©2002 ReeseMcMahon, L.L.C., Strictly Confidential
Evaluating Distressed Companies
William J. Henry
August 20, 2002
©2002 ReeseMcMahon, L.L.C.
2
Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Causes of Distress
Perception
ƒ Macroeconomic causes
Recession, interest rates, exchange rates, unemployment rate,
consumer sentiment, “shocks”
ƒ
Industry specific causes
Overcapacity (telecom), global shifts (textile), import limitations
(tariffs), restrictions (environmental), technology
ƒ
Financial causes
Overextended, undercapitalized, inadequate cash flow for debt
service, capex, working capital
ƒ
Operational causes
-
Loss (or addition) of major customer, over-expansion, failed
growth initiatives, failed restructuring initiatives
Reality: Management is the root cause of most distressed businesses
©2002 ReeseMcMahon, L.L.C.
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Financial and Operational Distress
Financial Distress:
Good business, ok cash flow, bad balance sheet
Restructure Debt
Operational Distress – Early Stage:
Ok business, bad cash flow, ok balance sheet
Turnaround
Financial & Operational Distress – Later Stage:
Questionable business, bad cash flow, bad balance sheet
Turnaround & Recapitalize
©2002 ReeseMcMahon, L.L.C.
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Threshold questions
Focus on fundamentals:
1).
Does a viable core business exist?
2).
Can the business be fixed?
3).
Is it worth fixing?
©2002 ReeseMcMahon, L.L.C.
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Threshold questions
Focus on fundamentals:
1).
Does a viable core business exist?
2).
Can the business be fixed?
3).
Is it worth fixing?
Tendencies
Successful
Turnarounds
Unsuccessful
Turnarounds
Severity of decline
Manufacturing efficiency
Turnaround philosophy
Product change
Management turnover
Management focus
Company attributes
Shallow
Lower
Grow revenues
Revolutionary
High
Financial
Deep
Higher
Cut costs
Evolutionary
Low
Operational
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Liquidation or going-concern value?
„When the value of assets exceeds the value of cash flows, the company is a
prime candidate for liquidation or break-up. A partial break-up should be
considered as an alternative to outright liquidation.
Going-concern Value
Partial Breakup Value
Liquidation Value
Asset
Liquidation
Value
Asset
Liquidation
Value
Cash
Flow
Value
Partial
Cash
Flow
Value
Partial
Liquidation
Value
Cash
Flow
Value
Asset
Liquidation
Value
©2002 ReeseMcMahon, L.L.C.
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Liquidation opportunities
ƒ
Purchase of assets in a “363” sale
A faster alternative than purchasing under a traditional plan.
Allowed when a sale satisfies “business judgment test.”
Purchase terms must be cash. “Stalking-horse variation”
ƒ
Purchase through a plan of reorganization
Purchase of assets as part of a confirmed Plan. The Chapter 11
process is stringent and lengthy. (A pre-packaged plan negotiated
out of court can expedite.) Purchase can be structured.
ƒ
Purchase of assets through purchase of claims
Purchase block of claims against the debtor and become a party
to Chapter 11 Plan negotiations. Negotiate for distribution of
assets or foreclose on secured claims.
ƒ
Purchase of assets out of bankruptcy
Purchase assets without court approval. Quick, but may require
consent or waiver of secured creditors. Potential exposure to
involuntary assumption of liabilities.
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Analytical framework for cash flow evaluation
Historical Reconstruction
Forward Projections
Opportunities
Rationalization
Adjustments
Normalization
Adjustments
Separation
Adjustments
Cash Flow
Evaluation
Revenue
Enhancement
Cost
Reduction
Capital
Redeployment
New customers existing products
New products existing customers
New channels
New pricing
New markets
New product technology
Change focus of sales & marketing
New products existing methods
New methods existing products
New process technology
Change production
Change sourcing
Change distribution
Change selling
Change marketing
Change administration
Change scale of operations
Reduce facilities
Reduce receivables
Reduce inventories
Change payables
Reduce other assets
Change investment process
“Left Brain”
“Right Brain”
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Rationalization
Identify the root causes that reduce cash flow and destroy value.
Think amputation, not brain surgery.
Revenue
Terminate unprofitable customers
Discontinue unprofitable products
Change inappropriate pricing policies
Exit unprofitable geography
Remove distractions from core business
Costs
Abandon inefficient production methods
Change inappropriate procurement policies
Reorganize inefficient distribution
Ineffective sales organization
Stop ineffective marketing expenditures
Eliminate redundant personnel
Capital
Sell off or abandon excess capacity
Close and consolidate facilities
Clean-up excess receivables
Liquidate excess inventories
©2002 ReeseMcMahon, L.L.C.
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Chemical Co Valuation
Illustrative – Unadjusted Historical
($ in Millions)
Y1
Y2
Y3
Y4
190
200
210
220
Revenue
15
20
25
20
EBITDA
8%
10%
12%
9%
EBITDA %
100
Low range multiple @ 5
120
High range multiple @ 6
95
Management buyout offer
©2002 ReeseMcMahon, L.L.C.
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Chemical Co Valuation after Rationalization
Illustrative – Adjusted Historical
Original
($ in Millions)
Y4
Y1
Y2
Y3
Y4
220
190
200
200
200
Revenue
20
15
20
30
30
EBITDA
9%
8%
10%
15%
15%
EBITDA %
100
150
Low range multiple @ 5
120
180
High range multiple @ 6
95
Management buyout offer
©2002 ReeseMcMahon, L.L.C.
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Normalization
Identify extraordinary events in the recent past. Understand the effect on
historical financials. Determine relevance as to the future.
Revenue
Price peaks and valleys
Loss of major account
Addition of major account
Costs
Plant closure / expansion costs
Severance / recruiting costs
Wind-down / start-up costs
Asset impairments
Settlement of claims and lawsuits
Contract termination costs
Qualified plan termination costs
Changes in accounting estimates
Loss or gain on sale of surplus equipment
Loss or gain on sale of facilities
Other losses and gains
Capital
©2002 ReeseMcMahon, L.L.C.
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Normalization
Identify extraordinary events in the recent past. Understand the effect on
historical financials. Determine relevance as to the future.
Revenue
Price peaks and valleys
Loss of major account
Addition of major account
Costs
Plant closure / expansion costs
Severance / recruiting costs
Wind-down / start-up costs
Asset impairments
Settlement of claims and lawsuits
Contract termination costs
Qualified plan termination costs
Changes in accounting estimates
Loss or gain on sale of surplus equipment
Loss or gain on sale of facilities
Other losses and gains
Capital
©2002 ReeseMcMahon, L.L.C.
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Separation
Identify shared corporate resources/activities of divested businesses.
Understand impact on historical financials. Validate replacement cost for
needed resources and determine adjustments for “de-consolidated”
financials.
Revenue
Inter-company product sales
Inter-company service revenues
Customers, distributors, sales reps
Costs
Plant, warehouse, office space
HR, benefits, insurance
Systems, accounting, treasury, tax, legal
Suppliers and service providers
Capital
Bank credit
Trade credit
Cash collections and disbursements
©2002 ReeseMcMahon, L.L.C.
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Separation
Identify shared corporate resources/activities of divested businesses.
Understand impact on historical financials. Validate replacement cost for
needed resources and determine adjustments for “de-consolidated”
financials.
Revenue
Inter-company product sales
Inter-company service revenues
Customers, distributors, sales reps
Costs
Plant, warehouse, office space
HR, benefits, insurance
Systems, accounting, treasury, tax, legal
Suppliers and service providers
Capital
Bank credit
Trade credit
Cash collections and disbursements
©2002 ReeseMcMahon, L.L.C.
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Rebuilding the past
Reconstruct historical financials to reflect “left side” adjustments.
Unadjusted
Historical
Rationalization
Adjustments
Normalization
Adjustments
Separation
Adjustments
Value added
Adjustment Layers
Cash
Flow
Value
Observations:
• Rationalization adjustments almost always add to value and can be very significant
• Normalization adjustments usually add to value, but are often overestimated
• Separation adjustments almost always subtract from value and are often underestimated
Change in value
based on historical
reconstruction
Value lost
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
22
Analytical framework for cash flow evaluation
Historical Reconstruction
Forward Projections
Opportunities
Cash Flow
Evaluation
Revenue
Enhancement
Cost
Reduction
Capital
Redeployment
Rationalization
Adjustments
Normalization
Adjustments
Separation
Adjustments
New customers existing products
New products existing customers
New channels
New pricing
New markets
New product technology
Change in focus
New products existing methods
New methods existing products
New process technology
Change production
Change sourcing
Change distribution
Change selling
Change marketing
Change administration
Change scale of operations
Reduce facilities
Reduce receivables
Reduce inventories
Change payables
Reduce other assets
Change investment process
“Left Brain”
“Right Brain”
©2002 ReeseMcMahon, L.L.C.
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Opportunities
Identify opportunities that add value on a prospective basis. Focus on
lower risk opportunities first.
Cost
Reduction
Opportunities
Revenue
Enhancement
Opportunities
Capital
Reduction
Opportunities
Risk
Adjusted
Valuation
Higher
Average
Realization risk
Lower
Composite
Analyze
Synthesize
Quantify the opportunity for value creation in risk-adjusted terms
©2002 ReeseMcMahon, L.L.C.
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Cost Reductions
Identify opportunities for savings. Focus on what can be changed. Cost
reduction is the first priority for companies in distress.
Potential cost reduction areas
Manufacturing and distribution:
ƒ Increase efficiency with new manufacturing methods
ƒ Increase utilization by consolidating production facilities
ƒ Reduce material costs by changing supply chain
ƒ Increase efficiency through better procurement
ƒ Increase distribution efficiency by concentrating coverage
Operating expenses:
ƒ Reduce selling expense by shrinking focus
ƒ Reduce engineering costs by consolidating parts and platforms
ƒ Reduce marketing costs by targeting customers
ƒ Reduce administrative costs by simplifying process
ƒ Reduce headcount by reducing organizational complexity
Non-operating expenses:
ƒ Better management of debt structure, foreign exchange, tax
©2002 ReeseMcMahon, L.L.C.
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Capital Redeployment
Identify opportunities to redeploy capital freed up by combining operations.
Fixed Capital
Sell under-utilized plant, warehouse, office space
Sell under-utilized manufacturing, distribution equipment
Sell under-utilized computer, office equipment
Working Capital
Reduce receivables by improved collections effort
Reduce inventory with better delivery
Systems, accounting, treasury, tax, legal
Extend payables with better credit
Investments
Sell non-core business segments
Liquidate marketable securities
Liquidate corporate-owned life insurance
©2002 ReeseMcMahon, L.L.C.
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Revenue Enhancement
Identify opportunities to enhance revenues. Be skeptical and estimate
conservatively. Then reduce your estimate by half….
Potential revenue enhancement areas
Reported* success rates
Revenue enhancements
Sales of existing products to new customers
Sales to new geographical markets
Sales through new distribution channels
Sales of new products
Sales from improved customer service capability
Sales from higher prices / reduced competition
Sales from higher efficiency of sales force
Sales from cross selling
45%
42%
32%
34%
32%
n/a
26%
25%
* Source: KPMG Global Research Report
©2002 ReeseMcMahon, L.L.C.
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Projecting the Future
Build on reconstructed historical to include “right side” adjustments.
Reconstructed
Historical
Cost
Reduction
Value added
Adjustment Layers
Cash
Flow
Value
Observations:
• Cost reduction opportunities almost always add real value, but are often overestimated
• Capital redeployment usually adds to value, but timing is usually underestimated
• Revenue enhancements almost always are overestimated
Change in value
over reconstructed
historical
Capital
Redeployment
Revenue
Enhancements
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Putting it all together
Combine adjustments with appropriate risk weighting to determine value.
Cost Reduction
Opportunities
Rationalization
Adjustments
R3
R3
Risk Adjusted
Value
R3
R2
Capital
Redeployment
Normalization
Adjustments
Historical
Performance
Separation
Adjustments
R4
R1
Revenue
Enhancement
R0
Increasing risk
©2002 ReeseMcMahon, L.L.C.
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Agenda
Overview of distressed business
Liquidation
Analytical Framework
Historical Analysis
Projected Opportunities
Risk Adjusted Valuation
Investor Considerations
©2002 ReeseMcMahon, L.L.C.
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Sharing of Incremental Value
Portion
captured by
seller
Portion
captured by
buyer
Competition for deals drives up acquisition price. In public deals, evidence
suggests most of the benefit is captured by shareholders of the seller.
Competition for distressed companies is not nearly as intense. Opportunity
for investors?
Acquisition Price
Value
Incremental value
0%
100%
Deal range
©2002 ReeseMcMahon, L.L.C.
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Potential Value to Investor
Illustrative Value
Best for
Investment
Best for
Liquidation
High
Expected Value Potential
„ Rationalization
„ Cost reduction
„ Capital redeployed
Low
Later
Earlier
Stage of Operational Distress
„ Financial distress only
„ Operational distress only
„ Financial and operational distress
©2002 ReeseMcMahon, L.L.C.
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Other Investor Considerations
Avoid businesses with battle fatigue.
Long-standing distress is much more difficult to resolve.
Look for profitability in recent past.
Ancient history is useless as a reference point
Be close to the business.
Industry knowledge greatly enhances chance of success
Understand specifics.
Be sure you know what went wrong and how it can be fixed
Search for ignorance.
Find problems before they find you
Look for happy customers.
Internal problems are temporary, angry customers are forever
Keep it simple.
Complexity kills time, money and distressed businesses
©2002 ReeseMcMahon, L.L.C.
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William J. Henry
William J. Henry has more than 25 years of experience in corporate financial management, including mergers and acquisitions,
restructurings, turnarounds, business planning and financial analysis. In addition to a comprehensive background in finance, tax,
accounting and treasury, he has experience with international and multi-stage manufacturing operations, foreign currency issues,
minority interests and intricate ownership structures. His industry experience includes process and discrete manufacturing,
distribution and service industries.
Strategic Finance
Henry has analyzed the financial implications of a wide range of strategic corporate events including acquisitions, divestitures,
recapitalizations and reorganization. He has created business reporting systems that integrate financial, operational and marketing
metrics. Specific areas of expertise include financial analysis, cost accounting and cross-border transfer pricing for multistage
manufacturing.
Corporate Recovery
Henry has completed several corporate reorganizations and restructurings. He restructured a struggling computer reseller that was
later merged into another entity – a transaction that captured significant tax benefits. He directed the wind down of a non-viable
industrial air-dryer manufacturer. He managed the foreclosure, restructuring and subsequent workout of a failed homebuilder,
ultimately achieving a full return of invested funds for the private-placement investor.
Transaction Services
Henry has performed due diligence and analytical support for numerous M&A transactions on both the buy-side and sell-side. He has
arranged financing for acquisitions and expansions with bank debt, revenue bonds, subordinated debt and mezzanine financing. He
has developed robust analytical tools for corporate valuation, cash planning and financial simulation to evaluate target entities both on
an historical and prospective basis.
Industry
Henry has experience in manufacturing, distribution, natural resources, energy and service industries, more specifically including
factory automation, motion control, fluid power, metal-forming and fabrication, oil and gas, chemicals, mining and cogeneration.
Previous Positions
Prior to joining ReeseMcMahon, Henry served as chief financial officer for Signa Group, Inc., responsible for the financial functions of
numerous North American client companies, including CKD Corporation, a factory automation manufacturer headquartered in
Nagoya, Japan. He developed a multi-lingual and multi-currency financial consolidation system and developed techniques for
managing dividend repatriation and optimizing foreign tax credits. A major accomplishment was the structuring, negotiation and
successful closing of a sale of several manufacturing companies in a $70 million stock transaction.
Prior to joining Signa, Henry served as a vice president of ANGUS Petroleum, a startup venture funded by Pacific Gas and Electric,
where he negotiated several acquisitions, divestitures and joint operating agreements. Prior to joining ANGUS, he worked in various
positions at IMC Global, most recently providing analytical support for key decisions including major investments, strategic alliances,
acquisitions and corporate financing alternatives.
William J. Henry
Managing Director,
ReeseMcMahon, L.L.C.
303 West Erie Street,
Suite 310
Chicago IL 60610
p: 312.397.3100
f: 312.397.1050
e: whenry@
reesemcmahon.com
Education
MBA,
University of Chicago
B.S., computer systems
engineering, University of Illinois
at Chicago
Professional Memberships
Association of Corporate
Growth
Financial Executives
International
Interests
Board Member, The Signa
Group, Inc.
Skills
Conversational Japanese