Wednesday, February 25, 2009

How to Package a Bankruptcy

Why does a company go bankrupt? We often point to factors such as the economy, high leverage, bad management, falling asset values, or strong competition. While all of these can be contributing factors, ultimately a company will file a bankruptcy petition when it can't generate enough cash to service its operating and financial obligations - when it runs out of cash.

Does this mean a bankrupt company has no value and should be liquidated? Not at all. The purpose of Chapter 11 (and similar provisions in other countries) is to allow companies to reorganize and continue to operate. A debtor can use the bankruptcy process to improve operating cash flow by canceling burdensome contracts and leases and closing or disposing of underutilized or unprofitable assets. Just as important, however, a company can use the bankruptcy process to reorganize the liabilities and equity side of its balance sheet to reflect the new reality of its asset values and cash flow.

The Journal Register Company Faces a New Reality
The Journal Register Company publishes 20 daily newspapers and over 150 (mostly weekly) other publications. It has been hurt by the general decline in the newspaper industry, which was greatly accelerated by the recession. The company responded by cutting costs, closing money-losing operations, and selling assets. Still, its margins and cash flow have been declining since 2005.

Source: The Journal Register Company

It became clear by late-2008 that the company was insolvent. Its stock was at $0.10 and it was in default on its debt. The company received a 3-month forbearance from its lenders and hired a Chief Restructuring Officer. On February 21, 2009, the company announced it reached agreement with investors holding 77% of its debt on a restructuring, and it filed a "prepackaged" Chapter 11 petition.

How Does a Prepackaged Bankruptcy Work?
In a prepackaged bankruptcy, the debtor negotiates the key elements of a plan of reorganization before filing for bankruptcy. If all goes as planned, the bankruptcy can be completed relatively quickly; perhaps in 6 months instead of the 18-24 months typical for a large-company Chapter 11. The Journal Register's plan provides for the company to continue to operate as usual and for existing shareholders to get wiped out. The company's existing $695 million of debt will be converted into:
  • $175 million term loan A
  • $100 million term loan B (with an option for pay-in-kind interest)
  • The common stock of the reorganized company
Thus, the debt load of the company is reduced by $420 million to a level the reorganized company expects to be able to service, the company's creditors receive a combination of new debt and stock, and the old owners get nothing. While it doesn't ensure that the Journal Register can survive the secular downturn in the newspaper industry, this reorganization is how the bankruptcy process is supposed to work.


Ron Carleton said...

One reason a prepackaged bankruptcy may be possible for Journal Register is its relatively simple debt structure: one class of secured bank debt (and then some unsecured creditors who would get wiped out in the plan).

On the Money said...

Thanks for this interesting and informative article (I used too be a free debt adviser in a lawyer's office here in the UK). More advice for firms to assess their financial health and recognise the road to insolvency also seems increasingly important these days. All the best.

Good Credit said...

When companies file bankruptcy what they are saying is that their assets are insufficient to cover their debt obligations. Companies will go through every financial strategy possible before filing for Chapter 11. What is confusing is that Chapter 11 is the vehicle companies use when they hope to reorganize and continue operations, to "emerge from bankruptcy." If the company cannot generate enough capital to pay off its creditors, then it will slide down the scale to Chapter 7, complete liquidation.

Arthur said...

Pre-packs are getting some criticism in the UK because unsecured creditors often get wiped out without even knowing that the business is in trouble.