Investment Banking

Chapter 6: Corporate Restructuring

Thach H. Pham (PhD)1

February 4, 2024

1
thach.ph@ou.edu.vn
Thach H. Pham (PhD) Investment Banking February 4, 2024 0 / 30
Outline

1 Financial Distress

2 Debt Restructuring

3 Stock Break-Ups
Key Concepts & Skills

Asset restructuring
Debt restructuring

Thach H. Pham (PhD) Investment Banking February 4, 2024 2 / 30

Topic

1 Financial Distress

2 Debt Restructuring

3 Stock Break-Ups
A Road Map

Distress is that the firm is unable to meet its obligations.

A situation of distress might be due to operating problems
(economic distress) or to excessive leverage and/or inappro-
priate mix of debt (financial distress)

Thach H. Pham (PhD) Investment Banking February 4, 2024 4 / 30

Classification

Private workout: an out-of-Court informal procedure

Bankruptcy: formal legal procedure
Liquidation: the assets are sold and the proceeds are used to
payback creditors according to the absolute priority rule (APR)
Restructuring: the firm is sold to a bidder who will take care of
its obligations

Thach H. Pham (PhD) Investment Banking February 4, 2024 5 / 30

Workout vs. Bankruptcy

Workouts are generally less expensive

Bankruptcy is in general longer than private workouts, because
no decision is subject to Court approval
Bankruptcy process results in higher direct and indirect costs
If the parties are unable to agree on how to split the cost
savings, then a trial may still be necessary
Moreover, a formal bankruptcy procedure might have some
advantages (simplified voting rules)

Thach H. Pham (PhD) Investment Banking February 4, 2024 6 / 30

Topic

1 Financial Distress

2 Debt Restructuring

3 Stock Break-Ups
The Holdout Problem

Claiments might not approve the restructuring plan

The likelihood of approval of the restructuring plan: the number
and sophistication of the claimants, the relative cost of the plan
relative to other solutions, etc.

Thach H. Pham (PhD) Investment Banking February 4, 2024 8 / 30

Examples

Thach H. Pham (PhD) Investment Banking February 4, 2024 9 / 30

Private and Public Debt

Private debt (borrowing) is much easier to restructure in

financial distress than public debt (issuing)
Banks are generally limited in their stockholdings in
non-financial firms, with a remarkable exception in case of
financial distress (in many jurisdictions)
Consideration when a bank decide to take an equity position in a
financially distressed firm:
the cost of restructuring relative to liquidation
the amount of public debt and the bondholders willingness to
restructure their claims

Thach H. Pham (PhD) Investment Banking February 4, 2024 10 / 30

A Model of Distress Resolution

Thach H. Pham (PhD) Investment Banking February 4, 2024 11 / 30

A Model of Distress Resolution (contd.)

Payoff under Different Projects

under-investment problem: the firm is liquidated even if keeping

it on business would generate more value

Thach H. Pham (PhD) Investment Banking February 4, 2024 12 / 30

A Model of Distress Resolution (contd.)

Equity Kicker
Convertible bonds or warrants
Creditors are offered: 60% of the equity payoff (CF - debt)

Creditors Shareholders
Safe project €100 €0
Risky project (Equity Kicker) €114 €36
€0 €0

Thach H. Pham (PhD) Investment Banking February 4, 2024 13 / 30

A Model of Distress Resolution (contd.)

Inefficient Risky Project

DB < K
DB = €30
DP = €90
K = €80
M = €100
Will the bank accept the restructuring?

Thach H. Pham (PhD) Investment Banking February 4, 2024 14 / 30

A Model of Distress Resolution (contd.)

DB > K (DP is scaled down)

DB = €90
DP = €30
K = €80
M = €100
Will the bank accept the restructuring?

Thach H. Pham (PhD) Investment Banking February 4, 2024 15 / 30

A Model of Distress Resolution (contd.)

DB > K (K is small)
DB = €90
DP = €30
K = €60
M = €100
Will the bank accept the restructuring?

Thach H. Pham (PhD) Investment Banking February 4, 2024 16 / 30

A Model of Distress Resolution (contd.)

DB > K (Larger fraction of bank debt)

DB = €110
DP = €10
K = €80
M = €100
Will the bank accept the restructuring?

Thach H. Pham (PhD) Investment Banking February 4, 2024 17 / 30

A Model of Distress Resolution (contd.)

Generalization
If DB < K
The bank will accept equity only if

M − DP > DB ↔ M > D
If DB > K
The bank will accept equity only if

M − DP > K ↔ M > K + DP

Thach H. Pham (PhD) Investment Banking February 4, 2024 18 / 30

The Role of Investment Banks

Manage Exchange Offers

Complex situations:
High leverage
Many long-terms contracts
The fraction of public debt increases

Mitigate the Holdout Problem

Certify the value of securities offered

Thach H. Pham (PhD) Investment Banking February 4, 2024 19 / 30

Topic

1 Financial Distress

2 Debt Restructuring

3 Stock Break-Ups
Definitions

Ownership restructuring
Create a new class of stock
Equity carve outs (ECOs), spin-offs, split-offs, tracking stocks

Thach H. Pham (PhD) Investment Banking February 4, 2024 21 / 30

The Initial Structure

Thach H. Pham (PhD) Investment Banking February 4, 2024 22 / 30

Equity carve out (ECO)

Thach H. Pham (PhD) Investment Banking February 4, 2024 23 / 30

Spin-Off

Thach H. Pham (PhD) Investment Banking February 4, 2024 24 / 30

Split-Off

Thach H. Pham (PhD) Investment Banking February 4, 2024 25 / 30

Tracking Stocks

Thach H. Pham (PhD) Investment Banking February 4, 2024 26 / 30

Economic Rationale

Information
Disclose additional relevant information both the parent and
sudidiaries at the time of the restructuring
Increase in the quantity and quality of analysts following the firm

Governance
Provide better managerial incentives: stock option plans
Elimate inefficiencies:
resource allocations
within-group transactions
bureaucracy

Thach H. Pham (PhD) Investment Banking February 4, 2024 27 / 30

Diversification Discount

Bottom-Up Approach
The difference between actual market value of the firm and the
“sum of the parts” value

Thach H. Pham (PhD) Investment Banking February 4, 2024 28 / 30

Diversification Discount (contd.)

An Example
The average EV/EBITDA multiple in the food & beverage
industry is 10x, while the average EV/EBITDA multiple in the
health-care industry is 20x.

What is hidden value?

Thach H. Pham (PhD) Investment Banking February 4, 2024 29 / 30

Diversification Discount (contd.)

Top-Down Approach
Subtracting the estimated Pharma EV from the conglomerate
market EV

Thach H. Pham (PhD) Investment Banking February 4, 2024 30 / 30