongful trading needs no finding of “intent to defraud”. In such case, directors have continued to trade a company past the point when they knew that there was no reasonable prospect of avoiding insolvent liquidation and they did not take every step to minimizing the potential loss to the creditors
Risk of challenges to transaction
Transactions at undervalue
Preferences in buyer selection
Risk to asset values arising from contractual rights / obligations
Insolvency legislation
Case Studies: Safilo
13
The Safilo Group is second-largest worldwide manufacturer of eyewear products. Founded in 1934 in Italy by G.Tabacchi
established itself as a major player. In 1987 Safilo was listed on the Milan Stock Exchange. In 2001, through a LBO, the Tabacchi
family delisted the company and re-listed it in 2005
The financial difficulties originate in the 2001 LBO that resulted in a significant financial burden that was not improved by the
2005 IPO (which, however, raised €314m). Moreover, the increased level of competition, wrong strategic decisions, poor
execution and the economic crises resulted in a mounting level of debt against a weakening financial and business performance
and therefore quasi bankruptcy
This situation lasted for one year (since H2 2008), until the intervention of HAL Holding, a diversified Dutch holding company
with investments also in the optical retail business. In March 2010, the capital increase of Safilo led to the entry of HAL as the
new reference shareholder. At the end-2009 HAL had a NAV in excess of €5.4bn and a market cap of €5bn. The €220m
investment in Safilo was relatively small.
Currently (August 2015) HAL is the controlling shareholder of the Safilo Group owning 42.2% of the share capital
Rescue Plan
Recapitalization plan aimed at strengthening the Group capital structure
HAL acquired 50.99% of Senior Notes
Safilo sold its non core retail activities to HAL
The lending banks approved the senior debt restructuring plan
HAL subscribed a reserved capital increase in Safilo and guaranteed €250m Rights Issue
New roles and strategy
New organizational framework
New board of directors and new senior management team
Focus on relevant licensed brands (13 brands renewed and one new license agreement)
Focus on Safilo brand portfolio (global positioning, product innovation and distribution, new business segments)
Case Studies: Safilo (Cont’d)
14
SAFILO GROUP SpA
(Italy) 4
OXSOL SpA
(Italy) 4
SAFILO CAPITAL
INTERNATIONAL SA
(Luxembourg) 6
SAFILO SpA
(Italy) 1
Carrera Optyl doo
(Slovenia) 1
Lenti Srl
(Italy 1)
Smith Sport Optics Srl
in Liquidazione (Italy) 3
Safilo Eyewear Industries
(Suzhou) Ltd (China) 1
Optifashion Hong Kong Ltd
(Hong Kong) 2
Tido Ti SA de CV
(Mexico) 2
Safilo Retail
(Shanghai) Co Ltd
(China) 2
Trading and Prod. Company
Royalties Company
Trading Company
Holding Company
Real Estate Company
Financial Company
Service Company
Safilo USA Inc
(New Jersey – US) 3
Safilo UK Ltd
(GB) 3
Safilo Services Llc
(New Jersey – US) 7
Safilo Realty Corp
(Delaware – US) 5
TBR Inc
(New Jersey – US) 5
Smith Sport Options
Inc (Idaho – US) 1
Solstice Marketing Corp
(New Jersey – US) 4
Solstice Mktg
Concepts Llc
(New Jersey – US) 2
QUEBEC Inc
(Canada) 4
Safilo CANADA
Inc (Canada) 3
Canam Sport
Eyewear Inc
(Canada) 3
Safilo AUSTRIA
GmbH (Austria) 3
Carrera Optyl Verbrieb
GmbH in Liquidation
(Austria) 1
Safilo INDIA Pvt Ltd
(India) 3
Safilo France Sarl
(France) 3
Safilo NEDERLAND BV
(Nederland) 3
Safilo BENELUX SA
(Belgium) 3
Safilo GmbH
(Germany) 3
Safilo NORDIC AB
(Sweden) 3
Safilo HELLAS Ottica
SA (Greece) 3
Safilo JAPAN Co Ltd
(Japan) 3
Safilo AUSTRALIA
(Pty) Ltd (Australia) 4
Safilo AUSTRALIA
Partnership (Australia) 3
Luxury Trade SA
(Luxembourg) 4
Safilo ESPANA SL
(Spain) 3
Safint BV
(Nederland) 4
Safilo PORTUGAL
Lda (Portugal) 3
Safilo SWITZERLAND
AG (Switzerland) 3
Safilo do BRASIL
Ltda (Brazil) 3
Safint EYEWEAR de
Mexico SA de CV
(Mexico) 3
OPTIFASHION SA
(Turkey) j.v. 1
Safilo FAR EAST Ltd
(Hong Kong) 3
Safilo SOUTH AFRICA
(Pty) Ltd (South Africa) 3
Safilo KOREA Ltd
(South Korea) 3
Safilo CIS Llc
(Russia) 3
Safilo HONG KONG
Ltd (Hong Kong) 3
Safilo SINGAPORE
Pte Ltd (Singapore) 3
Safint Optical
Investments Ltd
(Hong Kong) j.v. 4
Elegance
International
Holdings Ltd
(Hong Kong) j.v. 4
Safilo Optical
SDN Bhd (Malaysia) 3
Safilo Trading
(Shenzen) Co Ltd
(China) 3
Safilo Eyewear
(Shenzen) Co Ltd
(China) 3
(Treasury Shares) 9.07%
SAFILO INTERNATIONAL
BV (Nederland) 4 Safilo AMERICA Inc
(Delaware – US) 4
SAFINT Optical
UK Ltd (GB) 4
90.93%
100%
75%
100%
75.60%
100%
100%
100%
100%
60%
100%
100%
100%
100%
100%
49.70% 100% 2.5% 0.01%
99.99%
16.50%
0.02.4%
83.50%
93.976%
88.50%
99.995%
33%
100%
100%
100%
100%
100%
100%
100%
70%
100%
100%
66.30%
99%
99%
99%
99%
50%
100%
100%
100%
100%
51%
100%
51%
23.05%
100%
100%
100%
61%
100%
100%
100%
50.30%
Group Structure before HAL Takeover (FY2009)
Only 3T S.p.A.
(Tabacchi)39.893%
HAL Holding NV
2.082%
Diego Della Valle & C.
S.a.p.a.2.059%
FIL Limited
2.020%
Other Shareholders
53.946%
Shareholding Structure
Source: Company Reports
1%
1%
1%
1%
Case Studies: Safilo (Cont’d)
15
Group Structure after HAL Takeover (FY2014)
HAL Holding NV (Through
its Subsidiary Multibrands Italy B.V.),
42.2%
Only 3T S.p.A.
(Tabacchi), 9.2%
BDL , 2.6%
Oddo , 2.4%
M&G , 2.0%
Norges Bank , 1.9%
Other, 39.6%
Shareholding Structure
Source: Company Reports. Consob as of August 2015
6/Service Company
5/Real estate Company
SAFILO GROUP SpA
(Italy) 4
Safilo AUSTRALIA
(Pty) Ltd (Australia) 3
SAFILO GROUP SpA
(Italy) 4
Polaroid Eyewear BV
(Netherlands) 3
Polaroid Eyewear GmbH
(Switzerland) 3
Polaroid Eyewear AB
(Sweden) 3
Polaroid Eyewear
Holding BV (Netherlands) 4
Polaroid Eyewear Ltd
(GB) 1, 3 Carrera Optyl doo
(Slovenia) 1, 3
Lenti Srl
(Italy) 1
Safilo Eyewear Industries
(Suzhou) Ltd (China) 1
Treasury Shares 4.799%
Safilo INDIA Pvt
Ltd (India) 3
SAFINT Optical
UK Ltd (GB) 4
Safilo USA Inc
(New Jersey - US) 3
Safilo UK Ltd
(GB) 3
Safilo Services Llc
(New Jersey - US) 6
Safilo Realty Corp
(Delaware - US) 5
Smith Sport Optics
Inc (Idaho - US) 1, 3
Solstice
Marketing Corp
(New Jersey - US) 4
Solstice Mktg
Concepts Llc
(New Jersey - US) 2
QUEBEC Inc
(Canada) 4
Safilo CANADA
Inc (Canada) 3
Canam Sport
Eyewear Inc
(Canada) 3
Safilo ESPANA SLU
(Spain) 3
Safilo AUSTRIA
GmbH (Austria) 3 Safilo HONG KONG
Ltd (Hong Kong) 3
Carrera Optyl
Vertrieb GmbH in
Liquidation (Austria) 1
Safilo SOUTH
AFRICA (Pty) Ltd
(South Africa) 3
OPTIFASHION SA
(Turkey) j.v. 1
Safilo NEDERLAND BV
(Netherlands) 3
Safilo BENELUX SA
(Belgium) 3
Safilo GmbH
(Germany) 3
Safilo NORDIC AB
(Sweden) 3
Safilo HELLAS Ottica
SA (Greece) 3
Safilo JAPAN Co Ltd
(Japan) 3
Safilo KOREA Ltd
(South Korea) 3
Safilo CIS Llc
(Russia) 3
Safilo PORTUGAl
Lda (Portugal) 3
Safilo SWITZERLAND
AG (Switzerland) 3
Safilo do BRASIL
Ltda (Brazil) 3
(Mexico) 3
Safilo Eyewear de
Mexico SA de CV
Safilo FRANCE Sarl
(France) 3
Optifashion Hong Kong Ltd
in Liquidation
(Hong Kong) 2
Safilo Optical
SDN Bhd (Malaysia) 3
Safilo Trading
(Shenzen) Co Ltd
(China) 3
Safilo Eyewear
(Shenzen) Co Ltd
(China) 3
SAFILO INTERNATIONAL BV
(Netherlands) 4
SAFILO SpA
(Italy) 1, 3
Safilo SINGAPORE Pte
Ltd (Singapore) 3
Safint Optical
Investments Ltd
(Hong Kong) j.v. 4
Elegance Optical
International Holdings
LTD (Hong Kong) j.v. 4
95.201%
100%
100%
75.60%
100%
100%
100%
100%
100%
100%
100%
50.38%
49.62%
99.998%
Safilo AMERICA Inc
(Delaware - US) 4
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
50%
100%
100%
100%
100%
100%
100%
100%
99.976%
100%
100%
99.9%
99%
99.9%%
99.999%
99.995%
0.1%
1%
0.1%
0.001%
0.005%
100%
90%
100%
97%
23.05%
100%
100%
100%
100%
16.50%
100%
0.024%
0.002%
83.50%
100%
Safilo MIDDLE EAST
FZT (UAE Free Zone) 3
3/Trading Company
4/Holding Company
1/Production Company
2/Retail Company
Safilo FAR EAST Ltd
(Hong Kong) 3, 4
Safint BV
(Netherlands) 4
Case Studies: Safilo (Cont’d)
16
894 900945
1,025
1,1221,190
1,148
1,0111,0801,102
1,1751,122
1,179
2002 2003 2004 2005IPO
2006 2007 2008 2009 2010HAL
2011 2012 2013 2014
172
123
147153
162175
126
66
108
123115
122 118
2002 2003 2004 2005IPO
2006 2007 2008 2009 2010HAL
2011 2012 2013 2014
13
(27)
19
3
38
51
(23)
(34)
1
28 26
3945
2002 2003 2004 2005IPO
2006 2007 2008 2009 2010HAL
2011 2012 2013 2014
799825 807
479532 515
570 588
256 238 215183 163
4.6x
6.7x5.5x
3.1x 3.3x 2.9x
4.5x
8.9x
2.4x 1.9x 1.9x 1.5x 1.4x
2002 2003 2004 2005IPO
2006 2007 2008 2009 2010HAL
2011 2012 2013 2014
Net Revenues (€m) EBITDA (€m)
Net Income (€m) Net Debt (€m) – Net Debt / EBITDA
Source: Company Reports Notes: (1) Before non-recurring Items
(1)
(1)
(1)
(1)
(1)
(1)
Case Studies: Parmalat and Risanamento
17
The Parmalat Group is an Italian milk and dairy listed company with
operations in North America, Europe and Latin America
The company traces its root back to Parmalat Finanziaria,
established in 1961. During 2003, it was charged with one of the
biggest financial frauds in the corporate history. The fraud was
estimated to be worth $8.5bn to $12bn in the form of vanished
assets from the books of the company. The extraordinary
administration proceedings preceded the bankruptcy and continued
for the period 2003-05, ending up into the composition with
creditors (basically a debt-to-equity swap part of the restructuring
plan) with which 16 companies were combined to form the new
Parmalat Group which began its operations in 2005
Parmalat S.p.A. was established as the parent company of the new
Parmalat Group. After commencing the business, the new entity
was listed on the Milan Stock Exchange in 2005
As a part of its restructuring activities, Parmalat sold some of its
subsidiaries, engaged and settled damages actions against the
management, auditors, banks and other stakeholders involved in the
fraud. Parmalat was able to recover around €2bn through lawsuits
In 2011, Parmalat, at that time a public company with floating
shareholder base and 1.5bn net cash, was acquired by Lactalis, the
French multinational dairy products corporation.
Currently (August 2015) Besnier family (Lactalis owner) owns 86%
of the share capital
Risanamento S.p.A. is an Italian listed company and one of the biggest Italian property developers, part of a large group of companies that also include foreign operations, and in charge of two important urban re-development projects in Milan
In 2009 the company experienced financial difficulties not being able to implement its major urban re-development projects. In the summer of 2009, Risanamento had about €2.8bn net debt, mostly owed to Italian banks. The company went into insolvency and, after almost two months, a debt restructuring agreement was reached with the banks (Intesa Sanpaolo, Unicredit, Banco Popolare, Bpm and Mps) that entered into the equity capital becoming majority shareholders and established a restructuring plan
The debt restructuring agreement eventually reached with the creditor banks consisted of a €500m refinancing package, involving a debt-for-equity swap, the issue of convertible bonds and fresh cash injections, against the surrender of the control of the company to the banks
In June 2013 Zunino Launched a tender offer on the 88% of shares, owned by the Italian banks ISP, Unicredit, BPM, Banco Popolare and MPS, for a consideration of €0.25ps. Once reached the threshold of 30% a mandatory tender offer will be launched on the remaining shares
Rational of the deal: To take control of Risanamento in order to retain control of its French real estate holding, presently the subject of bids from Qatar Holding and investment fund Thor Equities
The offer has not been accepted by the Italian Banks
In May 2014 the creditor banks BPM, ISP, UCG and MPS increased their ownership to 82% through conversion of bonds for a consideration of €277.1m
References
Miller, E.L.J., 2008. Mergers and Acquisitions: A Step-by-Step Legal and Practical Guide. Wiley:
chapter 7
PricewaterhouseCoopers, 2008. Distressed M&A: Beauty is in the eye of the beholder
The Boston Consulting Group, 2009. Be Daring When Others are fearful: Seizing M&A
Opportunities While They Last
Wachtell, Lipton, Rosen & Katz, 2012. Distressed Mergers And Acquisitions
18
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