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Why Distressed Debt Is the Greatest Thing Since Sliced Bread

Wharton 3/27/2013

Staying Power
In 20 years, what is most likely to be around?
Facebook? Google? Bankruptcy?

Why Do Companies File?


Companies file for bankruptcy for three reasons:
They have run out of liquidity They will soon run out of liquidity They will eventually run out of liquidity

Distressed Debt Analysis = A Puzzle


Analysis of bankruptcies is really a study of three things
Rational Actors Assessment Sources of Value Value Leakages

Despite the complexity, you are working with MORE perfect information in distressed
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A Very Hard Puzzle


If it was easy, everyone would do it:
Voluminous documentation (credit agreements, indentures, plans, SOFAs, etc.) Org charts and capital structures (who has first right to what) Guarantees, security, pledges, etc.

While everyone is focused on exit multiples, spend time looking for opportunities and pitfalls of value creation
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Rational Actors Assessment *


Analysis of bankruptcies is also study of people and their motives:
Maxim #1: People, especially management teams, want to get rich Maxim #2: The bankruptcy code grants significant power to management teams * Peter Lupoff, Founder of Tiburon Capital Management and my former boss coined the
phrase

Overseas Shipping Group (OSG)


Global leader in energy transportation Crude, U.S. flag operations Filed for BK in November 2012 What are analysts focused on?
Exit multiple U.S. flag divestiture Tax claim

Holdco Debtor: Overseas Shipholding Group, Inc.


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Quick Detour: SOFAs


Statement of Financial Affairs Schedule of Assets and Liabilities for a single Debtor on a non-consolidated basis
Real property/assets Creditors holding secured claims Creditors holding unsecured claims Executory contracts / leases

Overseas Shipping Group


Between 2/26/2013 and 2/27/2013 OSG filed docket items 553-922 (Over 350 items): All SOFAs and Schedules of Assets/Liabilities

Corporate Structure

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Capital Structure Consideration


Bonds structurally subordinated to bank facilities for any value at subsidiaries Bonds essentially pari with bank debt for all value at holdco (cash, JV equity)

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Bond Pricing

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Overseas ST Holding LLC


Subsidiary of OSG Bulk Ships, Inc. (OBS) Assets: ~$340M
$96M Interco Receivable $245M of Vessels

Liabilities: ~$160M

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Overseas ST Holding LLC Liabilities


Listed in the $160M of liabilities at Overseas ST Holding LLC was a very curious entry:

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Interco Liability = Asset for Holdco


Creditors of OSG ST Holding LLC should recover par (huge overcollaterization) Therefore, Overseas Shipholding Group, Inc. creditors just recovered an extra ~$115M

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Conclusion
The more complicated the case, the more opportunities to uncover:
Hidden gems of value Hidden sources of value destruction / leakage

More importantly, the more complicated the case, the less likely analysts are looking at it, especially in smaller situations -> Alpha.
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