The Bankruptcy Boom : Finance: Big debts in the past decade are creating business opportunities in this one as firms begin to falter. Lawyers, investment bankers and “vulture funds” hope to cash in on the failures.
Bankruptcy means business. And as a growing number of firms collapse under the burden of their 1980s debts, a growing cadre of lawyers, consultants and investors is seizing a piece of the 1990s action.
“Unfortunately for the (debt-saddled) firms out there, it’s our view that we’re looking at a growth area,” said Daniel E. Davies, an assistant vice president at Bank of New York, which leads embattled firms through the paper maze of financial restructuring.
Big law firms now tout their bankruptcy expertise in press releases. “Workout artists” have emerged to lead ailing firms out of the hole--in or out of bankruptcy court. Accountants, investment bankers, property appraisers, real estate brokers and others all may sit down at the negotiating table.
In addition, a growing number of “vulture firms” are snatching up distressed bonds at garage-sale prices and joining the line of beleaguered firms’ creditors. The strategy: Resell the debt for a handsome profit after the firm is restructured.
With all this action, “It’s not unusual in a big case for the professional fees to run $3 million or even $5 million a month,” said Wilbur Ross, a senior managing director at Rothschild Inc., a New York investment bank.
The cases seem to be getting bigger all the time. In recent months, the sprawling retail empire of Campeau Corp.--including Bloomingdale’s, Abraham & Straus, Burdines and Jordan Marsh department stores--filed for bankruptcy. So did Circle K, America’s second-largest convenience store chain. Western Union and 7-Eleven’s parent Southland Corp. are teetering on the brink.
What’s going on? These companies and many others are the injured survivors of junk bond mania. In the 1980s they became entangled in deals that were partly paid for by the high-risk bonds. Their managers typically banked on sunny business forecasts in figuring how much debt they could repay. But now, these same firms in effect are telling lenders: You’re not getting all your money unless we get easier terms.
“A significant number of the deals that got done in the ‘80s are being undone in the ‘90s,” observes Bruce H. Spector, an attorney with Stutman, Treister & Glatt, a well-known bankruptcy firm in Los Angeles.
Indeed, the 1980s notion of “killer deals” is taking on a whole new meaning as more debt-burdened companies crawl gasping toward bankruptcy court.
The amount of publicly held assets in bankruptcy has soared, from just $5 billion in 1985 to a record $72 billion last year--even at a time the number of business bankruptcies dropped overall. In other words, “the size and complexity of the bankruptcies is growing very sharply,” said George Putnam III, publisher of Bankruptcy DataSource in Boston.
At the beginning of this year, the debt of public firms that were distressed or bankrupt had a market value of $44.5 billion, according to a study by Edward I. Altman, a finance professor at New York University, for the Foothill Group, a Los Angeles firm that invests in companies being reorganized. If private firms are also considered, the figure soars to $202 billion, Altman estimated.
And on Wall Street, the distress spells opportunity. At one time, the business of restructuring troubled companies’ debt was largely overlooked by most major investment firms. But these days, with a growing number of nationally established firms in trouble, “everyone in the world is trying to get into it,” said Alison Overseth, a vice president in First Boston Inc.’s reorganization group, which has grown from several people in the mid-1980s to a planned staff of 20 by year-end.
Investment houses such as Merrill Lynch, Morgan Stanley, Kidder Peabody and Smith Barney, Harris Upham are pouring resources into their financial-rescue staffs. The incentive is obvious: A single firm might charge $75,000 to $200,000 a month for advising a financially ailing client, one investment banker said. While that’s only a small fraction of the amount that changed hands during major buyouts of the 1980s, such fees represent a growth area in the debt-shy 1990s.
Issuing new junk bonds used to trigger “kind of a feeding frenzy” among potential buyers, recalls Karen Bechtel, a managing director at Morgan Stanley. “Now nobody picks up the phone.” Meanwhile, she noted, her firm is “very much expanding and focusing” on the restructuring of financially distressed companies.
Banks, too, have a self-interest in focusing on financial restructurings because many were lenders to companies that now are in trouble but still owe them money. “We’ll see a company start to go bad, and whether it’s in Chapter 11 or not yet . . . we try to help it get back on its feet,” said Travis W. Hammer, a senior vice president at Los Angeles-based First Interstate Bank, although he said the bank didn’t have major problems with its California loans.
Perhaps a bit shaken by the stampede into the previously backwater field of working with the financially distressed, one investment banker commented: “This is where they’re all heading--and they won’t all succeed.”
The stampede has been sparked by a 1990s phenomenon that Walter N. Torous, an assistant finance professor at UCLA calls “financial failure,” in contrast with “operational failure.” The financially failing company may offer goods and services the market wants but is saddled with so much debt that “it’s much easier to trigger bankruptcy than in the past,” Torous said.
At the same time, some advisers maintain, a prosperous life after bankruptcy may be possible because of the inherent strength of some financially failing companies. Consider Bloomingdale’s, part of the 258-department store empire conquered by Canadian financier Robert Campeau in the late 1980s. Campeau Corp.--teetering under $7.5 billion in debt from the ambitious takeover quest--placed the stores’ parent companies in Chapter 11 in January.
Through all the turmoil, Campeau’s nine department store chains have continued to make money, and most analysts expect them to survive for years.
Similarly, Circle K, the convenience store chain, filed for bankruptcy after an extraordinary expansion drive in which it almost quadrupled its U.S. outlets to 4,600. While not lacking for other problems, the Phoenix-based firm filed because it couldn’t meet payments on more than $1 billion in debt.
“You always had companies that made giant mistakes and filed for bankruptcy,” observes Jeffrey I. Werbalowsky, director of the financial restructuring group at Houlihan, Lokey, Howard & Zukin Capital, an investment banking firm in Los Angeles.
“Here you’re having really good companies--with average to slightly under-average years--that are going into bankruptcy.”
Often, the problems are sparked by seemingly clever lending devices popularized in the junk bond era. Some forms of borrowing, for instance, hit firms with a growing wallop of higher rates as time passes. As a result, some experts foresee a lot of trouble. “There are some time bombs ticking,” First Boston’s Overseth observed.
Many of the time bombs may explode at the doorstep of bankruptcy court, a forum that has taken on a new role for corporate strategists in recent years. Once, bankruptcy was a haven for truly broken companies. Major corporations avoided it--and the aura of failure it represented--at all costs. But increasingly, large enterprises--and their advisers--have seized on bankruptcy as another strategic weapon.
One reason: Unlike the marketplace, where survival of the fittest is the ideal, bankruptcy court takes an interest in the debtor’s survival. In a Chapter 11 filing--the sort generally used by large corporations--debts are placed on hold while the company bargains for an easier payment plan. Often just a fraction of the original debt is repaid; frequently old bonds are exchanged for shares of new stock, bonds or a combination.
“It used to be that bankruptcy was filed after the company was almost dead,” declares Henry R. Cheeseman, a specialist in bankruptcy law at USC. “That’s no longer the case. Bankruptcy is becoming a strategic financial tool.”
Legal experts trace the first wave of “strategic” bankruptcies to a series of landmark cases in the 1980s. In these suits, the bankruptcy court suddenly became a place to help companies manage lawsuits, labor disputes, even pension commitments. Together, these suits revolutionized the concept of bankruptcy, gave corporate strategists a new weapon and vastly increased the influence of bankruptcy courts over a range of social problems.
By contrast, in Western Europe, “society helps people who are injured by dangerous products,” said Richard F. Broude, an attorney with the White & Case firm in Los Angeles. “In other countries, society helps people who have black lung disease. In this country, we use the bankruptcy courts to solve those problems.”
The business of corporate financial restructurings has shifted over the years. Once, the vogue in corporate restructuring was to merge diverse entities into conglomerates. Later, when unwieldy conglomerates fell out of favor, takeovers financed by heavy debt became the rage. Now, a whole world of financial and legal advisers concentrates on deals between debtors and creditors that amount to out-of-court bankruptcy reorganizations.
Western Union and 7-Eleven’s parent Southland Corp.--both squeezed hard by junk bond debt--are trying to arrange more affordable repayment schedules in last-ditch efforts to stay out of Chapter 11. Western Union, for example, says its basic business is profitable--but not profitable enough to cover its $643-million debt load.
Advisers to management often point out that Chapter 11 has a downside, despite its benefits. Executives lose freedom if bankruptcy is declared, because they must clear major decisions with the court and creditors. Customers and vendors typically get jittery, making it harder for the ailing company to rebound.
Investors pay a price, too, because their company’s value may drop as soon as its name is tainted with an official bankruptcy. “It’s almost always better to do it out of court,” Broude maintained.
But it can’t be done for free. Law firms and other professionals are targeting corporate distress as a growth area. “Many of the chickens hatched during the mergers and acquisitions boom of the ‘80s now are coming home to roost,” notes the program for a summer legal conference on bankruptcy at Pepperdine University.
Legal seminars on the topic are packed with veteran attorneys eager to boost their market value by boning up on bankruptcy law, observed Marc S. Cohen, a bankruptcy specialist with the firm Greenberg, Glusker, Fields, Claman & Machtinger in Los Angeles. “I have no idea who these people are--and I used to know everybody,” said Cohen, who is chairman of the Los Angeles County Bar Assn’s. commercial law and business section.
Cohen added that Los Angeles “is one of the capitals” of bankruptcy practice, along with New York and Chicago.
Often the lawyers face off in a tug of war between a distressed firm, which seeks to get rid of as much debt as possible, and its frustrated lenders, who seek to get compensated as much as possible. “That’s the tension,” Broude said.
But judges tend to be sympathetic to the debtor. When it filed bankruptcy in 1988, for example, Care Enterprises of Orange County was bloated to 103 facilities and reeling with debt. The nursing home corporation now expects to emerge from Chapter 11 later this year with 40% fewer facilities and some $70 million in old debt converted to new shares of stock.
In bankruptcy, explained Douglas Drumwright, chief executive of Care Enterprises, the goal is “to try to keep the best of what you have and get rid of the troublesome areas.”
Increasingly, managers may find that their goals are not always shared by outside parties.
The debt used to buy companies in the 1980s will become “the takeover vehicle of the 1990s,” predicts C. Richard Lehmann, president of the Bond Investors Assn. in Miami Lakes, Fla.
In such a scenario, takeover-minded investors buy up a distressed company’s debt at bargain prices. When parts of the debt are converted to stock, the investors may end up with a controlling interest. Already, at least $5 billion is under active management by investors who are targeting distressed companies, including those in bankruptcy, the Foothill study found.
Typically, such bonds trade at only a fraction of their face value--but rise greatly if the company survives a financial restructuring. Potentially, investors who look ahead and see the outlines of a viable enterprise that is currently distressed can make a killing.
“Our main objective is to buy bonds that trade at 20 cents on the dollar because we think they’re worth 40 cents on the dollar,” explained James D. Bennett, a managing partner at R. D. Smith & Co., a New York investment firm that specializes in troubled securities.
Whether such machinations become common, it’s clear that for a whole world of corporate strategists, attorneys, investment bankers and consultants, the action of the 1990s is close to bankruptcy court. Spector, for example, foresees “tremendous new business” over the next few years, as the overly leveraged survivors of 1980s deals try to fix their balance sheets.
Consider the Dallas-New York flight earlier this year, where “workout” types filled the first-class cabin. An accountant joked that the merger experts--so visible just a few years ago--had retreated to coach, recalled Ross, the New York investment banker.
“It’s kind of an odd incident,” Ross said, “but it tells you a little about the state of the world today.”
WHEN PEOPLE GO BROKE
Personal bankruptcies are surging, and the stigma is fading. A1
BIGGEST BANKRUPTCIES OF 1989-90
Liabilities in Company millions of $ Bankruptcy date Campeau 9,947 January, 1990 (Allied and Federated) Lomas Financial 6,127 September, 1989 Eastern Airlines 3,196 March, 1989 Drexel Burnham Lambert 3,000 February, 1990 Integrated Resources 1,600 February, 1990 Circle K 1,580 May, 1990 Hillsborough Holdings 1,204 December, 1989 (Jim Walter) L.J. Hooker 1,200 August, 1989 Maxicare Health Plans 535 March, 1989 Braniff Airlines 178 September, 1989 (second filing) Dart Drug Stores 169 August, 1989
Source: The Altman/Foothill Report on Investing in Distressed Securities
A MOUNTAIN OF BAD DEBT Estimated public and private debt outstanding of defaulted and distressed firms as of Jan. 31, 1990.
Book value Mkt. value $ in billions $ in billions PUBLICLY TRADED Defaulted debt $26.0 $11.5 Distressed debt 50.0 33.0 PRIVATELY PLACED Defaulted debt $75.0 $45.0 Distressed debt 150.0 112.5 TOTAL PUBLIC AND PRIVATE DEBT $301.0 $202.0
Source The Altman/Foothill Report on Investing in Distressed Securities THE GROWING SIZE OF BANKRUPTCIES Total aset size of bankruptcies of publicly held companies in billions of dollars. ‘85: $5 ‘86: $12 ‘87: $40 ‘88: $43 ‘89: $72 10 ‘90: $47 Source: Bankruptcy DataSource
