Ian H.

Giddy/NYU

Distress Valuation-1

Distress Valuation
Prof. Ian Giddy
New York University

Whats Marvel worth? Whos winning? Whos losing?

Ian H. Giddy/NYU

Distress Valuation-2

When Default Threatens, Value the Company

Highest Valuation of Company?

Merged Value

Going Concern Value

Liquidation Value

Sale to Strategic Buyer

Auction

Voluntary Reorganization Ch 11 Reorganization

Voluntary Liquidation

Ch 7

Existing Management New Management

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Corporate Financial Restructuring 3

Example of Valuation: Zombie, Inc.

Zombie, Inc Share Valuation Shares Book Value Acquisition Value Management Est. NPV, based on EBITDA WACC Growth Debt Going Concern Value Option value? Bank lenders Debt (at market) Equity (NPV value) Total
Copyright 2003 Ian H. Giddy

$ $ $

Before 400,000 10.00 $ 8.00 20.00 $

After 850,000 10.00 9.41

1,100,000 1,100,000 17.48% 11.22% 2.5% 2.5% 10,100,000 5,600,000 $ (6.43) $ 8.62

Before 7,182,749 0 7,182,749

After 4,500,000 3,876,905 8,376,905

Corporate Financial Restructuring 4

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Distress Valuation-3

Valuation in Distress Restructuring

q Liquidation

value q Acquisition price q Enterprise value

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Corporate Financial Restructuring 6

Enterprise Valuation in Distress Restructuring

q Multiples q FCFF q APV q Capital

discounted at WACC

Cash Flows q Option Value

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Corporate Financial Restructuring 7

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Distress Valuation-4

Multiples in Distress
Allied Industries Multiples: Enterprise Value Industry (D+E)/EBIT Allied EBIT Allied est. Enterprise Value 12.9 32 412.8

Do Dothese thesemake makesense? sense?

Source: morningstar .com

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Corporate Financial Restructuring 8

Free Cash Flows to the Firm @ WACC

Historical financial results Adjust for nonrecurring aspects Gauge future growth Projected sales and operating profits after tax Adjust for noncash items

Projected free cash flows to the firm (FCFF)

Year 1 FCFF

Year 2 FCFF

Year 3 FCFF

Year 4 FCFF

Terminal year FCFF Stable growth model or P/E comparable

Discount to present using weighted average cost of capital (WACC) Present value of free cash flows
Copyright 2003 Ian H. Giddy

+ cash, securities & excess assets

- Market value of debt

Value of shareholders equity

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Distress Valuation-5

Free Cash Flows to the Firm @ WACC

Allied Industries FCFF@WACC: Enterprise Value EBIT EBIT after tax @34% Adjustments FCFF Terminal Value NOL tax shield Debt WACC PV Enterprise value 1 32 21.1 -2.1 2.7 300 10.0% 0.5 638.7 2 34.4 22.7 -9.3 3.4 302 10.0% -4.9 3 87.9 58.0 39 21.9 311 9.9% 45.9 4 90.3 59.6 36.8 19.6 272 10.5% 37.9 5 163.2 107.7 68.7 876.6953 0 235 11.1% 559.2

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Corporate Financial Restructuring 10

Capital Cash Flow Method

Use NPV approach q Project cash flows based on:
q
u Net

income: (R-C-D-I)*(1-t) u + Loss tax shield: NOL*t u +Cash Flow Adjustments: D-CE-WC+Asset sales u +I

Find terminal value based on CF(1+g)/(r-g) q Discount at unlevered WACC, ie cost of equity with Beta: u
q

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Corporate Financial Restructuring 11

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Distress Valuation-6

Capital Cash Flow Method

Allied Industries Capital Cash Flow Enterprise Value EBIT Tax at 34% after NOLs EBIAT Adjustments FCFF Terminal Value Ra PV Enterprise value 1 32 0 32.0 -10.0 22.0 12.0% 19.6 711.3 2 34.4 0 34.4 -19.2 15.2 12.0% 12.1 3 87.9 0 87.9 -25.5 62.4 12.0% 44.4 4 90.3 4.2 86.1 -29.0 57.1 12.0% 36.3 5 163.2 50 113.2 -28.4 84.8 970.5 12.0% 598.8

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Corporate Financial Restructuring 12

Option Value

For For some, some, The The riskier riskier the the better! better!

Mean

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Corporate Financial Restructuring 13

Ian H. Giddy/NYU

Distress Valuation-7

Common Stock as a Call Option

q

The equity in a firm is a residual claim, i.e., equity holders lay claim to all cashflows left over after other financial claim-holders (debt, preferred stock etc.) have been satisfied. If a firm is liquidated, the same principle applies, with equity investors receiving whatever is left over in the firm after all outstanding debts and other financial claims are paid off. The principle of limited liability, however, protects equity investors in publicly traded firms if the value of the firm is less than the value of the outstanding debt, and they cannot lose more than their investment in the firm.
Corporate Financial Restructuring 14

Copyright 2003 Ian H. Giddy

Payoffs to Shareholders on Liquidation

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Corporate Financial Restructuring 15

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Distress Valuation-8

Option Pricing Model

ENTER THESE DATA: ================= -> FUTURES PRICE -> STRIKE PRICE -> TIME IN DAYS -> INTEREST RATE -> STD DEVIATION
1.8 1.6 CALL PRICE IS......... 1.4 PUT PRICE IS....... CALL OPTION PRICE 1.2 1 0.8 0.6 0.4 0.2 0 93 93 94 94 95 FUTURES PRICE 95 96 96

94.75 94.5 300 7 15

0.40 0.17

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Corporate Financial Restructuring 16

Black-Scholes Option Valuation Co = So N(d1) - Xe-rTN(d2) d1 = [ln(So/X) + (r + 2/2)T] / ( T1/2) d2 = d1 - ( T1/2) where
Co = Current call option value. So = Current stock price N(d) = probability that a random draw from a normal dist. will be less than d.

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Corporate Financial Restructuring 17

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Distress Valuation-9

Marvels Option Value, Nov. 96

Option Value
When When Marvels Marvels stock stock price priceis isbelow below$9.18, $9.18, Perelmans Perelmansinvestment investment in inthe theHolding Holding Companies Companiesis is worthless worthlesson ona a liquidation liquidationbasis, basis,but but still stillhas hasoption optionvalue. value. Breakeven Breakevenstock stockprice price =Debt value/No. of =Debt value/No. ofcollateral collateralshares shares Debt Debt value=Mkt value=Mktprice*face price*face value value (Ex (Ex 6) 6) Collateral shares=77.3m Collateral shares=77.3m =$709.5/77.3 =$709.5/77.3 =$9.18 =$9.18
nn nn

Breakeven stock price

Nov 96 stock price

Copyright 2003 Ian H. Giddy

$4.63 $9.18

Marvel Ent. Price

Corporate Financial Restructuring 18

The Conflict Between Bondholders and Stockholders

q

Stockholders and bondholders have different objective functions, and this can lead to conflicts between the two.
u For instance, stockholders have an incentive to take riskier

projects than bondholders do, and to pay more out in dividends than bondholders would like them to.
q

Since equity is a call option on the value of the firm, an increase in the variance in the firm value, other things remaining equal, will lead to an increase in the value of equity .
u It is therefore conceivable that stockholders can take risky

projects with negative net present values, which while making them better off, may make the bondholders and the firm less valuable.

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Corporate Financial Restructuring 19

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Distress Valuation-10

Vulture Investors
q

These funds typically buy large blocks of debt (often across different seniority classes) in distressed firms in order to gain a seat at the bargaining table. As the term vulture implies, these investors have been viewed as bondmailers who seek only to delay and disrupt reorganizations in order to extract concessions from debtors. But by consolidating large blocks of debt, vulture investors facilitate restructurings by reducing the number of claimholders and aligning incentives across seniority classes. 3 largest players: Trust Company of the West, Fidelity Management and Research, and Apollo Investors.

Example: Example:Trust TrustCompany Companyof ofthe theWest Westplayed playedaacrucial crucialrole rolein infacilitating facilitating the theprepackaged prepackagedbankruptcy bankruptcyof ofKinder-Care Kinder-CareLearning LearningCenters Centersby bybuying buying up most of that firms bank debt and subordinated debentures. up most of that firms bank debt and subordinated debentures. Copyright 2003 Ian H. Giddy

Corporate Financial Restructuring 20

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Distress Valuation-11

Marvel
q q

1. Why did Marvel file for Chapter 11? Were the problems caused by bad luck, bad strategy, or bad execution? 2. Evaluate the proposed restructuring plan. Will it solve the problems that caused Marvel to file for Chapter 11? As Carl Icahn, the largest unsecured debtholder, would you vote for the proposed restructuring plan? Why or why not? 3. How much is Marvel's equity worth per share under the proposed restructuring plan, assuming it acquires Toy Biz as planned? What is your assessment of the pro forma financial projections and liquidation assumptions? 4. Will there be a "contagion effect," making it difficult for Marvel or other companies in the Perelman group to issue debt in the future?

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Corporate Financial Restructuring 22

Source of Problem?
q Bad

luck? q Bad strategy? Diversified youth entertainment company q Bad execution?

uOverpaying

for acquisitions uCOGS 50% 65%, SG&A 1928%

q Bad

finance?

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Corporate Financial Restructuring 23

Ian H. Giddy/NYU

Distress Valuation-12

Bad Finance?

Financing Ratios Debt/Capital D/(D+E) 73.60% 62.90% 61.30% 73.80% 78.40% Interest Coverage EBITDA/Interest 10.1X 10.4X 8.2X 8.oX 1.2X 1.4X

Year Total Debt 1991 1992 236.3 1993 250.2 1994 384.3 1995 586.5 1996Q3 654.5

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Corporate Financial Restructuring 24

Marvel Structure
Marvel Group Shareholders Perelman 100% Holding Company Bondholders Icahn 25%

78.8%

Public shareholders 18.8%

Marvel Entertainment

Creditors

26.7% Toy Biz

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Corporate Financial Restructuring 25

Ian H. Giddy/NYU

Distress Valuation-13

Perelman Proposal
q Buy

427m new shares for $365m @ $0.85 q Pay Marvel creditors in full q Acquire 100% of Toy Biz to use NOLs q Bondholders get 15% of shares (77.3m)

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Corporate Financial Restructuring 26

Marvel

Banks
n

Secured and senior Get fully repaid under plan Choices: n Accept Perelmans plan n Sell the debt at $.14-$.17 n Reject plan and propose own Controls Marvel equity NPV is negative Option value may be positive

Icahn et al.

Perelman

n n

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Corporate Financial Restructuring 27

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Distress Valuation-14

Perelmans Strategy
q Has

control for 120 days (under Ch 11) q Holds an out-of-the-money call option q He can credibly destroy bond debt value q Hence can extract rents from bondlholders

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Corporate Financial Restructuring 28

Decision Time
q

q q

Evaluate the proposed restructuring plan. Will it solve the problems that caused Marvel to file for Chapter 11? What is the company worth? As Carl Icahn, the largest unsecured debtholder, would you vote for the proposed restructuring plan? Why or why not? What other options does Perelman have?

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Corporate Financial Restructuring 29

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Distress Valuation-15

Decision Time

Perelman Perelman Shareholder Shareholder Group Group

Icahn Icahn Bondholder Bondholder Group Group

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Corporate Financial Restructuring 30

What Happened
Feb 26 judge lets bondholders seize their collateral q Perelman withdraws his plan q Icahn & bondholders propose own plan to change management, q Divest Sky Box and Panini & forgive $385 debt q Issue rights offering for working capital, pay off DIP, pay most of bank debt q Increased value of shares, est. $0.85 to est $2+
q

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Corporate Financial Restructuring 31

Ian H. Giddy/NYU

Distress Valuation-16

Marvel Stock Price

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Corporate Financial Restructuring 32

Marvel Zero-Coupon Bond Price

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Corporate Financial Restructuring 33

Ian H. Giddy/NYU

Distress Valuation-17

Update

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Corporate Financial Restructuring 34

Alphatec
What really caused Alphatec's collapse? q What was the January 1999 rehabilitation proposal? q What, specifically, is the "performance-linked obligation?" q Does the January 1999 Rehabilitation Plan meet investors expectations? Look at it from the point of view of:
q
u Existing u New

creditors equity investors u A possible management buyout

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Corporate Financial Restructuring 35

Ian H. Giddy/NYU

Distress Valuation-18

Contact Info
Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org

Copyright 2003 Ian H. Giddy

Corporate Financial Restructuring 39