Best Response

You're in M&A at an elite boutique (most of which have top RX practices as well) and have not a clue what a buyside distressed debt analyst does???

You analyze potential investments, duh. Depends on the exact strategy, whether distressed for control or passive, but in either case it all comes down simply to valuation. Where is the market valuing the firm? Where are you valuing the firm? If there's a disconnect, there's a way to make money. So having a good grasp of understanding business drivers and valuation is the best skill to have.

Understanding capital structure (opco/holdco, guarantors, restricted subs, etc...) is absolutely crucial in distressed. Once you value a company, you'll have to figure out where that value actually flows, and that's based on the capital structure.

Those are the two biggest components, really. You'll also spend a lot of time reading indentures and credit agreements to look for covenants, payment terms, event of default, etc...

So yeah, in short there's no such thing as a "distressed debt model." We build three-statement/operating models and use those to keep a close eye on covenant levels, liquidity and working capital. We'll layer on a DCF sometimes to get to a valuation, but generally we'll use multiples for going concern and liquidation values for downside.

 
mrb87:

You're in M&A at an elite boutique (most of which have top RX practices as well) and have not a clue what a buyside distressed debt analyst does???

You analyze potential investments, duh. Depends on the exact strategy, whether distressed for control or passive, but in either case it all comes down simply to valuation. Where is the market valuing the firm? Where are you valuing the firm? If there's a disconnect, there's a way to make money. So having a good grasp of understanding business drivers and valuation is the best skill to have.

Understanding capital structure (opco/holdco, guarantors, restricted subs, etc...) is absolutely crucial in distressed. Once you value a company, you'll have to figure out where that value actually flows, and that's based on the capital structure.

Those are the two biggest components, really. You'll also spend a lot of time reading indentures and credit agreements to look for covenants, payment terms, event of default, etc...

So yeah, in short there's no such thing as a "distressed debt model." We build three-statement/operating models and use those to keep a close eye on covenant levels, liquidity and working capital. We'll layer on a DCF sometimes to get to a valuation, but generally we'll use multiples for going concern and liquidation values for downside.

Perfect combo of hate and education.

Seconded on "no DD model". The beauty of DD is there is no model (not referring to excel here), they're all different. But dude, you need to clue up quick, the manner in which you communicate about RXing is really prosaic and uniformed.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 

Same place you'd source growth projections for a going concern. The only difference is you'd have to take into account factors associated with distress.

For example, you won't be spending much discretionary CapEx and acquisitions. You likely won't be dropping a few million to poach a top business head from a competitor to run one of your divisions. You likely won't be entering into JV's. The main consequence of this isn't that you wont have the cash outlay, its that you wont be benefiting from what these expenditures generate: revenue, growth and margin.

How does this translate to projections?

Well for one, in a competitive industry with noteable R&D spending, you'll be running a pretty lean R&D budget which will result in slimmer margins and/or reduced growth as compared to your peers spending what they want to spend.

Same goes for CapEx. Same goes for acquisitions and JV's. These are sources of growth.

If your competitors are capturing emerging market growth by LATM/Asian JV's and acquisitions, you're a bit limited in your options in that department because your creditors want their money and probably won't Okay a major acquisition in Brazil. The point for R&D can be applied to consumer products companies in the context of ad spend and marketing. You likely won't be shelling out big bucks for a celebrity spoke person or expensive new marketing campaign. You may back out of existing contracts where you're paying several hundreds of millions of dollars to sponsor a sporting venue, sporting event etc...

Distress hurts your brand and you competitiveness.

The above mentioned factors will impact your top line revenue growth (marketing, R&D, JV's, acquisitions; all sources of revenue growth). So your limited in entering new markets and your limited in gaining market share where you already have a presence. In addition to that you're likely also divesting assets which are perfectly profitable. In a distress situation, you often divest the better assets/business units, because those are the only ones that someone is willing to pay for. So you're losing top line growth on the front end and the back end.

They will also impact your margin (reduced brand presence / pricing power, reduced ability to differentiate your product i.e. demand a premium price). Now tie EBITDA back to the asset divestitures mentioned above. You likely expanded/acquired these businesses/assets because they facilitated economies of scale, increased pricing power, etc... now that you're divesting them, you're losing all the benefit that justified their acquisition/expansion in the first place. Thats goes to squeeze your margins.

We haven't even touched the expense of being in bankruptcy. That’s going to hit your bottom line pretty hard. You've got lawyer, advisors, consultants, accountants, trustees, possibly examiners, etc… they all need to be paid. Possible DIP financing and associated costs (not cheap).

So in sum, you forecast as if the company is a solvent going concern then you account for all of the above factors.

 

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