Out from Under

Deeply discounted corporate debt may tempt companies to buy it back or exchange it, but such deals are far from easy.

What’s Rational?

Now would seem like a good time for such deals, with bond and loan prices in the secondary markets exceedingly low — 60 to 70 cents on the dollar, and even cheaper for some issuers.

 ”The rational man would conclude that distressed-debt exchanges are an intelligent thing because they may prevent the need for going into a bankruptcy process and losing control of the enterprise,” says Trenwith’s Manning.

But in many cases, he adds, the rational man would be wrong, for two reasons. First, a wide variety of investors with conflicting agendas may hold the paper, adding friction to the deal. The trustee of a collateralized debt obligation, for example, often does not have the ability to negotiate a debt or redeem a bond for anything less than par. Other investors may be holding the debt in the hopes of owning the company after the equity gets wiped out. On the other hand, “if you can fit every one of your debtholders into a conference room,” Manning says, “an exchange is more likely to work.”

Second, investors are likely to be skeptical about the state of the company’s finances. Bondholders are going to think long and hard before entering any deal, says Christopher Meyer, a partner at Squire, Sanders & Dempsey. An analysis of the company’s financial situation is central to the decision. Creditors may be convinced the company is headed into a bankruptcy, where they have more rights and remedies. (The only thing many debt exchanges accomplish is delaying a Chapter 11 filing by a few months.) Or they may believe the company can shoulder more debt than it admits. “The debtholders have to be persuaded that such a transaction is necessary for the company’s survival,” Meyer says.

There are many ways for CFOs to compel investors to tender their bonds, however. In a distressed exchange, a company could issue new instruments with interest rates that increase over time, giving bondholders more income and the company the incentive to retire the debt early; financial sponsors could promise to kick in more equity ahead of the exchange or buyback, giving a vote of confidence; or, if the existing debt is “covenant lite,” a new instrument that affords creditors some protection if the issuer’s finances worsen could prove attractive, Meyer says.

And then there are the more forceful methods at a CFO’s disposal. Harrah’s Entertainment’s debt exchange last December stated that holders of old notes who didn’t tender their debt would be subordinate to the new, second-priority notes in a bankruptcy.

In this market, though, the best bait is cash, as Metaldyne discovered. “Many of our individual investors needed the liquidity,” says CFO Iwasaki. “There weren’t a lot of buyers of auto debt at the time.” Metaldyne did a lot of other things right. Asahi Tec, Metaldyne’s parent company, provided an equity injection in conjunction with RJH International, its largest shareholder, for example. Prior to the buyback offer, Metaldyne also withheld an interest payment to bondholders, proving the severity of the situation. And, in the actual buyback agreement, Metaldyne retained the right to file for a prepackaged bankruptcy if less than 67 percent of the bonds were tendered. The filing would have forced recalcitrant debtholders to take the deal. That provision was key, Iwasaki says, and most investors wanted it.

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