Alumni give insights during IBI Restructuring Week
By Daniel Kaufman, Two-Year MBA ‘19
Immersion learning at Johnson is best known for equipping students with technical skills required to succeed in their internships. One aspect of the immersion experience that often goes underappreciated is how immersion coursework is seamlessly integrated. As the Investment Banking Immersion (IBI) headed in to Restructuring Week, I was struck by how class topics overlapped to enhance our learning experience.
On a Wednesday, in Lectures in Finance class, Barry Ridings, MBA ’76, managing director and vice chairman of US Investment Banking at Lazard Capital Markets, would take us through Six Flags’ bankruptcy. From there we’d move on to our IBI case for the week—an analysis of Nieman Marcus Group (NMG), a distressed retailer. The week would close the following Monday during our team presentations and instructor debrief featuring Rob Symington, MBA ’92, visiting lecturer and senior advisor at Avenue Capital.
Valuation in restructuring scenarios
Ridings opened his discussion by breaking down the incentives of each party to a bankruptcy proceeding. An over-simplified view is as follows: equity owners don’t want their ownership stake to get wiped out, distressed investors want to take over control of the company by converting—some of, if not all of—their debt in to equity, while loan holders want to recover the full value of their claims. The different motivations of the stakeholders drive quite an interesting discussion about a key topic for bankers: valuation.
As we’ve learned through some of our other cases, and as Ridings reminded us, valuation is driven by one’s assumptions. As a restructuring advisor, your client’s incentives will ultimately drive your valuation assumptions, and how you have to justify them. With this in mind, Ridings walked us through each of the primary valuation methodologies, and his thought process behind the assumptions he, and other advisors, used to value Six Flags during its Chapter 11 proceedings.
Among the many insights shared, I found those on “ideal” comparable and “target” capital structure most fascinating. For example, when conducting relative valuation, one might think analyses are improved by including many comparable companies or precedent transactions. However, Ridings highlighted how in some instances it is sensible to over-weight the closest comparable. This quality over quantity principle was driven home when we saw how some advisors omitted Cedar Fair, Six Flags’ most direct comparable, and the recent takeover bid it received, entirely from their analyses in order to produce valuations that aligned with clients’ capital preservation objectives.
Similarly, in prior classes a company’s target capital structure is used to calculate cost of capital. In a restructuring scenario, when you are creating an entirely new capital structure, it was fascinating to see in practice, how vastly different capital structures created disparity in valuation. The take home for us heading in to the case, choose a capital structure that is in line with industry norms.
The Nieman Marcus Group (NMG) case
In the NMG case, deal teams served as advisors to different securities in a mock restructuring (worth noting NMG hasn’t yet filed for protection). Our team wanted to represent the bonds because we felt that it was likely the “fulcrum” security, or the security most likely to be converted in to equity during the workout process. The key for us was create a plan of reorganization (PoR) that allows bond holders to recover as much of our principal as possible while gaining the approval of other capital providers. This wasn’t going to be an easy feat with the bonds and loans trading at 70 percent and 50 percent discounts, respectively!
As our team delved in to valuing NMG, we started to draw on a lot of the key lessons from Ridings’ lecture. Specifically, in our relative valuation, Hudson’s Bay Company (HBC) stuck out as the ideal comparable—it carried the same upscale brands and catered to the same type of customer. HBC traded at a premium to the other department store retailers, and its inclusion was a key component of securing a valuation that would allow us to maximize recovery.
We also extensively debated the NMG’s target capital structure. At first, we left the company with approximately 70 percent debt and 30 percent equity. However, when we realized that the pro-forma leverage was still far too high, we recalled Ridings’ points about the target capital structure. From here, we wanted to flip the script to the industry average, and go for 70 percent equity, 30 percent debt. While this made our leverage metrics better, it created a bit of an issue with our discounted cash flow because it substantially altered our weighted average cost of capital. The iterative process of getting our capital structure, and in turn, our valuation, right consumed quite a bit of time, but really drove home the nuances of conducting valuation in a restructuring context.
As the clock approached 11 p.m. on Sunday evening, with the midnight submission deadline looming, Team 3 confirmed its PoR. Given the trading discounts of the debt, and our valuation, neither the bonds nor the loans were able to recover 100 percent of its face value. However, we secured 41 percent ownership of the restructured Six Flags, and an option for the bond holders to purchase the loan holders’ newly created equity position, which if exercised would give the bondholders a controlling stake of the company.
The investor’s perspective
Everyone was excited heading in to Monday’s debrief, as we were excited to see how our peers approached the case and to hear Rob Symington’s views on NMG.
I came to really appreciate watching my classmates present, as it provided a unique learning opportunity. This week, the class was struck by Gyurme Karma’s, MBA ’19, and Brian Sandler’s, MBA ’19, asset liquidation analysis and how it supported their view that the equity holders should retain some of their ownership stake in NMG. You could sense that the class really appreciated this novel approach.
After the group presentations, Drew turned the floor turned over to Rob. He first provided an investor’s approach to bankruptcy proceedings and some of the key legal statues that provide protection to creditors. Next, he shared his views on the retail industry, including the outcomes of some of its recent bankruptcies. From there, Rob drilled in to NMG. It was fascinating to see the breadth and depth Rob took in his analysis. One second he’d be talking about management, the next he’d be highlighting the geographic footprint of the stores and how regional economies impact NMG’s overall performance. Rob closed by sharing his views on what will happen to NMG and conducting an extended Q&A session.
Overall it was an incredible week. The IBI learned from one of the leading restructuring advisors, put those lessons in to practice, and tied it all together with instruction from a top-distressed investor. This type of experience really encapsulates what the IBI is about.
Barry and Rob—thank you for participating and your continued service to Johnson!