Question regarding debt structuring
Hey guys, I have to work on a university presentation for a club where I'm diving into the financials of a certain company and its debt obligations in specific.
Essentially, from 2019 to 2020, a fall in assets and an increase in liabilities has destroyed the company's equity. In addition, it is in a segment EXTREMELY sensitive to Covid-19. Secured Debt has been increasing precipitously while the assets the debt is backed by have decreased. A lot of a decrease in assets was due to goodwill impairment I assume based off the financials, but even if I look at current assets + PPE, the increase has been very marginal. For every dollar Current Assets + PPE went up by, secured debt has increased by $4.30.
Now, I'm very new to this, so this might not sound very intelligent, but is this a strong cause for concern for debt investors? I'd assume that if my debt is being secured by increasingly less assets, I'd demand a greater yield to compensate myself for the risk. In a situation like this, would it be wise for the company to try to issue shares to pay off some of the debt instead of continuously refinancing like they're doing now? I understand that junk bond yields are very low right now, making refi very attractive, but wouldn't the company be risking hitting its maturity wall at a time 5 years later when yields are back up? What other things can be done regarding a situation like that?
Once again, thanks guys, I'm a freshman so please don't be too hard on this :)
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Cap markets are roaring atm.
Instead of refi they could do: - Rights issue: cash injection with no immediate impact on existing shareholders and fast transaction execution if stake is small relative to market cap. - Cornerstone investor: One and only investor who understands the business and is confident about growth prospects. Often operationally knowledgeable. - Accelerated bookbuilding: fast process with targeted investors - Asset sales: Simple stuff, sell non-core asset to raise cash - Classic follow-on: Runs the risk of getting seriously beaten down by the market without a high conviction equity story and strong growth prospects.
In this situation, if they go for an equity solution, market signalling and transaction execution is paramount. Regardless, they will need to accompany the above with other measures which will reassure investors they will wisely use proceeds, a turnaround plan is there and that proceeds are enough to execute it.
If things get worse, a debt to equity swap is another solution.
Bump
A company financed by 100% debt is essentially financed by 100% equity. The higher the debt/equity ratio, the higher the risk for creditors, the higher the yield they need to get compensated for the risk of bankrupcty. They don't have an "equity airbag" anymore.
Consider a company A with 100$ equity and 400$ debt vs. a company B with 300$ equity and 200$ debt. If the company goes into insolvency and can e.g. only pay out 50% of its investors, company A can pay out 250$ to its creditors and 150$ don't get anything, because there is little equity left. In company B all creditors would have been paid out.
Yeah, this is usually the idea I've always rolled with - the benefits of debt are only present as long as there is some sort of subordination present
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