Double Exit

Dealing with companies that end up with too much debt is a core part of corporate finance. There are plenty of recent examples of companies that had unsustainable debt levels and needed to restructure these to survive (e.g. Digicel, NewLook, Carillion, PizzaExpress). For some, there can be a solution whereby the debt is restructured and the underlying business is saved, although the capital structure and business ownership may look drastically different post-restructuring (e.g. Pizza Express and Digicel). However, for others, there may be no viable business to save or no agreement on a restructuring plan, in which case the company goes bust (e.g. Carillion).

Note that this issue of debt restructuring also applies to government debt (think of Ireland around 2008/09) and personal debt (e.g. negative equity mortgages, personal insolvency). A lot of the core principles are the same but we will focus on corporate debt here.

Ultimately the objective of debt restructuring is to save the underlying business and create a more sustainable capital structure (i.e. mix of debt and equity). From a starting point of too much debt, this will likely involve some compromise from the lenders (who can be banks, or non-bank lenders such as credit funds or hedge funds) and the current shareholders (who likely have little value currently if there is too much debt)

There are a number of possible approaches as part of a debt restructuring plan;

1. Debt reschedule or maturity profile adjustment – this is corporate lingo for extending the duration of the loans to allow the company more time to pay (a kind of refinance with the same bank). The lenders may increase the interest rate to be compensated for this extension. Digicel did this in 2018 to extend the maturity date by 2 years.

Digicel closes in on agreement from bondholders to extend debt

 

2. Covenant waiver and reset – a smaller adjustment that allows a covenant (loan condition) to be breached and restart it to avoid a technical default. This still would not solve the overall debt issue however and is merely a short term fix

  Artyza gets green light for amendment to financial covenants

 

3. The current debt could be refinanced by new lenders. This would be unlikely in a lot of scenarios where a company has too much debt as most new lenders would not be willing to provide all the funds to refinance the debt fully (as you would be back to square one with too much debt) and thus some debt-write down from the original lenders or equity capital injection from shareholders would be needed also (see 4 & 6 below)

 

4. A debt write-down, debt right-sizing, or debt haircut – this would be where the lenders agree to write off a portion of their debt and it would usually be part of a bigger plan to restructure the company’s finances. Lenders would usually consider this when the alternative would return less money to them (i.e. the company going into liquidation).

Digicel proposes $1.7bn debt write-down deal

 

5. Companies may be forced to sell non-core assets to generate funds to repay some of the debt.

  Arytza sold off several non-core assets as part of its turnaround plan.

          SwissAir also plans to sell non-core assets soon to reduce its debt burden.

 

6. In some instances, new equity capital is invested in the business to improve the capital structure (i.e. gearing ratio) and provide much needed capital to the business

  Arytza undertook a rights issue as part of its turnaround plan

  It is planned that Denis O’Brien will invest his own capital as part of Digicel’s debt restructuring plan

 

7. One other common debt restructuring strategy is whereby the lenders swap their debt in the business for equity. This has the impact of reducing debt levels down but also significantly dilutes the existing shareholders. However, in many circumstances there may be no realistic alternative if the other avenues above are not available

  Pizza Express is being taken over by its lenders in a debt for equity swap

  Eircom (now Eir) was previously taken over by its lenders through a debt for equity swap back in 2012

          New Look is entering its second debt for equity swap in the space of two years

 

 

Conclusion

Most of these debt restructuring plans are multi-faceted and would include a number of the above mentioned aspects. For example, the current Digicel plan involves write downs, debt for equity swaps and new equity investment which highlights that these processes can be quite complex and drawn out. For the lenders, it will involve assessing what course of action will give them the best return of their funds (e.g. let the business fail or be part of the restructuring plan). For the shareholders, it will involve deciding if they want (or can) put more money in to steady the ship and save their business (e.g. Arytza) or whether it makes sense to hand the business over to the lenders and walk away.

Debt restructurings are rarely easy and will involve compromise from a lot of stakeholders who have a financial interest in the business (e.g. suppliers, tax authorities, employees, lenders, shareholders). Achieving a consensus around what a debt restructuring package looks like, who takes a financial hit, and the ownership of the business post-restructuring takes time, lots of negotiations and usually involves a lot of advisors.

 

Note: Corporate debt restructuring is closely linked to legal processes in the relevant jurisdiction. For example, in Ireland the legal processes of examinership, receivership, and liquidation are all important aspects when examining debt restructuring cases. Similarly in the UK and the US there are other aspects of legislation (for example in the UK they have administration and in the US they have Chapter 11) which while similar, can differ in important aspects to Irish legislation, thus increasing the importance of good profession advice (legal teams and corporate finance teams) during the process.