Houlihan Tough Restructuring Question
Hey I got asked these questions by HL during a restructuring interview .
- When does the firm actually call on restructuring bankers?
I said when it’s going to be missing an upcoming interest payment or will be breaching its covenant. He said no but didn’t clarify? What else can there be?
- Firm has a ebitda of 50 and is trading at 4x EV / EBITDA. It has term of 150 and sub debt of 150. What are they trading at? What is the current market cap for the firm?
I said term is trading at 100 (since it gets paid off fully) and the sub at 33 to par. Both are obviously correct. I couldn’t figure out the market cap. It obviously won’t be negative. It has to be somewhere closer to 0. To determine this, the interviewer floated some kind of call option being the floor price at which equity would trade. I didn’t get this concept. Can someone pls clarify to me what was he referring to?
is this London?
first question you are missing maturity wall (and implied refi risk) and liquidity issues. if it’s only covenant they can waive it using a debt advisor or doing it on their own
God HL always ask that equity question.
equity value is not 0 because it could recover later on. so you value it using option theory. it’s like a call where the strike price is the net debt (equity value only exist if the EV is at least superior to net debt)
USA but I don’t want to disclose location. So, - on the first question, by maturity and liquidity, you mean they’ve got a full or partial payment coming up and they don’t have enough cash for that? And they can’t obtain financing to pay it off?
Wow as an associate 2 you have a lot of work to do
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Firms typically don't "call on" restructuring bankers. Junior restructuring bankers spend a large part of their day identifying worrisome industry and company-specific trends, including performance of cap table analysis. Once distressed targets have been identified, senior restructuring bankers reach out to the executives and/or board members of the distressed target with the intent of soliciting advisory business.
Lol yes I agree but how is this relevant to my question?
So what the senior bankers do all day is find new business?
Dude the guy gave a precise answer which I couldn’t figure out. If you’re so smart, why don’t you tell me? Bloody prospect
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Thx for your value add
Can someone knowledgeable respond pl?
I'll take a crack at the second question although I do believe Amics provided an adequate answer.
EV = $200 ($50 x 4) EV = net debt + market cap (simplified formula)
$200 = $150 (term) + $150 (sub) + market cap
Because market cap is theoretically capped at a value of $0, we can determine that the term is trading at 100 and that the sub is trading a bit below 33 depending on the market's view of the equity option. The equity option is a gamble that the company can create economic value in the future.
$200 = $150 ($150 x 100) + $45 ($150 x .30) + $5 (illustrative example of call option).
If you don’t mind answering this, why is the sub assumed to be trading at 30%?
Can you please explain how you’re calculating the 200? What do those numbers in the equation represent and why did you choose them? Thank you
You def must be an MBA associate lol
I'm trying to sharpen my technicals and just broadening my knowledge- understood all the EV/Market cap calculations- glad I had same approach and the clarity of explanation is clear.
Two questions:
How do we know the sub is trading around 33?
What is the $5 in the call option showing
Sorry if these seem simple questions but I wouldn't know where to even look for these- any other resources would be useful.
Phoenix, let me attempt to clarify. Let's establish a floor. Assume the company is private and bankrupt. An enterprise value of $200 will imply that the entire enterprise value is tied to the value of debt. Equity is $0. We know that the most senior tranche of debt, the $150 in term loan, sits atop the capital structure and is entitled to full recovery. Under these assumptions, and assuming basic algebra, we can infer that the second tranche of debt is then trading at $50, which is the difference between an enterprise value of $200 and the $150 of term loan value.
Now, assume that this same company is actually public and traded on an exchange. From here, we know that the price of a stock is never $0.00, but the enterprise value of the company is still $200. Something must adjust, mathematically, to balance the basic enterprise value calculation that enterprise value equates to net debt + market capitalization. In this instance, it must be the subordinate debt, which implies that it'll trade at a steeper discount to adjust for a positive market capitalization. The $5 referenced above was meant to be illustrative from a mathematical point-of-view.
A positive, albeit small, market capitalization aligns with fundamental financial theory that equity ownership is essentially a call option on the future financial performance of the firm as equity shareholders share in the upside of future economic performance similar to the holder of a traditional call option.
We can determine that the term is trading at 100
That's an over-simplification. The market tends to add a "risk premium" in these situations as even if you are eventually going to get your principal back, you might get extended / rolled into a new facility / primed.
How is the question on market cap supposed to be an easy question?? Id be surprised if many answer this correctly
WTF....I learned how to answer that last question during my undergraduate finance program.
you call an RX sometimes years in advance when the biz is struggling and you know leverage will be something to address. sometimes mgt doesn’t do this and you identify those companies and pitch
your answer makes sense (assuming no cash). equity is virtually 0. it may be slightly over zero molting some low probability event the company survives and the equity investor make a bugle multiple on invested capital
Debt is $100 more than enterprise value. What happens to that extra value with equity value being 0?
great question.
let’s say you lend me $300, then I file bankruptcy. the judge and lawyers confirm I now only have $200 (assuming no lien on my future earnings blah).
how am I going to pay you? you lost money on your investment.
It's all there, black and white, clear as crystal! You bumped into the ceiling which now has to be washed and sterilized, so you get nothing! You lose! Good day sir!
Not that this will be helpful to answering your specific question, but these overly academic questions/answers are just absurd.
OP if I was interviewing you those would have been fine answers, maybe I would have prodded a little more on the first question but definitely wouldn't have just said 'no'. The call option/academic approach is just complete theoretical BS - if you put that in a Board book or even just showed your MD it would end up with a massive 'x' through it on the markup
Uhhhh....where do I even begin? Lmao
The call option/academic approach is not complete theoretical BS...it's literally real life. Anyone who's ever spent time looking at distressed credits will encounter this. It's not even like a rare thing. Every single time a publicly traded company is in distress....this "call option" BS takes precedence. Literally you're part of the cohort of people that would think it's an amazing strategy to short the stub equity on all these pre-BK companies and get blown out. You're selling call options man. Think about it this way so a 5th grader could understand it...if there's even a 1% chance that the equity ends up in the money by the time the debt matures and the company ACTUALLY FILES (due to EBITDA/valuation growth or whatever the fuck)....then should the stock be worth zero? Maybe in M&A groups that big 'ol 0 would fly in Board Books but hell in an RX group if you were so naive as to think market cap is just zero because it happens to be underwater at that moment in time....you're sure as shit not getting the mandate from the company.
In your HF world, great you need an approach to valuing these stocks. I work at an EB and I work on restructurings, I'm well aware the stock is not just straight $0 and never said it was. My whole point was that OP in his response to the interviewer said it would be close to $0 (which it would be) and explained the dynamics around the TL and sub would trade. I personally think that would have been an acceptable answer and making him do some call option math is excessive - agree to disagree.
I personally have never seen a restructuring presentation, court filing, etc. actually put the call option math on paper for their clients/counterparties to review but I haven't seen it all so who knows. If it is common and it is something bankers are commonly calculating as part of their day-to-day/presentations then I'll gladly admit I'm wrong.
Do they ask SA this type of shit?
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For sure. Candidates are often asked to calculate YTW, YTC and YTM in their head with various figures and scenarios thrown their way.
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Jesus,,, If you applied to Evercore someone like you wouldn't even get a phone interview LMFAO
don’t be a dick....he’s an Associate in M&A doing equities all day
lol cfa level 1 "charterholder" You are not a charterholder of anything
incoming charterholder
r/woosh ?
Yeah agree. Those questions are really easy to understand. I am not sure where the confusion comes from.
There is no way associate level interviews at HL Rx are asking these questions as "tough" questions smh
they wouldn’t plan to. it could happen if the VP or MD was very busy and forgot about the interview and poofed up a basic question to test technicals
Yeah these are pretty straightforward questions. He is lucky that he got asked these questions. As far as the last question goes, I learned how to answer that one during my undergraduate years.
lol
I just skimmed Moyer. I couldn’t find anything on my second question. Can someone point the chapter to me? Thanks.
Chapter 3 covers the basic content. He doesn't necessarily talk about equity trading as a call option though, but it intuitively makes sense
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