When Enron Corp. put its trading operation on the block last December after filing for bankruptcy, creditors and shareholders alike held their breath. After all, the business accounted for 90 percent of the failed energy giant’s revenues (however inflated those might have been). The hope was that the proceeds from the sale would be substantial enough to satisfy a significant portion of Enron’s liabilities.
Alas, the business proved virtually worthless, as UBS Warburg paid nothing up front to Enron for it, agreeing merely to an “earn-out” arrangement under which UBS would pay Enron royalties equal to 20 percent of whatever profits it earned for the next 10 years. The structure is not surprising, given that the assets’ worth hinged on such intangibles as Enron’s now-tarnished brand name, says Stephen Wright, a finance professor at the University of London and the author of Valuing Wall Street. “The only other asset an operation like that has is its people, and, since the Civil War at least, these can’t really belong to a company.”
From a buyer’s perspective, the record-breaking number of business failures is making it necessary to at least think about bargain hunting. More than $250 billion worth of corporate assets ended up in bankruptcy proceedings last year, easily eclipsing the previous year’s record of $94.8 billion, according to Boston-based BankruptcyData.com. An untold number of businesses are currently in dire straits. However, since so much of that $250 billion was in such intangibles as brands and relationships, attaching worth to them is proving to be difficult. “On paper, the number of opportunities is clearly larger than in the [last downturn in the] early ’90s,” says Michael Petrick, managing director of Morgan Stanley. But because so few can show a reasonable return on invested capital, he says, there is “a vast amount of uncertainty [about valuations]. You’re essentially buying a platform, an opportunity to create value.”
Buying these intangibles out of bankruptcy requires an especially critical eye. “You go into the process with a cautious view because bankruptcy could tarnish a company’s intangibles,” says Lante Corp. CFO Bill Davis, who recently led his technology consulting firm’s acquisition of Luminant Corp., a competitor specializing in the energy industry. “The obvious question is, why are they in bankruptcy in the first place?” says Davis. “Then you’ve got to be mindful of whether the bankruptcy process itself creates a stability issue.”
To be sure, bankruptcy is a well-traveled route, given the opportunities it affords buyers to pick and choose among assets and to leave liabilities behind. Sales of assets from bankrupt companies neared $8 billion in 2001, nearly double the 2000 sales mark and more than a 350 percent jump from 1993 activity, according to investment bank Houlihan Lokey Howard and Zukin. However, the value of the average Chapter 11 deal last year was 17 percent lower than it was in 1993, indicating just how volatile the value of intangibles can be.
Making sure the value is for real, then, is one of the most crucial aspects of buying distressed assets. Granted, not all intangibles are as dicey as Enron’s. Consider Digimarc Corp.’s purchase of Polaroid’s photo-ID-card unit out of bankruptcy court last December for $56.5 million, a price roughly equivalent to the unit’s annual revenues. With it, Digimarc inherited long-term contracts with 37 state licensing agencies, along with numerous other customers. Plus, Digimarc gets the chance to set the security standard for ID systems.