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?
Wow as an associate 2 you have a lot of work to do
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.
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).
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
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.
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
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.
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