introduction to distressed investing · communications and has served on several creditors...

Introduction to Distressed Investing

Shelly Lombard

Shelly Lombard Copyright 2018 www.linkedin.com/in/shellylombard/

1


Shelly Lombard is a consultant with 30 years of experience analyzing and investing in high yield and distressed debt and special situation equities.

After earning her MBA in Finance from Columbia University, she joined the leveraged finance group at Citibank. Shelly was the first analyst selected to work on the RJR Nabisco management buyout, which at that time was the largest LBO in history. Later, she joined the high yield group at Drexel Burnham Lambert, the firm that essentially created the new issue market for junk bonds, in particular the use of junk bonds to finance LBO and hostile take overs.

Shelly spent the next 25 years working on both the buy side and the sell side. She helped start the bank debt trading desk at Chase and ran a prop trading desk at Barclays Capital. She was involved in many high profile bankruptcies, including Tyco, Adelphia, and Charter Communications and has served on several creditors committees. From 2003 to 2010, she worked as a high yield analyst, covering the automotive industry. During the 2007-2009 downturn and the General Motors bankruptcy, Shelly was one of the most quoted analysts on Wall Street and often appeared in the New York Times, Wall Street Journal, and on CNBC.

Shelly is currently an independent consultant who does financial and credit analysis for individual clients as well as financial training. She has taught financial modeling, valuation, credit analysis, and capital markets theory to analysts at top investment banks and hedge funds. She is a lecturer in the graduate business executive education programs at the University of North Carolina-Chapel Hill, Columbia

Shelly Lombard Copyright 2018 www.linkedin.com/in/shellylombard/ 2


What went wrong? Can it be fixed?


Does management have enough time to fix it?

What are the company’s bonds & equity worth?

What price should I pay for the stock or bonds?

Developing an

InvestmentThesis


Read 10K & 10Q: business description, MD&A


Listen to earnings calls.

Analysts’ reports e.g. Seeking Alpha

Review financial statements.

Developing an

InvestmentThesis



Revenue

Industry wide?

Companyspecific?

Costs

Industry wide?

Company specific?

Cyclical Secular

Operating

Cyclical

Operating

Secular



6

• High oil & gas prices driving synthetic rubber prices higher & miles driven lower.Goodyear

• Problems scaling up to build more carsTesla

• 2nd largest radio station operator in US• Advertisers now have many more optionsCumulus



Costs

Industry wide?

Cyclical

Rubber prices up but able pass on price increases because:

• Industry-wide• Inelastic demand• No substitution risk from

outside of industry



Revenue

Industry wide?

Cyclical

Miles driven down so slower replacement.

Offset lower volume by getting customers to pay higher price for new products that are safer.



What Went Wrong? Can It Be Fixed?

Cyclical Management will usually acknowledge When will it end?

And can they offset the impact of lower revenue or higher costs until cycle turns?

Operating Not always obvious. Management may not acknowledge.

Can THIS management team fix the problem?

Secular Not always obvious. Management often in denial.

Will it end?

May not be “fixable”. If there has been a change in customer preferences or ability to substitute, company may not longer have a reason to exist.


Two Keys to “Can it be fixed?”

•Management execution•Reason to exist


10







Developing an

InvestmentThesis


Run out of cash


Can’t refinance an upcoming maturity

Nervous trade creditors require COD.

Banks will not waive covenant violations.

Why Companies

GoBankrupt



13

Teslain 000’s

Fiscal Year Ended

12/31/2017

Fiscal Year Ended

12/31/2016

Fiscal Year Ended

12/31/2015

Revenue $11,578.751 $7,000,132 $4,046,025

Cost of Revenue 9,536,264 5,400,875 3,122,522

Gross Margin 2,222,487 1,599,257 923,503

Selling, General & Admin 1,378,073 834,408 717,900

Research & Development 2,476,500 1,432,189 922,232

Loss from Operations or EBIT (1,632,086) (667,340) (716,629)


Shelly Lombard Copyright 2018 www.linkedin.com/in/shellylombard/14

Teslain 000’s

Fiscal Year Ended

12/31/2017

Fiscal Year Ended

12/31/2016

Fiscal Year Ended

12/31/2015

Loss from Operations or EBIT (1,632,086) (667,340) (716,629)

Depreciation & Amort 1,636,003 947,099 422,590

Stock Compensation 466,760 334,225 197,999

Nonrecurring ChargesNon-Cash Charges 131,665 65,520 44,940

Cash Charges

Adjusted EBITDA $602,342 $679,504 ($51,100)



EBITDA orAdjusted EBITDA

Useful for valuation

NOT a proxy for cash flow NOT sufficient

for financial analysis



EBITDA & ratios that use EBITDA do not capture:

Cash Taxes

Working Capital

Capital Spending

Non Recurring Cash Expenses

Pension Contributions


Shelly Lombard copyright 2018 https://www.linkedin.com/in/shellylombard/

17

EBITDA

Cash from Operations

Free Cash Flow



18

Teslain 000’s

FY Ended 12/31/2017

FY Ended 12/31/2016

FY Ended 12/31/2015

Net Loss ($2,240,578) ($773,046) ($888,663)

Depreciation & Amortization & Stock Comp

2,102,763 1,281,324 620,589

Non-Cash Interest Expense 226,274 79,511 98,436

Non Recurring Non Cash Charges 347,490 (17,757) 138,428

Change in Working Capital (496,603) (693,861) (493,289(

Cash from Operations (60,654) (123,829) (524,499)



19

Teslain 000’s

FY Ended 12/31/2017

FY Ended 12/31/2016

FY Ended 12/31/2015

Cash from Operations (60,654) (123,829) (524,499)

Capital Expenditures (4,081,354) (1,440,471) (1,634,850)

Free Cash Flow ($4,142,008) ($1,564,300) ($2,159,349)


≥


20

PROJECTEDEBITDA

Interest ExpenseCapital Spending

Cash RestructuringWorking Capital

Cash TaxesPension Contributions



21

Tesla Liquidity @ Year End 12/31/2017

Cash $3,367,914

Unused Revolver Availability 729,929

Non-Recourse Revolver Availability 864,393

$4,964,253



Tesla in 000’s 2018 2019

Cash & Revolver Availability at Start of Period $4,964,253 $789,600

Projected EBITDA 1,375,000 3,465,000

Cash Interest Expense (225,000) (225,000)

Cash Taxes (50,000) (100,000)

Change in Working Capital (844,653) (840,000)

Capital Expenditures (4,100,000) (3,300,000)

Minor Debt Maturities (330,000) 0

Cash (Used)/Provided during the Period ($4,174,653) ($1,000,000)

Cash & Revolver Availability at End of Period $4,964,253 $789,600 ($210,400)



Tesla Debt

Total Debt $10,167,380

Debt due in 2018

2.75% Convertible Notes ($560.64 per share) $230,000

Related Party Promissory Notes due February 2018 100,000

Non-recourse Debt 157,095

Debt due in 2019

0.25% Convertible Notes ($359.87 per share) $920,000

1.625% Convertible Notes ($759.36 per share) 566,000

Non-recourse Debt 835,607







Developing an

InvestmentThesis


EBITDA Valuation

25

“Normal” EBITDA Range

Enterprise Value

Multiple


Introduction to Distressed InvestingComps Company A Company B Company C

Stock Price $xx.xx $xx.xx $xx.xx

x Diluted Shares Outstanding xxx,xxx xxx,xxx xxx,xxx

Market Value of Equity $xxx,xxx $xxx,xxx $xxx,xxx

Total Debt $xxx,xxx $xxx,xxx $xxx,xxx

Less Cash x,xxx x,xxx x,xxx

+ Net Debt $xxx,xxx $xxx,xxx $xxx,xxx

+ Preferred Stock $x,xxx $x,xxx $x,xxx

+ NonControlling Interest $x,xxx $x,xxx $x,xxx

= ENTERPRISE VALUE $xxx,xxx $xxx,xxx $xxx,xxxShelly Lombard Copyright 2018 www.linkedin.com/in/shellylombard/ 26


Comps Company A Company B Company C

ENTERPRISE VALUE $xxx,xxx $xxx,xxx $xxx,xxx

Enterprise Value/LTM Sales .xx .xx .xx

Enterprise Value/LTM EBIT X.xx X.xx X.xx

Enterprise/LTM EBITDA X.xx X.xx X.xx

copyright 2018 Shelly Lombard https://www.linkedin.com/in/shellylombard/

27


Radio Operator Comps Salem Emmis CBS Entercom

Market Value of Equity $63 $32 $8,377 $183

Net Debt 322 348 6,987 805

Enterprise Value 385 380 15,363 988

LTM EBITDA $51 $45 $1,740 $112

EV/LTM EBITDA 7.5x 8.4x 8.8x 8.8xSept 2009. From company 10Qs & 10Ks

Shelly Lombard copyright 2018 28


Comps Company A Company B Company C

ENTERPRISE VALUE $xxx,xxx $xxx,xxx $xxx,xxx

EV/Projected Sales .xx .xx .xx

EV/Projected EBIT X.xx X.xx X.xx

EV/Projected EBITDA X.xx X.xx X.xx


29


Cumulus 2016 2015 2014 2013

Revenue $1,141,400 $1,168,679 $1,263,423 $1,245,715

Adjusted EBITDA

205,867 259,145 329,526 363,357


30


CompanyDownside

CaseBaseCase

UpsideCase

Projected Normalized EBITDA

$200,000 $250,000 $290,000

Multiple 8.25 8.50 8.75

Enterprise Value $1,650,000 $2,125,000 $2,537,500



Bankruptcy Waterfall

Debtor-in-Possession Loan (DIP)

Admin and Priority Claims

Pre-Bankruptcy Secured Debt

Unsecured Senior Bonds

Unsecured Subordinated Bonds

Equity



Downside Case

Base Case

UpsideCase

Enterprise Value $1,650,000 $2,125,000 $2,537,500

Existing Bank Revolver/DIP (500,000) (500,000) (500,000)

Bank Term Loan (1,280,400) (1,280,400) (1,280,400)

Value to All Unsecured Creditors

(130,400) 344,600 757,100


33


Downside Case

Base Case

UpsideCase

Value left for Senior Unsecured Bonds (130,400) 344,600 757,100

7.75% Senior Bonds due 2023 $275,000

What are Senior Bonds Worth? 0% 100% 100%

Value left for Subordinated Bonds 0 69,600 482,100


Introduction to Distressed InvestingDownside

CaseBase Case

UpsideCase

Value left for Subordinated Bonds 0 69,600 482,100

11.5% Bonds due 2025 $335,000

What are Subordinated Bonds Worth? 0% 21% 100%

Value Remaining for Equity 0 0 147,100

# of Shares Outstanding 29.3mn

What is Stock Worth (per share)? $5.00




36

Home Worth $500,000

____________

Mortgage Debt: $400,000

Equity worth:$100,000

Value Drops to $350,000

___________

Mortgage holder entitled to: $350,000

Equity worth: $0

New Owner Finances

$350,000 with___________

New Mortgage:$300,000

New Equity:$50,000







Developing an

InvestmentThesis


A company’s distressed bonds are offered at 75.

•The bonds pay a 8% coupon and mature in 4 years. •Your liquidity analysis indicates that the company may run out of

cash in a year, leading to a restructuring. •Your valuation analysis indicates that the bonds could recover 91

cents to par after two years in bankruptcy. •What should you pay for the bonds?


38


Calculating a bond’s yield to maturity on Excel


39


Modify cash flows to incorporate the most likely scenarios.Use Excel to determine what return you will earn

if you buy bonds at 75.


Worst Case ScenarioCash flows are -75, 8, 0, 91

=IRR(cashflows)IRR = 10.3%

Best Case ScenarioCash flows are -75, 8, 0, 100

=IRR(cashflows)IRR = 13.7%

40


Use Excel to determine what you should pay for the bonds

if you want a 20% return.


41

Base Case ScenarioCash flows are 8, 0, 100

=NPV(desired return, cash flows)= NPV(.20,8,0,91)

NPV = 59.3

Upside ScenarioCash flows are 8, 0, 100

=NPV(desired return, cash flows)= NPV(.20,8,0,100)

NPV = 64.5


The company’s stock is trading at $2.00.

• If the company restructures, the stock will be worthless.•But if in two years, the company manages to increase EBITDA to

the level in your Upside Case and avoid bankruptcy, the stock could be worth $7.35


Best Case Scenario=IRR(cashflows)=IRR(-2,0,7.35)

IRR = 92%







Developing an

InvestmentThesis

introduction to distressed investing · communications and has served on several creditors...

Documents