Four Principles to Consider When Choosing an Exit Financing Lender
The following article is excerpted from a recent GE Lending Views Newsletter.
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As the national economy shows signs of a recovery, an increasing number of bankrupt businesses are shifting their focus away from court-ordered protection toward a restoration of profitable operations. Exit financing plays a key part in such recoveries, and as experts from Wharton and GE Corporate Financial Services observe, understanding a few key principles can help companies navigate a process that can be both complex and dynamic. Following this discussion, a Case Study involving Kmart Holding Corporation (NASDAQ: KMRT), will show how this process can be made actionable.
The Strategy Shift
During the first half of 2003, only 76 publicly held companies filed for Chapter 11 bankruptcy protection, according to a PriceWaterhouseCoopers study. The number represents the fewest bankruptcy filings during any six-month period since the first two quarters of 2000, and is a significant decline from the 114 recorded in the first half of 2002. The results are even more encouraging when "large" bankruptcies, defined as those with assets of $3 billion or more at filing, are considered separately. Only three such filings were made during the first half of 2003, compared to eight "large" bankruptcies in the prior-year period. But despite the encouraging trend, GE Corporate Financial Services' Senior Vice President Penny Friedman notes that as more companies focus on exiting Chapter 11 they may encounter new challenges.
"During the past few years, many companies became familiar with Chapter 11 as ripple effects from the economic downturn and from negative trends in the travel, telecommunications and high-tech sectors spread to suppliers and other companies," says Friedman. Companies soon realized that there are three primary ways of exiting bankruptcy:
1. Conversion to a liquidating Chapter 11 or Chapter 7.
2. Engage in a 363 sale (named after the applicable section of the bankruptcy code), which involves the sale of a debtor's selected assets or business units free and clear of virtually all liens, claims and interests.
3. Reorganize and emerge as a viable concern.
The third alternative, emerging from Chapter 11 with a fresh start, can be a very positive step. "But CFOs and other top executives should be aware that a number of challenges may arise during the exit process," says Friedman. "One significant concern involves securing exit financing during this critical time-and that means identifying a lender that understands the many issues involved in emerging from bankruptcy."
The Chapter 11 Process is Simplified, But It's Far From Simple
The Bankruptcy Reform Act of 1978 restructured the bankruptcy court system and overhauled the nation's bankruptcy laws in an attempt to conform to modern commercial transactions, observes Wharton Assistant Professor of Finance HÃ¼lya K. K. Eraslan. "The revised bankruptcy process, along with lower interest rates, has helped to slash the time it can take to emerge from bankruptcy," she says. "From about 1979 through the 1990s, it took an average of two to two-and-a-half years; now that time's down to about a year-and-a-half." Eraslan adds, though, that a successful recovery involves regaining the market's confidence. "It means acknowledging that there was a problem, and letting suppliers and others know that the problem has been solved," she says. "This may involve securing exit financing."
Developing Trends in The Exit-Financing Arena
As businesses in general begin to recover, some trends appear to be developing in the exit-financing segment. "Although banks, which provided pre-petition financing, continue to exhibit some hesitancy about providing exit financing, we're seeing other kinds of lending institutions-including GE Corporate Financial Services-offering cash-flow-based exit financing that taps into the rating-driven market with large term B loans and a small revolver," says Friedman. "Recent examples include Hayes Lemmerz International Inc., the leading global supplier of automotive components; and Laidlaw International Inc., which provides specialized transportation services."
In conjunction with its emergence from chapter 11, Hayes Lemmerz closed an $800 million exit-financing facility that includes: a $100 million senior secured revolving credit facility maturing in five years; a $450 million senior secured term loan facility maturing in six years; and $250 million of senior unsecured notes that mature in seven years. Separately, Laidlaw's exit-financing package was valued at $1.225 billion and includes a $625 million Term B loan. Overall, says Friedman, the market for exit financing is expanding. "It's a cyclical market that is now reemerging," she observes. "The opportunities for companies are definitely out there. But making the most of them means having a thorough understanding of your position and finding an experienced, flexible lender that's willing to go the extra distance for you."
Exit financing can be a complex process. But the following principles may assist emerging companies that are looking for a lender:
1. Focus Early And Use An Exit-Financing Lender That Delivers On Its Promises.
As part of a plan of reorganization, exit financing can be very complicated. Addressing the issue at an early stage can help to relieve time and other pressures. But be sure your exit-financing lender has the track record and resources to follow through on its commitments.
2. Know Your Needs Before Talking To A Lender.
While the debtor often wants enough funds to address liquidity concerns without being overloaded with debt, your creditors may want you to maximize debt load so they can be paid in full. The right lender will work with you to forge an agreement that reasonably satisfies the needs of all the parties.
3. Identify A Lender Who Can Meet The Timing Requirements Of The Process.
It's critical for your lender to have an experienced and extensive team dedicated to keeping the debtor on a path to emergence from bankruptcy. Both you and a potential lender can save time if detailed information is available early in the process. Among other efforts, it may mean gathering information about your particular circumstances and presenting it in a package for review by potential lenders. Such an information package typically includes the following:
1. At least three full years of historical financial statements
2. Year-to-date financial statements for the most recent year and the same period in the prior year
3. Business plan/projections (including projected cash requirements and detail on all assumptions in the model) covering the anticipated term of the exit financing
4. Draft plan of reorganization
5. Detailed information on collateral for asset-based loans
4. Take A Realistic Look at Your Circumstances.
Assessing your company's current status, revenue and expense projections, and business plans-and then considering them from a lender's point of view-could help to determine the type of financing that might be available.
A Case Study:
In May 2003, Kmart Holding Corporation (NASDAQ: KMRT) announced it was emerging from Chapter 11, signaling it had achieved the key objectives outlined in the Plan of Reorganization. As part of its emergence, Kmart successfully secured $2 billion in exit financing. As administrative agent in the transaction, GE Corporate Financial Services provided a $475 million commitment at the close - the largest commitment among the lenders. The combination of a committed, experienced lender and a top-flight management team helped Kmart to regain its direction and move forward in a timely manner.
In May 2003, Kmart Corporation announced it was emerging from Chapter 11, signaling it had achieved the key objectives outlined in the Plan of Reorganization that was confirmed on April 23, 2003 by the U.S. Bankruptcy Court for the Northern District of Illinois.
As Kmart President and Chief Executive Officer Julian C. Day explained, the time the company spent in Chapter 11 enabled it to strengthen the balance sheet, significantly reduce liabilities, close stores, renegotiate onerous lease agreements, develop a more disciplined, efficient organization and lower overall operating costs. As part of its emergence, Kmart successfully secured $2 billion in exit financing, which provided continued assurance to vendors and landlords about the viability of the company's liquidity. As administrative agent in the transaction, GE Corporate Financial Services provided a $475 million commitment at the close - the largest commitment among the lenders.
GE's relationship with the respected retailer dates back to January 2002 when GE provided a $500 Million commitment as part of Kmart's $2 billion Debtor-in- Possession (DIP) facility. That gave GE the opportunity to work closely with Kmart during the Chapter 11 period, and positioned GE to begin proposing Exit Financing facilities in December 2002.
GE's timeliness in proposing a well structured facility, and its large commitment and desired hold level reduced the syndication risk to Kmart. As part of the package, GE also fielded a responsive deal team that had extensive experience in the retail industry. The combination of a committed, experienced lender and a top-flight management team helped Kmart to regain its direction and move forward in a timely manner.
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