Distressed Takeovers Soar

The brutal recession is opening up the landscape to vulture investors as never before.
New data show that distressed-debt deals — in which creditors use their debt positions to seize ownership of troubled companies — are running close to double the pace of 2008. Some 140 of the deals have been struck during 2009, compared with 102 transactions for all of last year, according to data provider Dealogic. Those figures also include corporate takeovers, encompassing a wide array of transactions related to bankruptcies, restructurings, recapitalizations or liquidations.

The deals are valued at $84.4 billion altogether, dwarfing the $20 billion figure from 2008. And they involve companies from virtually every nook of the U.S. economy, from auto-parts maker Delphi Corp., to retailer Eddie Bauer and hotel chain Extended Stay America.
In many of these cases, debt holders aren’t concerned about getting monthly payments, but rather using their debt positions to angle for ownership. It’s the equivalent of a bank making a loan to a homeowner with the intent of foreclosing on a delinquent mortgage. Such strategies have been around for years and are known in financial circles as “loan to own” or “vulture” deals. But never have they occurred with such volume and velocity, say bankers and lawyers.
Today’s lenders are “increasingly hedge funds who are thinking about a loan-to-own strategy,” said Barry Ridings, the vice chairman of U.S. investment banking at Lazard Freres & Co. LLC. At troubled companies that can’t pay their debts, boards find that ceding control to lenders is “the best way to maximize value,” Mr. Ridings said.
The deals are changing how Wall Street bankers and lawyers work. These days, M&A lawyers are increasingly collaborating with their firms’ bankruptcy practices and Wall Street restructuring shops. Rather than working with a suitor that wants to buy a company for cash or stock, they now work with groups of creditors who want to convert the debts into ownership of a crippled company. The new cliché among restructuring professionals: Bankruptcy is the new M&A.
That was on display in June, when hedge fund Elliott Management took bigger stakes in a loan used to fund Delphi while it was in Chapter 11 bankruptcy proceedings. That move effectively helped block other investors who wanted to take over Delphi.
Ahead of its June bankruptcy filing, theme-park operator Six Flags Inc. reached a deal with lenders, including Silver Point Capital and Beach Point Capital, to exchange debt for a 92% stake in the new company when it emerges from Chapter 11.
The opportunities for similar deals are likely to increase. Bank of America Merrill Lynch estimates that about $145 billion in debt could default this year, followed by about $130 billion next year and $120 billion the year after. Default rates are hovering around 10%, up from around 4% in 2008 and less than 1% in 2007, when credit was easy and the economy strong.
“This will continue for three to four years with all of the bank debt that comes due,” said Scott Levy, head of distressed mergers and acquisitions at Bank of America Merrill Lynch. “The absolute dollar value of projected defaulted debt is six or seven times as much” as in the recession of the early 1990s.
Some of the biggest turnover is in real estate. Maguire Properties Inc., one of the largest office-building owners in Southern California, said Monday it is giving up control of seven buildings due to “imminent default” on the loans backed by those properties. The company has struck a deal to turn over one of the buildings, which is located in Irvine, Calif., to LBA Realty, a real-estate company that bought its debt at a discount.
And unlike traditional deals conducted in secret, bankruptcy courts usually subject transactions to public scrutiny. Southwest Airlines Co., for instance, recently said it would offer a competing bid to take Frontier Airlines Holdings Inc. out of bankruptcy proceedings — after a judge approved an initial deal for the carrier to be bought by Republic Airways Holdings Inc.
Distressed deals often include hardball tactics. Earlier this year, Integra Telecom Inc. Chief Executive Dudley Slater met with Michael Leitner, a managing director at Tennenbaum Capital Partners LLC and significant holder of the telecommunications firm’s junior debt. Mr. Slater explained that Integra remained profitable, but that flat earnings meant a looming debt-covenant violation. Senior lenders wanted high interest rates to restructure the company’s $1.3 billion of debt. Today, Tennenbaum and other junior lenders are poised to own Integra, after exchanging $700 million of debt for equity stakes in an out-of-court restructuring.
Mr. Leitner said he wanted to work with stakeholders to do what was best for Integra’s capital structure. Turning the company over to debtholders proved Integra’s only recourse, Mr. Slater said. “Life is always better when you have options and in this case, we didn’t have options,” he said.

Wall Street Journal – Mike Spector and Jeffrey McCracken
August 10, 2009