Tuesday, August 11, 2009


There is an A1 WSJ article this morning, Distressed Takeovers Soar. The main points of the article are that M&A deals are largely occurring in bankruptcy court these days and that many investors are buying the debt to take over financially troubled companies.

I agree that M&A bankers are now spending most of their time on bankrupt M&A deals. This is not because it is a novel way to do a transaction or because it is efficient. No one would ever accuse a bankruptcy M&A process of being efficient. Expensive yes, efficient no. It is simply because in these economic times, corporations are playing it close to the vest and not on acquisition sprees. It is sometimes easier to let a competitor go out of business than to aquire the competitor.

The other main point is that investors are using debt to acquire bankrupt companies. This is the so-called loan to own approach. There are several examples of this technique and the article implies this is now happening everywhere. Au contraire!

Most of these so-called 'loan to own' situations are really as follows. Banks, hedge funds and others make loans to less than stellar companies. The lenders believe they have priced the deal and collateralized it to protect their reasonable downside. The company then underperforms and the debt starts trading down. Some of the banks and mutual funds sell their loans to hedge funds and other distressed investors. These investments are still made with the thought of getting a large enough return to justify the purchase. The investment thesis is not generally, 'hey, let's buy more of the debt at a discount and then we can bid our debt and buy the company'.

The way it often works is that the funds now have one or two rounds of debts purchases at a discount and then the company underperforms again! Now the investors realize that a sale of the company is not imminent at a sufficient price (see Delphi). The next great thought? Hey let's own the company! We can buy it with out debt. Just great, now they are bidding in their debt to own a company which the buyers are not set up to own.

Loan to own works much better when a buyer decides to buy an underperforming company whose debt is trading at a discount. The buyer starts buying the debt at a price under which it will bid for the company. This effectively lowers the buyer's price and protects the buyer against losing the purchase in a bankruptcy. If the buyer is outbid by another buyer, then by definition it will have made a profit on its efforts.

Loan to own, not as a black and white surgical process as you might be led to believe.

Cheers, Mike

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