Distressed Debt / Restructuring Question: Asset Sale to buyback bonds trading below par effects
Hi All,
Had a quick question regarding below scenario -
Assume a firm has $50 in EBITDA, $500 in notes publicly trading at 40. This implies leverage at face value is 10x and leverage at market value is 4x.
Now, say the firm sells an asset that contributed $20 to EBITDA for $200 (10x sale multiple).
My question is: Say the firm uses the proceeds to buyback the publicly trading notes and they remain trading at 40, does this mean the firm can buyback $500 worth of notes ($200 / 40%) and therefore retire / extinguish the debt?
Thanks in advance.
yes in an ideal world. basic idea on DDA page 202
is this for an rx superday lol
I’ve also been going through the Moyer book and am learning this myself so if anyone has more in-depth knowledge / works in the industry then please please add your two cents as well.
My understanding is that they can choose to enact an open-market repurchase in which they buy back the shares at a discount. Theoretically, if they could do this discreetly, then yes they could retire all $500 of the debt at their market value of 200. If the market somehow found out that they were doing repurchases of the bonds, however, then the price of the bonds might increase which would prevent them from retiring all the debt.
My follow-up questions to OP or anyone else following the thread would be:
A) In what circumstances would a distressed firm be forced to retire bonds (not bank debt) at face as opposed to market value when they can simply repurchase them in market for less than face?
B) Apart from an increase in the demand for bonds as a result of buybacks, are there any other factors that would cause the market prices of these discounted bonds to increase if the market found out the debtor was conducting open-market repurchases?
.
I'll take a start, but will leave to the RX pros to give more thoughts
a) Put provisions under a change of control for one (100 / 101) - not sure how this plays out under a distressed scenario (esp for in-court processes)
b) Plenty - liquidity in the market, ceteris paribus. Other players who think the bonds lie in the value fulcrum. Equity / liquidity injections to increase the cushion. Maybe somehow you get more collateral through a repricing event.
Thinking critically here, I think the assumption that the bonds will continue trading at 40 is flawed. First, why are they trading so low? Probably because a company can't meet some upcoming payment and hence probability of default is high. Second, what happens to that assumption after the sale of the company's most profitable division? The capital infusion probably extends the cash runway of the company, and I imagine it is now a lot more likely to meet the interest / amort payment it would have defaulted on otherwise. Hence, the price of the bonds should appreciate. You can now no longer conduct this maneuver.
Do you think if there was another tranche of longer-term debt (suppose it was subordinated debt) that was not going to be retired with the proceeds of the asset sale, that the sale of a profitable division could cause that tranche of debt to either increase in price due to the elimination of senior debt or decrease in price due to the increased risk factor of the company given the sale of a profitable division? Practically speaking, which would be more likely?
Let me preface this by saying I work in credit origination, not RX. However, some food for thought:
First, why would you retire senior debt over subordinated debt? Usually you're paying a lot more interest on your subordinated, and since it's junior it'll be trading cheaper too so you can buy back more. I guess in extreme cases – i.e. you have a major bullet payment due on your senior – that might make sense, but then you start the game of chicken with investors the other posters talked about. They know you can't. meet your payment and your only way out is to buy out all the bonds, so as soon as they catch wind that's what you're doing the price will shoot up.
Second, what's the legality of this? Are there restrictions on asset sales in the docs? Is there an equivalent of a prepayment penalty for buying back the bonds? (edit: didn't think about the legality of retiring subordinated debt first. not sure what the precedent is for secret open market repurchases, but I can't imagine senior lenders will like that)
Third, I feel (again, not an RX person) it can go either way, depending on tenor, interest coverage, amort timing, etc. Gun to my head? I think the price will increase since you're now top dog.
Anyone with more knowledge: please correct me if my reasoning is off.
I think the answer to this could be mathematically derived given the situation and not have to be left to general probability. For example, if division to be sold contributes $20 EBITDA toward the firm's hypothetical $50 EBITDA is sold for $100 and the capital structure before sale is as follows: Cash = 0, Senior Secured Term Loan = $100, Subordinated Notes = $100; before the sale, the subordinated notes stand at 4 turns of EBITDA (whereas senior secured loan stands at 2 turns). Pro forma sale of division and assuming all proceeds are used to retire term loan, the Subordinated Notes stand at 3.33 turns of EBITDA. Therefore, this would be a deleveraging deal and the notes are more likely to be recovered (price would go up).
However, if all else equal above, if the asset contributed $40 in EBITDA instead of $20, pro forma sale the subordinated notes would stand at 10x leverage at face value (price would go down).
To address a point brought up elsewhere, you may have to retire senior debt prior to handling subordinated claims if maturity wall is approaching for term loan and refinancing capital is unavailable.
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