Hey, was hoping some of the Wall Street oasis veterans could shed a little bit of light on some of the restructuring interview questions my friend received. Thanks in advance. (aside: this was for the Restructuring group)
What is the value of the equity if the market value of the debt is greater that the company's assets?
How would you measure a company's cost of debt if its soo distressed that it cannot issue new debt?
How would you calculate the value of a portfolio of distressed assets that dont trade and therefore have no readily available market price?
a) equity should be worth nothing, but in reality will likely have marginal value bc investors will hope that they will receive something (maybe OTM warrants) during a ch 11 filing
b) not sure really. i suppose you could look at what its current debt securities are yielding based on trading prices but dont really think this is the right way to look at it
c) i would look at whatever precedents you can and try to gauge how the assets sale (say as a % of book) when sold off in a fire sale
A. I think that you would actually have negative equity, otherwise the B/S won't balance. I've heard about negative equity situations before, but I am not very familiar with what it means in real life.
B. I also think that you should look at the yield on the company's outstanding debt. You might want to look at the yields for debt of comps.
C. Precedents work. And perhaps you could do a DCF on the specific assets.
For Part B, If the distressed company is so over leveraged, that the yield investors would require is too high, than would the cost of debt even be meaningful?
A is negative equity; I've seen it on balance sheets.
Maybe comps for the cost of debt?
A- The Book Value of Equity will be NEGATIVE however as a previous post noted, the Market Value of Equity will be POSITIVE (think lehman)
B- You can look at yield spreads for comps with the same capital structure in the same industry. If it is so distressed that it cannot issue new bonds, then that means that debt covenants are probably in place to restrict the issuance of new debt (lenders do not want to be diluted in the event of company solvency), and then you cannot measure cost of new debt until you measure the cost of breaking covenant restrictions.
C- This is the trickest part. Basically you would have to value this from the individual firm's perspective. You would have to compute the after tax shield gain from the loss on the assets (assuming MV is less than BV) and then look at comps for guidance on current MV. An example of this can be a portfolio of subprime MBS's with with a long YTM.
can someone explain to me in what situations does the book value of equity change? i thought it stayed the same at the IPO price (obvi not a finance major).
and in the case of lehman - why would people think that owning any equity would potentially yield any return? in the case of an overleveraged institution, wouldn't debt holders have seniority over any equity holders and take everything?
A. Negative equity is possible. B. I would assume if it was that distressed, you wouldn't issue debt, you'd wait for a chp 11 and then DIP Finance would be my most comparable debt piece. C. Market comps on equity and dcf for debt... Unless the company's results are so severe that it requires a waterfall calculation and the debt starts to be written down and tested for impairment (fas 157)
Bv of equity changes all the time, it is called retained earnings... If you have consistent negative net income, it will errode you book value... Also, it doesn't stay at the IPO price on the books, it is kept at par value with an additional line named "additional paid-in capital" (proper gaap accounting).
As for lehman, you hope for a govt bail out to boost the equity price... It's just hope...
there are also situations where the equity holders sue during bankruptcy (ie Solutia) due to poor management, etc. To appease the equity holders, the senior and unsec creditors may agree to provide OTM options or warrants to the equity holders.
and don't ever make that mistake in a restructuring interview...
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