Hi!
Was asked the following question during my IB SA interview at a regional office of one of the top BBs (GS/JPM/MS):
Company A has a MCap of $50m, bonds of $300m and bank debt of $700m (needless to say, you assume the company is basically bankrupt). As the bond investor, what would you argue the value of the company is? How about if you are the bank debt investor?
Curious to see how you guys would approach this question!
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700 if you are bank and 1000 if you are bond. Each one will argue for a valuation that ensures at least their stake is covered by the valuation and whatever the surplus remains, they get to hold a larger share of it (ie fulcrum Equity)
Why is it 300 for the bank? Won't they argue 700 to cover 100% back on their investment? I understand the bond argument.
Well think about it. There’s still a huge risk that the company won’t recover post reorg so each party is going to argue for a number that at least ensures they get a full recovery. The pie is fixed here so your gain is someone else’s loss. Any potential upside, you get to keep all of it but you don’t know if that will materialize. Valuation is hotly contested. Maybe the senior will give some leeway to bond holders in terms of valuation to buy in their support. Maybe if the bond holder represent a significant part of the pre petition capital base (which they do in your example), they’ll actually have more negotiating leverage and will be able to more successfully argue for a higher price in front of the judge. Hope that helps
Sorry I actually meant to write 700. That 300 was a typo
Can you explain why its 700 for the bank and 1000 for the bondholders?
Greater than 700 if you are a bondholder and less than 700 is you are a bank debt investor.
I am not too familiar with distressed debt, but can you explain the reasoning behind this?
is bank debt always paid before the loan? how did you figure out the seniority
Yes it’s understood unless there is structural subordination which can be overcome with having the subsidiary as restricted or getting a super guarantee from the parent
not always. sometimes they’re pari. it all depends on the seniority. bank debt is almost always senior secured and at the opco. bonds can be also but can vary widely in their security status and structural subordination. I’ve never seen bank debt be unsecured or have a 2L while a bond has a 1L but theoretically there could be a case of that happening. it’s not enough to just assume bank debt is always senior, you have to know WHY in 90% of cases the bank debt is senior
Concur with 700 for bank and 1000 for bond. However, it is not exactly clear to me as to why would valuation be contested by the parties? Couldn't they just agree on a higher number which would be a win-win for both parties involved?
Could someone elaborate as to what exactly happens in this case? Why does valuation matter so much? Is it because the debt is converted into equity in a reorg?
DUDE DID YOU NOT READ ABOVE? IT's A BANKRUPT CO. HOW THE HELL DO YOU KNOW WHAT WILL HAPPEN AND IF IT WILL SUCEED POST BANKRUPTCY SO YOU WANT TO KEEP MOST OF THE PIE FOR YOURSELF
My follow up question would have been are the bonds senior? It's an interesting question because they usually give you a little more description of the bond/loan.
To me it seems like the interviewer left the question open ended to determine what kinds of questions you would ask, and your thought process behind walking through the valuation.
Agree with above, however clearly dependent on the subordination of the bondholders (almost always subordinate to bank debt).
In an event of bankruptcy, the rationale investor will argue the value of the entity is greater than the claims on the business senior to them (such that they receive value for their investment/claim).
In this example, the bondholders (either secured 2L or unsecured) are assumed to be structurally subordinate to bank debt (secured 1L) and therefore will argue the entity value is >$700m (preferably $1bn to cover 100% of their investment).
Both would likely lend directly to the OpCo (desirable as closest to the operational CFs).
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