The Covid-19 pandemic has pushed major consumer brands such as Neiman Marcus, J. Crew, and Gold’s Gym into bankruptcy, but a much larger wave of corporate restructurings is still a ways off.
The reason: unprecedented restrictions combined with government assistance make it hard to predict future demand, determine which businesses might rebound, or accurately attach a value to their assets.
“It’s impossible to value a company right now,” said Christopher Ward, chair of the bankruptcy and financial restructuring practice at Polsinelli PC. “All of your historical projections are based on revenue projections.”
In the meantime, lenders are offering struggling businesses forbearance on loan payments instead of forcing borrowers into default situations and liquidation proceedings.
Doing so would be against their own interest because “their reclamation on collateral is going to be diminished,” Hogan Lovells attorney Erin Brady said.
Letting The Dust Settle
Chapter 11 bankruptcy cases often end in a financial restructuring of the existing business or a sale of the company, with the goal of maximizing asset value to repay as many creditors as possible. A successful transaction is supported by financial analyses that predict future performance.
In the present state of stay-at-home orders, sickened workforces, and a dropoff in global economic activity, there’s not much for even the riskiest investors to feel good about and not much certainty to build out a major restructuring.
“Things have to get better for people to see what companies need to file for bankruptcy,” attorney Monique Almy of Crowell & Moring LLP said. “It’s months down the road, not weeks down the road.”
It’s hard to understate the commercial uncertainties caused by the Covid-19 health crisis. Even companies that were at the finishing line of their bankruptcy cases earlier this year were sent back to the starting position when purchase arrangements fell through at the last minute.
EP Energy Corp. said it essentially started its Chapter 11 restructuring process “from scratch” after Apollo Global Management Inc. and Elliott Management Corp. withdrew plans to finance the shale driller’s $3.3 billion restructuring plan in March.
Alta Mesa Resources Inc., another oil and gas company derailed by an international price war and the pandemic’s drag on demand, was forced to accept a bankruptcy sale in April for $100 million less than the same buyer agreed to pay in January.
Major retailers also have been forced to change course in their bankruptcy cases because storefronts can’t open for business. Both Modell’s Sporting Goods Inc. and Pier 1 Imports Inc. have received permission to take the unprecedented step of mothballing their bankruptcy cases and delaying store closing sales without paying their landlords at least through the month of May.
“In this environment, it’s hard to make a plan when you don’t know what the landscape is going to look like,” Brady said. “Nobody is there to buy this stuff.”
There have already been some notable bankruptcies by companies with underlying problems that predated the pandemic.
Neiman Marcus Group filed for Chapter 11 May 7 with a prearranged plan to shave $4 billion off its balance sheet. The luxury brand’s bankruptcy came just three days after fellow clothing retailer J. Crew Group Inc. sought Chapter 11 relief with a similar plan to convert $2 billion in debt to new equity.
Both companies were also dealing with bloated balance sheets and restructuring pressures before the pandemic. Their carefully tailored bankruptcy plans illustrate what seemed bound to happen anyway.
“The pandemic forced them to accelerate the process, just as it will for many other retail institutions,” said Ward of Polsinelli.
Beyond retail, internet, TV, and phone service provider Frontier Communications Corp. filed for bankruptcy last month with a whopping $17 billion in debt following years of losses.
The April bankruptcies of Whiting Petroleum Corp. and Diamond Offshore Drilling Inc. add to a list of more than 200 U.S. oil and gas companies that have filed for bankruptcy since 2015 because of a prolonged period of depressed commodity prices.
Generally, the major companies that have filed Chapter 11 this year “were already in economic stress,” said Almy.
Time to Evaluate
It takes several months, sometimes up to a year, for large companies to assemble comprehensive restructuring plans ahead of a bankruptcy filing, lawyers say.
Those that don’t allot enough time may fail to adequately test the market for interested buyers, risk backlash from angry creditors, and come up short on value-maximizing solutions.
“If you want to have have a successful Chapter 11 result, you want to have an adequate period of planning before that,” Brady said. “People aren’t going to want to file those cases without having those plans in place, otherwise they’re going to risk it just blowing up immediately.”
To the extent there’s a silver lining for companies facing unsustainable disruption from the coronavirus, it’s that the economy was coasting on a decadelong period of growth before it hit. That period of stability, including most of this year’s first quarter, gives corporate borrowers some leeway with lenders and buys time to develop restructuring plans, Ward said.
“If we were struggling before we went into this it would have been a lot different,” he said. “The distressed funds are going to be circling” as well, he said.
The market for distressed investing had been ripening before the health crisis. According to reports, private equity firms were sitting on roughly $1.5 trillion in deployable cash at the beginning of the year.
But while the pandemic creates distressed investing opportunities, it also impedes funds from fully assessing the market.
To assess risk, investors first need some clarity about the general timeline of an economic recovery and a sense of what a post-Covid business world will look like.
Restrictions on travel and gathering are also disrupting the restructuring process by preventing site visits to take stock of what a company’s collateral may be worth, said Duff & Phelps LLC restructuring specialist Geoffrey Frankel.
Deal-making is also hard to do when interested parties can only speak over the phone or through teleconferencing, said Frankel.
“A lot of the art of restructuring is done in person, face to face,” he said. “People are adapting, obviously, but there’s still no substitute to getting people in a room.”
For additional legal resources, visit Bloomberg Law In Focus: Coronavirus.