You probably have heard from a number of armchair quarterbacks that a distressed company belongs to the creditors. So why don’t you just hand them the keys and move on?
Someone Needs to Drive the Train
First, we would advise that life is rarely so simple. One constant across a sea of distressed restructurings is that the various constituencies of a company will have differing views as to values and related parameters. After all, each is myopically focused on its own recoveries – or from the employees’ vantage point, the preservation of the enterprise and their jobs.
Left to their own devices, these groups may squabble as long as they can. And if one group manages to tilt the scales so they are getting more than they are entitled to, a Bankruptcy Court can make everyone go back to Square One and begin the allocation process anew. Meanwhile, the company may suffer as it languishes in insolvency. In order to prevent these ill-advised delays (after all, the company wants to put the crisis behind it as soon as it can), the debtor at least needs to take the lead in driving a process and that results in either the necessary compromises, cram-down implementation or other appropriate mechanism. Let’s call this the “Train Conductor” role. And the Board and management need to fill it.
Values Can Be Subjective and Transient
If the subjective determination of value (i.e., some expert’s opinion) is based upon where the company is today – perhaps after an operational disaster – it may be unsurprising that Old Equity and other junior constituencies are deemed to be “out of the money”. But not that long ago, Old Equity may have had significant value in the stock market. And if management’s plans come to fruition, Old Equity may be in the chips again. To freeze Old Equity out at this low point may be unfair. After all, through the Board it elected, Old Equity has both “control value” over the restructuring process and “option value”.
Even if there is a more objective determination of value (such as an auction of the assets in a Bankruptcy sale), the process may also be skewed against an Old Equity recovery. Because the operational turnaround may be still in the future, a buyer may not give the company sufficient credit for prospects not yet realized. Under such circumstances, Old Equity would be better off waiting for a potential recovery down the road vs. getting zero today. That is the essence of why we say that Old Equity has “option value”.
The tension between Old Equity and other constituencies can become even more pronounced when there is significant equity concentration – so that a major Board-level voice in the restructuring has a meaningful economic stake in the outcome. We at Gordian Group heartily embrace the concept of meaningful Old Equity recoveries in restructurings. Creditors do not readily cede value to Old Equity. But Gordian has developed numerous “carrot and stick” strategies to deliver the goods for Old Equity.