Loan to Own – Is Maximizing the Value of the Estate Enough?

Guest author Rachel C. Strickland is the moderator for "Loan to Own Plays - The Good, the Bad and the Ugly," an educational session that takes place Friday, January 28, 9:45 -10:45 a.m. at the 2011 TMA Distressed Investing Conference in Las Vegas.

Meeting with several of my colleagues (and future panelists) the other day, the conversation kept turning to how loan to own strategies are viewed in comparison to other bankruptcy strategies where similar factors are at play.

Control. Cash. Competition. Common enough – but when did getting the most value for your distressed company, or ensuring payback of your secured debt, require that you first past a litmus test of good faith?

Innkeepers in the Southern District of New York comes to mind as a recent example. There was a plan, and there was coordination, but the control was too great; the plan support agreement was thought to go too far. Or consider DBSD North America, also in the Southern District of New York: The timing of the investors was critiqued, motivations were questioned and “strategic” somehow became a dirty word – not only by the bankruptcy court, but by the larger media. Certainly industry and economic stressors have heightened our sense of caution in the past couple of years, but, when a distressed company needs an infusion of capital, when did we start to care about investors’ motivations, and why? Don't most applaud the efficiency of a debtor charging into bankruptcy with a pre-packaged plan or fast-tracked 363 sale with a stalking horse bidder?

What’s the difference? And why does it matter? It undoubtedly matters to certain bankruptcy courts and judges – pick up a paper and you’re likely to see some mention of a loan to own gone sour – but what distinguishes the investment opportunity, roles, strategy and timing of loan to own from other debtor-controlled situations? Should good faith be, as some have proposed, a baseline duty for investors, co-existing with fiduciary duties?

From the concrete decisions and our collective experiences to the larger theoretical issues, and back to the practical: How can one best prepare for a successful loan to own strategy? Join us January 26-28 in Las Vegas at the 2011 TMA Distressed Investing Conference to explore these issues in-depth, and take-away our rules of the road to help you best strategize—whatever side you may fall on.

Forecast on Distressed M&A and the Shape of the Economic Recovery in Canada

We thought it might be helpful to provide Turn the Page blog readers a brief overview of distressed M&A activity in Canada.

The obvious distinguishing feature of the current Canadian recession is speed — the speed of the descent and the apparent speed of the recovery. It remains to be seen whether the recovery takes the steep “V” shape some economists predict, a long and gradual climb out, or a bumpier, up-and-down “W” path out.

Certainly, Canada’s productivity gap and lagging consumer confidence combined with a climbing dollar are trending toward a slower recovery. Canadian industry sectors relying on U.S. demand likely face a long climb ahead.

There were four key features of the Canadian recession impacting upon distressed M&A:
  1. No liquidity
  2. No bottom
  3. No buyers
  4. Patient creditors
We have identified at least two “stages” in the evolution of the distressed M&A market which we extrapolate to suggest a possible third stage. While not cleanly separated or clearly identifiable, the first two stages suggest a general trend and provide insight into the third.

Stage I: No Deals

Once the 2008 financial crisis had hit the U.S. and then Canada, and for many months following, virtually no distressed businesses were being sold as going concerns. Liquidation scenarios were equally grim, with traditional liquidators opting out of entire asset classes.

A decline in “healthy” M&A in both countries was expected, but the absence of a robust distressed M&A market was not. With no bottom in sight, even liquidators and buyers stayed out of the market. No liquidity meant no PE/Hedge funds were acquisitive since their models required debt to make their deals work. Many creditors took a wait-and-see position. The result: Buyers were holding out for a fire sale and lenders were not pushing assets to market.

Stage II: Bottom in Sight, Limited Liquidity, a Few Buyers and Secured Creditors Starting to Lose Patience

In this second stage, distressed acquisition funds and strategic buyers consider acquiring distressed businesses which were market leaders or niche players. Troubled entities were selling, but in relatively small numbers. Since buyers focused on businesses that complement their own, deals remained hard to close and prices remain low. Moreover, the recovery of the equity markets ahead of the grassroots economic recovery created a price expectation gap. In some cases, existing lenders to a distressed target were financing the acquisition to avoid even lower pricing.

With trouble continuing to plague creditors, insufficient liquidation values to drive “going concern” sales and few buyers, Stage II was not conducive to a high volume of distressed M&A activity.

Stage III: The Future: Exiting the Recession, Increased Liquidity, More Buyers and Impatient Secured Creditors

As mentioned, distressed M&A activity in the coming months will depend on whether the recovery tracks the “V” shape; a long, gradual incline; or the slower and bumpier “W” model. With a quick recovery, fewer businesses will be sold as increased cash flow will sustain them through the recovery. Traditional M&A activity appears to be returning but the targets remain few and far between.

If the recovery stalls or becomes a bumpy “W,” creditors who have been patient may finally start pulling triggers. With floor asset and going concern values being hit and with the return of some liquidity, the pieces are in place for increased distressed M&A activity in 2011 should the recovery stall (but not reverse).

For a more detailed analysis, visit:

David F.W. Cohen is a partner with Gowling Lafleur Henderson LLP and the Leader of the firm’s National Restructuring and Insolvency Practice Group. He is also a member of the TMA Board of Directors and the incoming V.P. of Membership for 2011. His contact information can be found here.

Not So Fast - Colleague Warns Not to Get Too Excited Over Black Friday Results

In discussing last week's posting about the success of Black Friday, colleague Peter N. Schaeffer, partner, Carl Marks Advisory Group LLC, warned about getting too excited about the recent results and mentioned his recent newsletter written about the topic. I thought I would share the article with you.

Strong Black Friday sales propelled retail results for November and put retailers and retail investors in giddy moods as visions of sugar plums and hefty sales figures drove stocks higher. Don't be fooled by four days of intense markdowns, record-breaking advertising, dramatic press coverage and, for the first time, the use of the "Black Friday" moniker in most advertising and news reports about the weekend.

Of course, the malls were mobbed. Christmas is less than a month away, and if you were willing to rise at 3 a.m. on Black Friday, plenty of good deals awaited you. Shoppers always pack the malls on Black Friday and the weekend that follows. Our friends in Canada look on with envy at the United States because of the "official" start to the shopping season on the day after Thanksgiving. The rest of the world does not have this shopping delineation and realizes the value of an official start to the holiday, which encourages spending and concentrates advertising and promotions to a tight window.

There is no escaping the fact that sales were strong and certainly encouraging, but let's not forget the margin implications of the radical markdowns and the fact that many people use the holiday weekend to do most of their seasonal shopping. Just how much money remains to be spent is the big question, and will this number propel sales higher than the anemic results of the past two years?

Looking at same store sales results for November, one is struck by the number of retailers with positive numbers. This is in contrast to major negative results in 2008 and 2009. Yet, most retailers are quick to forget what numbers they actually are beating. For example, Abercrombie & Fitch had stellar results for November, with same store sales rising 22 percent. However, last year A&F's same store sales dropped 17 percent, and in 2008 they dropped 28 percent. It's amazing how once A&F learned to promote itself, sales went up. But, if you look at its same store results over the past three years, the company is actually doing only 73 percent of the business that it was doing in 2007. Obviously, the numbers are not entirely accurate due to store closings and other factors but still reflect the sad fact that many retailers have lost significant business over the past several years.

Some of this loss has moved to the Internet, where record sales are made daily and sales penetration is eroding results of the brick-and-mortar stores. This year, the proliferation of free shipping, by just about everyone on the Web, will impact Web margins which, in the case of brick-and-mortar stores with strong online businesses, already reflect the sale prices available in the stores.

Reports from the field regarding sales this past weekend were mixed but generally soft. There is no indication that Black Friday's strong showing is continuing. With the exception of the luxury sector, it looks as though 2010 results will be better than 2009, but not by much. The luxury sector continues to outperform as wealthy patrons are less intimidated than they were last year and are returning to their favorite retail haunts. In addition, solid results on Wall Street and the weakened dollar have propelled luxury sales in New York, which can affect total sales due to the size of the New York market.

We don't want to be Scrooge and ruin the holidays with dour comments and a bleak outlook, but don't be naive and believe all that you read, because the retail economy isn't nearly as good as it seems.