Bankruptcy, Liquidation and Reorganization (24)
FINC 5880 SUFE Webster University
Managing Reorganizations
Failures that trigger reorganization
Economic failure: LT Revenue market value of the assets Legal bankruptcy: firm has filed for bankruptcy with the court
Dun&Bradstreet Inc.
There is a whole industry out there checking on companies’ credit worth…
The largest bankruptcies
Enron Worldcom Tyco Texaco Airlines…
The down fall of companies often tricker the downfall of some of their customers and suppliers….
Current cases of potential bankruptcy
Company Bankruptcy Date (click for more info) Pre-Bankruptcy Total Assets Filing Court Distric t
The car industry in the US The airline industry Rover…Roewe…
Worldcom, Inc.
Enron Corp.* Conseco, Inc. Texaco, Inc.
07/21/02
12/02/2001 12/18/02 04/12/1987
$103,914,000,000
$63,392,000,000 $61,392,000,000 $35,892,000,000
NY-S
NY-S IL-N NY-S
Financial Corp. of America
Global Crossing Ltd. UAL Corp. Adelphia Communicati ons Pacific Gas and Electric Co. MCorp Mirant Corporation First Executive Corp.
09/09/1988
1/28/2002
12/09/2002
$33,864,000,000
$30,185,000,000 $25,197,000,000
$21,499,000,000
CA-C
NY-S
IL-N NY-S
6/25/2002
04/06/2001 3/31/1989 7/14/2003 5/13/1991
$21,470,000,000 $20,228,000,000 $19,415,000,000 $15,193,000,000
CA-N TX-S TX-N CA-C
Gibraltar Financial Corp. Kmart Corp.
02/08/1990
$15,011,000,000
CA-C
1/22/2002
$14,600,000,000
IL-N
Who is next ?
GM Ford Daimler Chrysler North West Airlines Altria
The firm in distress; first signs
The firm can not meet its scheduled payments due to cash flow problems The firm starts to wonder if this is temporary or a more structural issue The firm starts to think if its worth more dead or alive The firm considers filing under chapter 11 protection against creditors who will chase the firm’s assets The firm starts to think of the new management that should take care of the turnaround…
Informal reorganization
Creditors work with the firm to find a solution for its problems These problems are temporarily The debtor is perceived as a good moral risk The debtor must present a reasonable plan to solve its problems General business conditions must be favourable for recovery
Informal liquidation
The firm is seen to be of more value if it liquidates The firm may still agree to partly repay its creditors Since this is not a formal procedure a lot of costs and interests are saved…to benefit the remaining creditors The debtors assets are assigned to a trustee who sells the assets in a private sale or public auction The proceeds are distributed among the creditors
Federal Laws on bankruptcy
Chapters 1,3,5,7,9, and 11 US Bankruptcy Laws Chapters 1,3,5: general provisions Chapter 7: procedures of liquidation Chapter 9: financially distressed public bodies Chapter 11: protection under law avoiding creditors to chase assets of the firm
Filing under chapter 11
The company seeks protection against creditors The company works on a reorganization plan or regulation for creditors The company has the flexibility to negotiate with its creditors and stockholders
Reorganization Bankruptcy
Informal procedures are less costly and offer most chances of quick solutions Two problems arise:
1) common pool problem: if a creditor waits for the other creditors the firm has to share between the creditors if the firm forecloses on the debtor it can get priority and hold the chance of getting all what is owed back! 2) hold out problem: only if all creditors agree on getting less then what is owed they will agree not if some will hold 100% right to their credits…
Further provisions of chapter 11
Interest and principal on delayed payments may be delayed without penalty The firm can issue Debtor In Possession financing (DIP) this is borrowing for short term liquidity purposes The firms managers get 120 days after filing to come up with a reorganization plan plus another 60 days to obtain agreement (the court may extend these dates)
Sharing the pie with creditors…
Absolute priority doctrine:
Creditors should be compensated for their claims in a rigid hierarchical order; Senior claims must be paid in full junior claims may not receive a single dime
Is the reorganization viable
Future sales to be estimated Operating conditions to be analyzed Future earnings and cash flows to be analyzed Company value to be estimated Capital structure after chapter 11 period to be determined Firm’s securities should be allocated to the various claimants in a fair manner
Measures taken
Debt maturity is lengthened New management team in control Obsolete inventories to be replaced Modernized production equipment to improve competing strength Stronger operations and marketing approach… Develop and enter new markets and products…
Pre-packaged bankruptcy
Hybrid form of bankruptcy between formal and informal workout Informal: debtor negotiates restructuring with its creditors Formal; restructuring under chapter 11 Prepack: debtor gets creditors to agree to the reorganization plan prior to the filing for bankruptcy
Time and expense
Typical bankruptcy case takes 2 years under chapter 11 until final plan is approved by all creditors In the meanwhile sales suffers Good employees leave the company In the meanwhile all other employees worry about their jobs rather then work Good bankruptcy lawyers charge 250 USD per hour; all other costs of creditors will be imposed on the firm as well… At some point parties may just want to settle some deal…to stop the bleeding.
Liquidation in bankruptcy
The company is worth more dead then alive: chapter 7 explains how to share the assets over the creditors: Secured creditors (pledged/ collateral) Legal fees Expenses incurred before trustee is appointed Wages to workers up to 3 months prior to the filing Payments for contributions to pension plans Claims for customer deposits (max $900 pp.) Taxes (federal, state ) General creditors Preferred stockholders Common stockholders
Predicting the likelihood of bankruptcy
Multiple Discriminant Analysis (MDA) Discriminant function is described as: Z= a+b1(current ratio)+b2(debt ratio) Z=z score; multiple regression based on data of the book gives; Z= -0.3877-1.0736(current ratio)+.0579(debt ratio) Discriminant analysis defines a boundary between current ratio and debt ratio defining high and low probabilities of bankruptcy The lower the Z score the less likely bankruptcy Financial Institutions use their own criteria for the value of Z
3D picture of Z score
3D Scatterplot of Z-score vs current ratio vs debt-asset ratio
2 40
20 0
Z-score 80 -2 1 3 2 current ratio
60 debt-asset ratio
Multiple regression Z score
Regression Analysis: Z-score versus current ratio, debt-asset ratio The regression equation is Z-score = - 0.388 - 1.07 current ratio + 0.0579 debt-asset ratio
Predictor Coef SE Coef T P Constant -0.387856 0.000233 -1664.66 0.000 current ratio -1.07371 0.00009 -11572.58 0.000 debt-asset ratio 0.0578922 0.0000044 13253.17 0.000 S = 0.000282689 R-Sq = 100.0% R-Sq(adj) = 100.0%
Analysis of Variance Source DF SS MS F P Regression 2 18.0043 9.0022 1.12649E+08 0.000 Residual Error 16 0.0000 0.0000 Total 18 18.0043 Source DF Seq SS current ratio 1 3.9679 debt-asset ratio 1 14.0364
Altman’s MDA
Z= 0.012X1+0.014X2+0.033X3+0.006X4+0.999X5 Where: X1=Net working capital/total assets X2=retained earnings/total assets X3= Ebit/total assets X4=market value of all shares/book value of debt X5=sales/total assets The higher the Z score the less probability of bankruptcy Altman’s model is a reasonable predictor for bankruptcy within a period of 2 years…
When using MDA
Collect your own data from the industry in question Run your model/use Altman’s predictors Test for significance and fit Define critical zone… Predict future for case on hand…
Assignment: Z-score and Altman’s MDA
Calculate the Z-score for your company Calculate Altman’s MDA Calculate similar scores for the main competitors Based on your findings which competitor is relatively most likely to go bankrupt earlier than the others…