Undergrads, hopefully you can appreciate this topic. Let’s start with a fundamental understanding of corporate capital structures and work towards my question. Consider a fairly vanilla capital structure consisting of $700MM Sr. Debt, $300MM of Sub Debt, and $1Bn of market cap. Our $2Bn company takes a turn for the worse, and Sr. Debt holders aren’t too worried because they know that a fire sale of their assets would yield at least $800MM even in the darkest of days.
What happens, in the real world, to our sub debt and equity holders?
Everyone knows the textbook answer, that sub debt ranks above equity in a resale scenario, but somehow public companies who go through difficult restructurings often haircut and sweet talk bond holders into repayment below par, leaving some equity still on the table. What is actually the norm in the market place? In the scenario above would we really expect market cap to fall to $0 before a dollar of sub debt is shed?
Market cap rarely goes to $0 due to the call option, transaction costs and nuisance value of holding equity.
And to answer the main question: depends on the lenders. In 2009 lots of LBOs claimed "liquidity crises" asked banks to rollover, some did, others didn't. if you have distressed funds wanting the business, they're going to want their equity now. but in a large public company, few funds are going to be big enough to do loan to own, and many of the lenders will be relationship banks who haven't syndicated the debt and so are not wanting to rock the boat (ie, they'll take the haircut). The new equity (remember, unless the business is sold to a newco, the old equity will still be there, the debt that gets converted into equity will just issue a shit load of new equity resulting in the existing equity’s % being small ) will go to lenders and to management to keep their skin in the game, and with the rump left to the incumbent (especially if they injected some more equity).
In addition, few lenders are sophisticated enough to think other than “i want my principle back and will not take a hair cut unless someone shoves it down my throat. They’ll grow out of this, interest costs aren’t killing this company that bad” They’ll more likely A&E for a while and hope the market turns. Also due to it being public they’ll have more varied access to capital, hence have a greater ability to refi out of the issue rather than restructure.
[quote=Oreos]Market cap rarely goes to $0 due to the call option, transaction costs and nuisance value of holding equity.
In addition, few lenders are sophisticated enough to think other than “i want my principle back and will not take a hair cut unless someone shoves it down my throat. They’ll grow out of this, interest costs aren’t killing this company that bad”
I will definatley agree with this statement. Being a young credit risk analyst out ot Texas, when things go south the first question is always how do we get out principle back, and how much interest can we charge down.
I've never quite understood it, but I'm usually told that "I have a lot more to learn"
Anyone have any empirical evidence who would like to quantify. In the example I have above, how far does market cap drop? Are we talking 5% of original value? 25%? What kind of haircuts are banks taking? Also what if we're talking bond debt and the holders are money hungry hedge funds and pension funds? Are they taking haircuts?
Senior debt holders are not necessarily the first bros to get paid. There are oodles of scenarios where junior debt holders get paid first. It all depends on whether or not a subisdiary structure exists and where the assets are actually held. It's a little something the really crafty bros like to call structural subordination.
Yeah, you bros are so sick and twisted. Us Americans are just simple folk, proponents of what I like to call 'barnyard finance'. Capital structure is one bond and maybe a sliver of common shares as a sort of garnish.
there will be a day when international non-guarantor subs are the bane of your existence...and you will hate those crafty bros who thought up the structure.
also, equity often gets OTM warrants in comprehensive restructurings
An upstream guarantee is sort of like an umbilical cord. Except the difference is that the parent is actually dependent on the child since all the food and nutrients flow the other way! And who said shifty finance bros aren't creative. I guess the similiarity though is that if you cut it off the wrong way then blood gushes out and splatters all over the place.
One of the things you should learn is how to spell definitely.
OP - in the real world, there are real people with very different real things at stake. Our CEO used to say the right answer in a restructuring is probably the one that pisses everyone off just a little bit, but everyone is equally pissed. Each deal will vary dramatically in terms of who got into the various investments when, who needs to please whom, which funds are involved and what they need to do to not piss off their investment committees, etc. Firms do keep some empirics (probably what Oreos was citing) but only as a rough guideline - equity tip studies, management incentive plan studies, etc. to see what a generally acceptable exception to absolute priority is, but these are rough guidelines at best and any good restructuring banker will rely primarily on the stakeholder dynamics and unique peculiarities of a situation to drive recoveries, not some empirical study. Finance is messy, esp in restructuring. And that makes it fun.
Non maiores et quidem temporibus ut quas laboriosam. Suscipit id aut et cum magnam expedita. Sequi expedita repudiandae debitis dicta.
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