December 2020 Issue
The devastating impact of coronavirus (COVID-19) has dominated distressed M&A in 2020, with many overleveraged companies pushed over the edge and countless others across many industries brought to their knees. With governments across the globe struggling to stem the tide of a pandemic more pervasive in the fourth quarter than earlier in the year, further market disruption and sectoral declines appear inevitable throughout 2021 and beyond, adding fuel to the distressed M&A market.
FW: What are some of the key drivers of distress in today’s business world? Do any sectors or industries appear particularly susceptible?
Jones: Since March, the key driver of distress has been illiquidity. With few exceptions, businesses have been cash-starved as a result of a dramatic reduction in operating income, with limited ability outside government initiatives such as the furlough scheme to reduce their committed outgoings. At best, these liabilities have just been deferred and the damage this is doing to balance sheets will have to be addressed sooner or later. Unlike the global financial crisis, where distress was primarily driven by overlevered balance sheets as a result of falling asset prices, the burning platform for many businesses now is that they are running out of cash.
Sumner: Financial stress and distress among companies is being driven by both the obvious issues like coronavirus (COVID-19) and Brexit in the UK and Europe. The former is stifling consumer demand as consumers cannot access services and products because of local lockdown restrictions, while the latter is causing uncertainty about the shape of UK trade with Europe and the rest of the world. The market has been polarised by COVID-19. There are businesses well positioned to take advantage of new business-to-business (B2B) service demand or the online economy. However, other sectors such as the travel, entertainment and hospitality industries, have been heavily impacted due to the national lockdown earlier in the year and the restrictions currently in place. COVID-19 has also had the effect of increasing the speed of change for some of these businesses. Retail and consumer is a good example where in-store demand, which was already in decline, has been decimated and companies can no longer afford the cost of carrying a store portfolio but are stuck with significant lease costs. A record number of shops disappeared from high streets across the UK in the first half of 2020 as COVID-19 lockdowns hammered the retail sector. Our research, compiled by a local data company, revealed about 11,000 outlets shut in the first half of 2020 – twice as many as in the same period last year.
Butler: The overarching development dominating distressed M&A in 2020 is the occurrence of the global COVID-19 pandemic. Federal and local governments across the world continue to struggle with a pandemic that is more pervasive in the fourth quarter of 2020 than it was in the front-half of the year. We expect the pandemic to continue to dominate domestic and cross-border commerce deep into calendar year 2021 and is likely to materially affect industries such as tourism, hospitality, transportation and real estate for several years to come. The pandemic has created ‘haves’ and ‘have-nots’ by industry, geography and socioeconomic status. Supported by the injection of trillions of dollars by central banks globally, current capital market activities are masking the depth and severity of the economic destruction that has occurred and will continue to occur at least over the short term. Recovery from the COVID-19 impact on global markets and economic prospects is complicated by complex geopolitical risks such as Brexit, US-China trade tensions, the proliferation of bilateral and regional trade agreements and the declining influence of the World Trade Organization (WTO).
Baker: The key drivers are twofold. First, there are fundamental problems in certain industries, such as retail – due to a decline of brick and mortar – and commodities, particularly coal and oil and gas, due to oversupply, economic slowdown and, for coal, obsolescence. Second, there is the impact of the COVID-19 pandemic. The market disruption caused by the pandemic has accelerated the sectoral declines in commodities and retail, but both industries were in distress prior to COVID-19. In addition, the travel and leisure industries have been impacted. Looking forward, we would expect increased distress in commercial real estate and possibly healthcare, depending on the length of the pandemic and how governments respond.
Durrer: In the last days before the presidential election in the US, capital markets were down due to a surge in novel coronavirus infections. If that trend continues, the pandemic and consequential impacts on the capital markets will necessarily spur distress. Beyond that, susceptible sectors include senior living, recreational facilities such as fitness studios of all kinds to themed restaurants catering to children’s parties, for-profit education including continuing education and networking, and all forms of hospitality such as resorts, travel, hotels, restaurants, bars and real estate. In fact, we predict that commercial real estate will face devastating losses in 2021. Ironically, the gambling industry seems to have been spared somewhat. While the hospitality element of gambling has suffered just like non-casino hotels, online gambling – buoyed by a 2018 ruling by the US Supreme Court striking down a federal statute limiting gambling in the states – has offset pandemic losses in large measure.
Husnick: The unprecedented worldwide COVID-19 pandemic pushed many overleveraged companies over the edge and brought countless other companies across many industries to their knees. The more complex answer, however, is technology. Restructuring practices across the country remained busy through a 10-year bull run because massive advances in technology left many companies overleveraged and undercapitalised. For example, advances in fracking, horizontal drilling and other technologies related to the oil and gas industry resulted in increased production levels and decreased commodity pricing that, in turn, requires oil and gas companies to restructure. Likewise, advances in logistics technology enabled same-day or next-day delivery and left many retailers in the dust. I expect retail and oil and gas distress to continue in 2021. But I also expect to see increased distress in industries directly affected by the COVID-19 pandemic, including the commercial real estate, hospitality, gaming, automotive and travel industries.
“There is a genuine opportunity to acquire assets at below their long-term valuations. Profits are depressed and there is some uncertainty on length of recovery which naturally reduces the pricing of assets.”
FW: For distressed investors, what are the advantages – and potential disadvantages – of participating in this market?
Sumner: There is a genuine opportunity to acquire assets at below their long-term valuations. Profits are depressed and there is some uncertainty on length of recovery which naturally reduces the pricing of assets. However, this is a double-edged sword as forecasting future performance and the cash requirement of the business is highly challenging. Investors are having to build in significant headroom in their funding plans to accommodate the potential for the effects of a pandemic to last for the next 12 months. Corporates are also more rigorously assessing their portfolio of businesses and looking to exit those which are non-core or distressed to preserve the remaining group. This is providing opportunities to acquire businesses that might not have been available previously and which provide good upside potential with a focused and skilled investor behind them.
Butler: Given that disruption, dislocation and volatility generate value opportunities for value investors, many distressed investors are currently very active harvesting market opportunities and betting on their investment thesis around market trends. Distressed M&A transactions are attractive if the acquisition price is below the target’s intrinsic value and many investors have focused on proprietary pipeline channels to complete value transactions of stressed businesses. Market values often deviate from intrinsic values in the stressed business environment. The goal is to be positioned to act where there is misalignment between the two valuations while avoiding overvalued transactions which often occur in competitive auctions situations. While there is markedly more risk in the current market, there is the potential for unprecedented returns in an unpredictable market.
Baker: The advantages are that prices may be in a trough due to the COVID-19 crisis, which could provide favourable returns to distressed investors. Capital markets are robust and so acquisition financing should be available, but that could depend on the industry. As an aside, new capital in the US oil and gas industry remains relatively limited, putting a lot of stress on out-of-court solutions in that industry. There is the obvious disadvantage that market values may further decline.
Durrer: Distressed investors are asking themselves two key questions during the fourth quarter of 2020. First, when will the global economy rebound from the unprecedented impacts of the pandemic? Second, what impact will the result of the 2020 US presidential election have? While the democratic ticket is leading in most polls, such was the case in 2016 as well. The incumbent recently posted a better-than-expected performance in the final debate among the candidates. While a vocal majority of voters are urging change following November, the incumbent seems to remain an economic favourite based on the capital markets’ performance following the announcement of a national health emergency in March. If a distressed investor predicts the answers to one or both of those questions correctly, that distressed investor will reap the advantages of this distressed market.
Husnick: Bank and bond markets are very active and interest rates remain at historically low levels. As such, stressed and distressed companies generally have been able to access the credit markets for additional liquidity to ‘bridge’ past the COVID-19 pandemic. This provides significant opportunities for investors to put money to work albeit at reduced yields. The future of the economy, however, is highly uncertain for distressed investors given the unknown trajectory of COVID-19 and market volatility related to the US election.
Jones: This is a great market for distressed investors and is only likely to get better as more investment opportunities enter the market. There are so many ongoing uncertainties for businesses that are caused by COVID-19. Are we at the bottom of the market? What will the government do next? What shape recovery can we expect in any particular sector? If you make the right bet now, the rewards could be significant. In my recent experience, accelerated M&A processes do yield a lot of initial interest, but the universe of interested parties narrows very rapidly and offers, when received, are very low – sometimes not enough to cover the costs of the process itself. In retail this has resulted in a lot of connected party activity, where there is effectively no credible interest from the market and existing owners are able to buy back their businesses, or just the valuable brands, for a significant discount and clean up their balance sheets in the process.
“Capital markets are robust and so acquisition financing should be available, but that could depend on the industry.”
FW: Have any recent, high-profile distressed M&A transactions caught your eye? What lessons can we draw from their outcome?
Butler: The pending acquisition of J.C. Penny by Simon Property Group and Brookfield Property Partners – their latest proposed acquisition in recent years of a major bankrupt mall tenant – demonstrates innovative rescue action by large-scale retail property owners. Harbin’s purchase of GNC, where the original stalking horse bid negotiated pre-pandemic was subsequently increased, underscores the importance of strategic acquirers when available and motivated to participate in a distressed auction environment. While the risks in a distressed M&A transaction are often more substantial than traditional M&A, the risk is often correlated with increased potential returns.
Baker: The acquisition of Brooks Brothers by Simon Properties and Authentic Brands was interesting and encompasses many of the recent trends in distressed M&A. Brooks Brothers filed for bankruptcy in July. Like many retailers, it was struggling before COVID-19 as a result of the shift to online shopping. The pandemic was the final trigger and the company entered into bankruptcy with the goal of selling the entire company through section 363 of the Bankruptcy Code. As a large landlord of Brooks Brothers, Simon Properties exercised self-help and submitted a joint bid with Authentic Brand. As part of its bid, Simon Properties and Authentic Brands agreed to keep open at least 125 stores, giving it an important advantage over competing bids from non-landlords. The acquisition shows the ways landlords can use distressed M&A to mitigate the damages causes by tenant bankruptcies.
Durrer: In 2016, a group of landlords of clothing retailer Aeropostale teamed up with a retail brand investor to purchase the retailer’s assets out of Chapter 11 bankruptcy. At the time, observers wondered whether distressed M&A transactions of retailers brokered by landlords would become a trend, or whether the Aeropostale transaction was more of a unicorn. That question has been definitively answered in 2020. Groups led or supported by large mall landlords have already acquired Forever 21 and Brooks Brothers and have proposed transactions involving J.C. Penney and Lucky Brand in 2020. Landlords making distress investments in consumer retail brands in this fashion have justified their decisions by the strength of the brand and acquiring the underlying retail inventory at cost to enable a later profit. Some such investors have disclaimed the notion that the investments are merely protective of their leaseholds.
Jones: The administrators of Flybe recently agreed to a sale of its business and assets, including the brand, intellectual property, stock and equipment. What makes this so interesting is that due to the limitations of UK insolvency laws, which does not presently contain a debtor-in-possession regime, when administrators were appointed in March following significant disruption to the airline industry caused by COVID-19, Flybe’s fleet was immediately grounded. Nevertheless, subject to satisfying certain conditions, the deal is expected to allow the business to restart operations as a regional airline in early 2021. There is little, if any, precedent for this outcome in the UK and it goes to show that whatever the age of the tools – the administration regime was introduced by the 1986 Insolvency Act – they may be flexible enough still to be used in innovative ways.
Husnick: Liability management transactions – such as debt repurchases, up-tier exchanges, amend and extend transactions, and strategic use of basket capacity – have become commonplace during the last few years. The viability of such transactions, at least in the short term, has been tested in courts, including the Simmons/Serta dispute and the iHeart debt repurchase dispute. Two lessons have been clear from these litigations. First, process is critically important to structuring and implementing a successful liability management transaction. Companies and investors alike need to ensure that corporate formalities are followed, and transactions are negotiated and documented at arm’s-length with the oversight of independent fiduciaries. Second, language in the documents matters because courts have been unwilling to read ‘equitable’ or ‘quasi-contractual’ remedies into loan documents when the language of the documents are clear on their face. Companies and investors should read their documents very closely.
Sumner: We have actually seen only a limited number of distressed transactions undertaken since the COVID-19 lockdowns. Governments around the world have been quick to address the cash shortfalls in businesses to enable them to retain staff and restructure as necessary. However, many companies have also taken on unsustainable levels of debt during this period and therefore we see restructuring M&A as being a very relevant and important tool for the recovery.
“In terms of structuring a distressed M&A deal, it is very important to pay attention to the seller’s rights to transfer intellectual property rights.”
FW: Based on your experience, what particular considerations need to be made when structuring and financing a distressed M&A deal? How do aspects such as valuation and risk management directly impact return on investment?
Durrer: Most of the same considerations that arise in any M&A transaction remain applicable. In terms of structuring a distressed M&A deal, it is very important to pay attention to the seller’s rights to transfer intellectual property rights. Even in the US, Chapter 11 does not always provide for the same clean transfer of intellectual property that it does for many other assets such as real estate or accounts receivable. Likewise, US bankruptcy laws do not permit the transfer of real property assets free and clear of environmental responsibility if ongoing environmental obligations remain. In our experience, investors typically approach valuation from the perspective of what return they can achieve, which can be very different from the historical return – in other words, the buyer may have a better management team, more capital to invest in growth or synergies that drive down the cost of future revenue.
Husnick: High levels of uncertainty regarding the future of the economy require thorough diligence, careful planning and thoughtful drafting. Many M&A transactions have a multi-month lag between signing and closing during which external events can have a significant effect on the value of a business. As such, there is a renewed focus on closing certainty and risk management beyond the protections provided by a traditional ‘material adverse effect’ clause. The risk goes both ways, especially for strategics, who themselves may face their own financial and operational issues. Investors also need to be very focused on potential swings in value and shifts in the lending markets. What may be a fulcrum security today could quickly become an out-of-the-money position with a sudden decrease in total enterprise value. Likewise, shifts in the lending markets due to macro-distress can put over-secured lenders at risk of getting stuck with a new piece of paper with a longer-dated maturity and lower interest rate where borrowers are unable to refinance the loan because the loan markets are not functioning efficiently.
Sumner: There are two key aspects to any transaction. Firstly, getting the operational plan right and secondly, the financial structuring. As with any investment, the business plan and the right management team are crucial to delivering a successful deal. The acquirer needs managers with specialist skillsets who are used to working at speed, being decisive and are able to effect change in the business. They also need a clear plan to deal with key customers and suppliers. These stakeholders will have been through a period of uncertainty and will need prompt reassurance that the new owner can support the target given. In many cases, they may have lost money through association with the target. Those operational issues directly affect the financing of the business. None of the suppliers or customers are going to be keen to support the acquired target in the future if it is highly leveraged, so acquirers can expect to fund through equity at the outset until the target has an established track record under new ownership. Also, suppliers are unlikely to extend credit initially, especially if the business has been acquired out of some form of insolvency process. Therefore, assessment of the day one working capital requirement is important.
Jones: Simplicity and speed of execution are key. Distressed M&A transactions usually happen very quickly, where operating businesses are involved and there is a burning platform. Due diligence has to be laser-focused and even though the insurance market has innovated some interesting products to plug the gaps of a limited warranty package, these can be expensive and cannot always fully de-risk the transaction. In the current market, with values being so uncertain, we have seen sponsors and junior lenders be even more robust than usual opposite senior lenders in protecting their economic interests in a deal. This puts more pressure on the analysis of the intercreditor arrangements and the route from default to enforcement and release of claims and security.
Baker: Valuation is a key driver of investment return, and careful consideration must be given to company specific and macro factors. From a risk management perspective, due diligence will be particularly important because distressed companies may postpone capital expenditures or may have deteriorating relationships with customers and trade creditors. Purchasers should establish a shell company to acquire the assets to shield the corporate parent from any inherited liabilities. In order to minimise potential liabilities, asset acquisitions may be more appealing than a merger because the former permits liabilities to remain with the seller. However, if the seller ultimately commences a restructuring transaction post-closing, any recent asset sales could be susceptible to fraudulent conveyance claims or other challenges from the seller’s creditors. These risks lead many distressed investors to require a sale in bankruptcy pursuant to section 363 of the bankruptcy code. ‘363 sales’ allow the purchaser to take the assets free and clear of all liabilities and the sale will be authorised and approved by a federal bankruptcy judge.
Butler: Successful acquirers of stressed businesses have a thoughtfully developed exit strategy in place at the time of acquisition. They target underperforming companies that have an inherent reason to continue to exist and can benefit from their performance improvement capabilities to create value. Distressed investors with long-term value creation goals employ robust due diligence programmes to assess business models, management, intellectual property, industry headwinds and company-specific challenges, including governance and legal issues. Reactive, auction-centric processes present their own challenges and sometimes lead investors to pursue transactions with prices below their valuation model without carefully assessing asymmetrical risk – upside more limited than downside – or transactions that have been financially engineered to meet market hurdle rates. Key structuring considerations include sorting out the appropriate execution timing of a proposed transaction, identifying the tenor of the transaction and anticipated exit strategy, valuing assets such as intellectual property, tangible assets and real property, evaluating deal dynamics, regulatory and tax issues, and determining the execution method and related ability to obtain assets free and clear of liens, claims and encumbrances.
“Many M&A transactions have a multi-month lag between signing and closing during which external events can have a significant effect on the value of a business.”
FW: Could you provide an insight into some of the legal aspects and issues that typically arise in distressed transactions? How might such issues affect the way agreements are drafted?
Sumner: The key priority for many of these transactions is to create a clean break from the seller. The seller’s priority is to resolve any overhanging liabilities and to achieve a quick transaction. Therefore, most transactions in this arena have limited recourse to the seller albeit that is reflected in the price. Therefore, acquirers should not expect pages of warranties and indemnities and it can be ‘buyer beware’. However, particular areas that can be dealbreakers include environmental and pension liabilities, particularly in the UK and Europe. These may even have to be carved out of the agreement and left with the seller to resolve. In the UK, where the target has a defined pension scheme liability, the Pensions Regulator has certain powers to challenge trade and asset transactions. So, the Pensions Regulator is a key stakeholder that should be consulted by both the seller and buyer in the run up to any transaction to avoid unnecessary delay to completion.
Jones: We have recently seen an increasing use of credit bidding as a means of transacting. Credit bidding is where a secured lender acquires the secured assets and ‘pays’ by offsetting the value of the assets against its debt. There are real advantages in a credit bid, the principal one being that there is little actual cash movement, and so no need for third-party finance or costly equity. We are also seeing a number of funds on loan-to-own transactions, where the strategy is to effectively indirectly acquire the asset by buying into the defaulted debt at a discount to face value, before the asset comes to market, and then credit bid for it up to the full face value of the debt when it does come to market. This does not have much impact on the drafting of the acquisition documentation, but it does put a lot of pressure on the drafting of the relevant finance documents to ensure that, for example, the security agent is permitted to accept non-cash consideration, and what the steps are to obtaining a release of security and claims from the security agent.
Baker: Managing the target’s liabilities is a key legal consideration and therefore special attention must be given to the survival of representations and warranties and the indemnification obligations in the purchase agreement. However, those protections will have limited benefit if the seller is highly distressed. For this reason, purchasers often prefer to acquire the assets through a 363 sale in bankruptcy, which insulates the purchasers from known and unknown liabilities. If the seller conducts a 363 sale, the purchaser should focus on the no-shop and go-shop provisions of the agreement because a bankruptcy court will almost always require that the seller publicly market its assets before committing to a purchaser. However, that marketing should be conducted through a formal process with a beginning and end, and the purchaser should look to limit any soliciting or consideration of bids outside that defined marketing period.
Husnick: One of the key goals in a distressed M&A transaction is ensuring that the source of the distress is eliminated or at least mitigated. This goal is more difficult to achieve in the face of macro-distress – distress not just of the individual company, but the entire market in which the company participates. While a company can reduce debt, trim expenses and otherwise improve its balance sheet, no amount of ‘restructuring’ can increase or replace the revenue line. As such, there is increased focus in M&A agreements around certainty of financial and operational performance. While sellers are likely to push for ‘as is, where is’ transactions, buyers are looking for additional representations and warranties related to the company’s operational and financial performance. Representations and warranties insurance is a potential tool in distressed transactions given that there may be no real recourse for the buyer after the proceeds of the transaction have been distributed to creditors.
Butler: In distressed situations, the fiduciary responsibilities of officers and directors often play out more as ‘centre stage’ considerations. Acquirers need to account for the expansion of customary fiduciary duties as a seller’s business enterprise approaches insolvency – often referred to as being in the ‘zone of insolvency’. These duties may expand beyond traditional considerations to consider the interests of creditors and to even require that decision makers take actions that maximise business enterprise value before considering how to allocate realised value to stakeholder groups. Understanding the quality of the target’s assets and earnings while triaging the company’s on- and off-balance sheet liabilities runs in parallel to developing an informed understanding of an appropriate business plan, management team and ultimately, an exit strategy. Post-transaction, the company can be monitored through information surveillance activities and mechanics built into investment documents, ranging from board participation, or observer rights, to enhanced reporting requirements.
Durrer: One set of issues that arises in almost every transaction is what rules govern the parties between the time that a transaction is signed and the time when it is actually consummated. Luckily, distressed M&A transactions typically are closed in a short time frame, but when they linger post-signing due to regulatory approvals or other issues, these rules become very important. The parties should develop clear provisions that address how the seller is permitted to conduct business pending closing. What happens to cash at closing – is it acquired or not? And who is responsible for invoices that inevitably arrive post-closing but may relate to pre- or post-signing periods of time? In non-distressed transactions, such provisions are important, but they become especially important in a distressed environment because the seller may not exist, or not exist for long, after a transaction is consummated.
“What is interesting is how these unique times and, in particular, government intervention, has entailed a rewriting of the playbook.”
FW: What advice would you offer to distressed investors on working with various stakeholder groups during a deal process, and understanding their interests?
Husnick: Transparency is key. When all parties involved in a transaction know what the other parties are looking to accomplish, there is an ability to identify common goals and efficiencies in the dealmaking process. In contrast, keeping everything ‘close to the vest’ when negotiating a transaction can lead to lack of trust, miscommunications and delays. Stakeholders may be concerned that they are giving up strategic ground, but there is little appetite in or outside of the courtroom for ‘gotchas’, especially in the midst of the current economic climate.
Baker: If the transaction is being conducted through a 363 sale in bankruptcy, and the purchaser is not an existing creditor, it is important that communications with other stakeholders funnel through the debtor and seller. Because a 363 sale is supposed to be a public auction process, there is particular sensitivity about any potential collusion between a potential purchaser and stakeholders. Accordingly, the debtor and seller should coordinate all conversations between parties.
Jones: In my experience, most distressed investors are highly skilled in stakeholder management – it is a prerequisite. What is interesting is how these unique times and, in particular, government intervention, has entailed a rewriting of the playbook. For example, the temporary restrictions on the use of forfeiture and winding-up petitions has severely curtailed the usual powers that landlords have to take action on non-payment of rent, and therefore altered the dynamics with any dialogue with that stakeholder group.
Butler: Understanding who the major stakeholders are in a potential transaction and what their competing interests may be is always part of a preliminary transaction assessment. Successful transactions often gain momentum when competing interests are aligned and stakeholders are helped to find common ground and shared interests. Deal sponsors need to remain agile and preserve flexibility to revise proposed transaction structures to respond to evolving circumstances and more informed views of stakeholders’ preferences and requirements. The approach is informed by the reality that the ‘best deal’ does not always win the day – the transaction that is completed is the deal that gains the most traction and support from stakeholders whose support may be helpful and even required.
Durrer: The best advice for distressed investors in this area is to focus as many resources on communication as possible to create frequent and multi-channel discourse with as many stakeholders as possible. Specifically, take advantage of existing close relationships to promote high quality, candid information sharing – that could mean principal to principal, lawyer to lawyer, banker to banker, or even lawyer to principal, with appropriate advance consents – whatever best promotes the communication. Sometimes, parties are reluctant to be candid if they are still involved in litigation in a formal insolvency proceeding or otherwise. One effective tool to mitigate that problem is to propose a court-supervised mediation which carries with it a very strong privilege to prevent the disclosure of information shared during the mediation for any other purpose, such as litigation. As long as face to face meetings remain impossible during the pandemic, we also recommend use of video conferencing alternatives.
Sumner: Successful restructuring M&A requires the support of all the stakeholders. In normal M&A, the needs of the stakeholders such as governments, suppliers and customers might be a secondary consideration to the transaction. They will typically support the transaction provided they get a seamless service. However, in the distressed arena, they all may have a reason not to support the transaction, particularly where they have been impacted by supply issues and late payment. Building trust and transparency throughout the deal process is critical, so those stakeholders can understand why supporting a transaction is the right course of action and beneficial to them in the long run. This is one of the areas where advisers are particularly helpful to a transaction. They have independence from the circumstances that have created the distressed situation and therefore can be the broker between parties. Stakeholder management is increasingly important as company structures and stakeholders have become more complex and numerous over the years. Often, we see transactions with private equity, multiple lenders, powerful customers or suppliers and management teams with their own agendas. The difficulty of aligning all these parties should not be underestimated.
“Successful transactions often gain momentum when competing interests are aligned and stakeholders are helped to find common ground and shared interests.”
FW: What is the current outlook for the distressed M&A market? What are your predictions for future activity levels?
Baker: In general, the distressed market has retreated since the spring and summer. If capital markets continue to be robust and governments continue to adopt stimulus programmes, there may not be a meaningful uptick in distressed activity.
Jones: Activity levels will definitely increase. It is inevitable. There is a lot of pent-up distress, which is held back by the temporary restrictions on the use of forfeiture and winding-up petitions. When those measures fall away, which could be as early as at the end of the year, this will create a real burning platform for businesses that have survived by not paying their creditors. Moreover, there is demand. Many funds have dry powder to invest, and businesses that have weathered the storm will see opportunities to consolidate.
Butler: We expect that there will be a substantial uptick in distressed M&A transactions as investors harvest cash-starved businesses where asset values have been depressed and will ‘crystalise’ in a transaction well below their intrinsic business enterprise values. Unless there is some future event that shuts off or limits the current oversupply of capital, distressed M&A deals will get done because many of them will be involuntary transactions where the traditional M&A mandate of a willing buyer and willing seller settling on a common transaction price does not apply. All of this will occur against the backdrop of the nascent 'gig' economy accelerating amid a global coronavirus pandemic that has not abated yet and without any common understanding of how corporate and consumer behaviour across multiple industries has been changed and whether such changes are short term or permanent. The ‘fasten seatbelt’ sign has been illuminated. There is turbulence and storm clouds ahead – a perfect storm for the distressed investing community.
Durrer: We predict sustained growth in the distressed M&A market for years, but perhaps not for an obvious reason. Many will point to the pandemic as the driving force behind a distressed economic outlook. Our view is that the pandemic will not ultimately be the root cause, but rather it has exposed and accelerated the inevitable disruption that the so-called ‘gig’ economy already began, albeit at a slower pace. Born of necessity, the new normal ushered in by the pandemic has caused us all to discard traditional methods of conducting commerce and even educating our children. Many predicted that such disruption was coming, but 2020 has seen it happen over a half dozen months rather than years. Many businesses and even industries that anticipated a sunset of a number of years are facing extinction on a much more rapid pace. This will fuel distressed M&A.
Sumner: We are likely to see a significant level of restructuring M&A over the next two to three years. It is vital that businesses maximise their options now to ensure they are in the best shape to face the challenges ahead. Some of the market is performing strongly through COVID-19, creating a need to work differently. However, many good businesses have seen a temporary reduction in demand or an inability to service the demand they have got. This is driving short term financial distress. However, as different to 2009, there is lots of liquidity available through banks, well capitalised corporates and private equity. This means that rather than facing closure or insolvency, there might be ways of rescuing businesses through an equity sale or injection. We are likely to see two waves of transactions. The first being those businesses that have exhausted their cash reserves through short-term losses which have not been covered by government support, and the second as demand returns to the market post COVID-19 and businesses have to finance a growth in working capital. Whatever the reason, restructuring M&A will be an important feature of the market for the foreseeable future to preserve businesses and jobs through this downturn.
Husnick: With certain exceptions, many of the companies seeking Chapter 11 protection since mid-March were already stressed or distressed prior to the COVID-19 pandemic. I expect an active distressed M&A market over the next 12 months. Otherwise healthy companies must deal with the ramifications a multi-quarter hole in earnings and the additional leverage required to bridge past the pandemic. Undoubtedly, certain companies will not be able to ‘work’ their way out of the hole.
One of the most highly regarded dealmakers and thought leaders in the restructuring, corporate reorganisation and M&A communities, Jack Butler has been credited as one of the principal architects of restructuring solutions for Delphi, Kmart, Rite Aid, Sprint, Xerox and on behalf of creditors in the American Airlines’ merger with US Airways. His recent transactions at Birch Lake include leadership of merchant banking relationships in the food, consumer electronics, legal tech and transportation industries. He can be contacted on +1 (312) 757 2330 or by email: jack.butler@birchlake.com.
Ben Jones specialises in corporate restructuring and insolvency matters, having worked in the area for over 20 years. He is particularly experienced in advising in situations where companies are, or are likely to become, subject to formal insolvency proceedings, undertaking contingency planning and providing strategic advice to stakeholders. He also has extensive experience in refinancings and distressed M&A. Mr Jones is BCLP’s EMEA leader for restructuring and insolvency and co-leader of the multidisciplinary special situations team. He can be contacted on +44 (0)20 3400 4717 or by email: ben.jones@bclplaw.com.
Chad Husnick is a partner in the restructuring group at Kirkland & Ellis LLP. He represents debtors, creditors, equity holders and other stakeholders in all aspects of corporate liability management, restructuring, bankruptcy and insolvency proceedings. He is also a lecturer in the law at the University of Chicago Law School and a contributing author for Collier on bankruptcy, the leading treatise on bankruptcy law. He can be contacted on +1 (312) 862 2009 or by email: chad.husnick@kirkland.com.
Neil Sumner is a restructuring director advising on national restructuring M&A transactions for businesses suffering financial stress or which are underperforming to create equity value for shareholders. Before joining PwC, he led M&A for IMI plc. His recent deals include the sale of Harveys and Bensons, Allied Healthcare, Gardman and Brabant Alucast. He can be contacted on +44 (0)7813 313 410 or by email: neil.d.sumner@pwc.com.
Nicholas Baker is counsel in Simpson Thacher’s corporate practice, based in New York. He concentrates his work on restructuring and bankruptcy matters and has represented clients in some of the largest Chapter 11 proceedings and out-of-court restructurings. He can be contacted on +1 (212) 455 2032 or by email: nbaker@stblaw.com.
Van C. Durrer II regularly represents public and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors and asset-purchasers in troubled company M&A, financings and restructuring transactions, including out-of-court workouts and formal insolvency proceedings. He can be contacted on +1 (213) 687 5200 or by email: van.durrer@skadden.com.
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Kirkland & Ellis LLP
PricewaterhouseCoopers LLP
Simpson Thacher & Bartlett LLP
Skadden, Arps, Slate, Meagher & Flom LLP