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How To Value A Company Undergoing Debt Restructuring

By Spodek Law Group | February 20, 2024

How To Value A Company Undergoing Debt Restructuring

Valuing a company that is undergoing debt restructuring can be challenging. Debt restructuring is when a company attempts to renegotiate its debts with creditors in order to make the debt more manageable. This usually happens when a company is struggling financially and at risk of defaulting on its debt obligations.

Assess the Company’s Financial Health

The first step is to thoroughly analyze the company’s financial statements to understand what led it to the point of needing to restructure its debt. Look at trends over the past several years for key metrics like revenue, profit margins, cash flow, and debt levels. This will give insight into the company’s overall financial health and viability of its business model.

Some key questions to ask:

  • Is revenue growing or declining? Declining revenue over several years likely means problems with the company’s products or changes in market demand.
  • Are profit margins stable or getting squeezed? Slim or worsening margins indicate issues with costs and ability to maintain profits.
  • Is operating cash flow positive or negative? The trend here signals the company’s ability to fund itself.
  • How much debt does the company have relative to assets and equity? High debt levels constrain options for servicing debt obligations.

Understand the Restructuring Plan

Next, review the details of the proposed debt restructuring plan. This will spell out the changes to debt agreements the company is seeking from lenders and bondholders.

Typical elements of a restructuring include:

  • Term extensions – Pushing back maturity dates on debt to allow more time for repayment
  • Interest rate reductions – Lowering interest expenses to free up cash flow
  • Principal reductions – Creditors taking a “haircut” and agreeing to lower the total amount owed
  • Debt-for-equity swaps – Canceling debt in exchange for ownership stakes

Assess the likelihood of the plan being accepted as proposed based on incentives for creditors. Also consider worst case scenarios like Chapter 11 bankruptcy if the restructuring fails.

Project Future Cash Flows

With an understanding of the financial history and proposed restructuring, develop projections for future cash flows over the next 5+ years. This is key for valuation.

Build projections starting from recent financial figures and layering on assumptions about:

  • Revenue growth rates
  • Profit margin trends
  • Capital expenditure needs
  • Changes in working capital
  • Debt service requirements per restructuring plan

Be conservative in projections given past financial difficulties. Run various scenarios to sensitivity test key drivers.

Choose a Valuation Method

Common valuation methods include:

  • Discounted cash flow (DCF) – Forecasts future free cash flows and discounts them to present value at an appropriate rate based on riskiness. Most applicable for distressed companies.
  • Comparable company analysis – Benchmarks valuation metrics like EV/EBITDA against similar public companies. Challenging for distressed situations lacking peers.
  • Precedent transaction analysis – Looks at valuation multiples paid in prior M&A deals of distressed companies. Requires access to deal terms and may have limited transactions.

DCF is typically the preferred approach since it directly uses projected future cash flows. Pick an appropriate discount rate higher than normal to reflect financial distress risk.

Make Adjustments

Additional considerations when valuing a financially troubled company:

  • Account for costs of restructuring – Factor in expenses for legal and professional fees related to negotiations with creditors and executing the restructuring plan. These can be substantial.
  • Risk of failure – Assign probability of not completing the proposed restructuring or needing further restructuring in future. Apply haircuts or probability weighting to valuation accordingly.
  • Lack of buyer competition – Expect lower valuation multiples than healthy companies due to fewer willing and able buyers.
  • Limited access to capital – It may be years before the company regains access to debt and equity markets for funding after restructuring.

After making adjustments, the valuation likely implies substantial losses for current shareholders if company previously had a high market value. This reflects new reality after financial problems surfaced.

Recap Key Value Drivers

Critical assumptions that can make or break the valuation of a distressed company:

  • Revenue growth – Projections for volume and pricing recovery
  • Profit margins – Ability to cut costs and return to profitability
  • Debt service – Interest savings and cash flow relief from restructuring
  • Credit risk – Perceived likelihood of default post-restructuring

Sensitivities around these drivers should be explored in scenario analysis.

In summary, valuing companies in the midst of debt restructuring requires digging into financials, projecting performance given proposed changes to debt obligations, and heavily risk-adjusting traditional valuation methods. Keep focus on the cash flows available for debt service and equity shareholders in the years ahead.

Resources

For more on valuing distressed companies, check out these additional materials:

I hope this gives a helpful framework for thinking through how to value companies that have entered financial distress and debt restructuring. Let me know if any questions!

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