Reasons To Relapse
Gathering historical clues about relapses is difficult, because much about bankruptcy has changed since the last Chapter 11 boom, when 125 companies filed between 1990 and 1993. In particular, the average number of days a company spends under bankruptcy protection has decreased from 741 in 1990 to 367 in 2002, due in large part to the rise of prepackaged or prenegotiated cases, according to LoPucki’s Bankruptcy Research Database. In addition, more companies are opting to sell off their major assets within the protection of Chapter 11, and then dissolve.
What hasn’t changed, however, is the major warning signal for a relapse; namely, too much debt. Former bondholders tend to press for too much debt, experts say, because they stand a better chance of recouping their losses with notes than with new equity. But steep interest payments or a rapid amortization schedule can hamstring efforts to rebuild operations. In the end, debt “may be the straw that breaks the camel’s back, especially if your projections are too rosy, or you were expecting the economy to rebound in the fourth quarter last year,” says New Jerseybased bankruptcy attorney Richard Tilton.
Not only can debt siphon funds away from growth, it may be an obstacle to obtaining additional capital. That was the case at Pittsford, New Yorkbased Mpower Communications Corp., a local telephone and Internet service provider that came out of bankruptcy with 10 percent of its original $650 million debt load last July. “We got through the bankruptcy quickly, but emerged with a plan that was still in need of cash,” says CFO Gregg Clevenger. Potential investors balked, though, at $51 million in secured debt due in October 2004.
“They were saying, if you need $35 million to $50 million to fund the business and you have $50 million coming due in 18 months, what I’m really doing is giving you money to pay your debt,” recalls Clevenger. Mpower was finally able to buy the 2004 noteholders out at a discount and sell assets for cash to fund the repurchase, a process that was completed nearly nine months after its Chapter 11 exit.
Unfortunately, even bondholders that take equity tend not to be model investors. “When you emerge and have creditors who have taken stock in lieu of debt, they don’t behave like normal investors,” says Carter Pate, U.S. managing partner at PricewaterhouseCoopers. “Instead of thinking of capital appreciation, they’re looking at capital retrieval.”
Motient Corp. CEO Walt Purnell agrees. His Reston, Virginia-based wireless company exited Chapter 11 last year with only 6 percent of its former debt and a revenue stream that had started to increase. When Motient’s growth prospects were slowed by the subsequent bankruptcies of two of its top resellers, Purnell turned to his new investor group, which is largely composed of former bondholders.
“Bondholders tend to be pretty conservative people; they hammer you all the time to cut costs because they always think something terrible is going to happen,” says Purnell. He was able to win another $12.5 million credit facility from the group, announced in January, but only at the price of deep internal cuts, including a 29 percent workforce reduction.