Investment Banking Restructuring
A broken business model, a discarded piece of manufacturing equipment that still has 80% of its useful life,
and a determined reader, pursuing expertise in restructuring.
This is not just another industry or product group article.
This is:
The Restructuring Zone.
Normally, restructuring investment banking is known as a standalone group – but every now and then it may be combined with other groups.
At one firm, the team is known as “Financial sponsors, restructuring, and leveraged finance” (I guess the common theme is “debt”).
Here’s what we’ll tackle as we drive past the goal posts in the Restructuring Zone:
- What you actually do in a restructuring, reorganization or recapitalization function.
- Market conditions that lead companies into restructuring.
- Typical assignments, and advising the debtor vs. the creditor.
- Restructuring-specific analysis and financial modeling.
- How to turn around a failing business… if you can.
Pre-Apocalyptic Times: A Brief Introduction
Q: So how’d you get started in Restructuring?
A: I actually joined a well-known group via on-campus recruiting.
But a lot of bankers end up here after working in related groups, such as Leveraged Finance or M&A; you join our group because you decide you want to work on more complex or unusual deals.
Q: Great. So what does your group actually do, at a high level?
A: Mainly valuations, operations forecasting, and liquidity assessments.
The team can also assist with financing, such as for debtor-in-possession (DIP) financing, but for the most part we focus on the 3 items I just mentioned.
Understanding debt is critical for all the analysis in this group: it explains why companies get into trouble, and what they can do to get out of trouble.
Q: On that note, what leads to these restructuring assignments in the first place?
A: The need to “restructure” – to dramatically change a company’s capital structure and/or operations in order to survive – often comes up when:
- A market heads toward a structural downturn where companies must radically change their business model in order to survive (ex: typewriters, film for cameras, a brick-and-mortar bookstore opens an online page to sell books, a chain of video rental stores opens on online channel to deliver video rentals).
- A sponsor-owned portfolio company becomes unable to meet interest payments and required principal repayments. In most cases, the company was acquired in a leveraged buyout (LBO) during a frothy market, and then the market crashed or the company’s business took a turn for the worst immediately after.
- A company raises debt when there’s a “window of opportunity” (read: decides to raise debt just because comparable firms are raising debt), but is unable to service its debt commitments later on.
On a more granular level, they’ll discuss points like the market demand for a company’s products/services and changes in the underlying raw materials costs, and they’ll use those points to explain why the market suddenly shifted (these areas are typically covered by a coverage team).
Q: So those are the trends that lead to restructuring – what about specific catalysts, though?
What events make a firm green light a restructuring process and hire bankers?
A: Here are the most common events:
- Credit rating downgrade (e.g., the company was rated ‘A’ by S&P and then it gets downgraded to ‘BBB’ or ‘BBB-’… or likely something worse than that).
- The company’s customers start delaying payments, or cash collection becomes more difficult (e.g., Accounts Receivable Days doubles within a quarter).
- Limits established by debt covenants are exceeded (e.g., Net Debt / EBITDA cannot exceed 4x but then it increases to 5x or 6x in one quarter).
The decision to restructure is based on a company’s leverage and coverage ratios.
In some cases, a company can be “saved, ” but in other cases, a liquidation or a distressed sale might be the only viable alternative.
Q: And what if I don’t want to go through with the restructuring process?
A: You could always bet on multiple expansion, but I recommend against that one unless you can time travel back to the 1999 stock market…
Q: Good point… finally, where do new restructuring clients come from?
A: Often, they come from industry coverage teams. I have seen cases where the deal team consists of just a sole senior coverage banker, plus a much larger restructuring team.
The Restructuring Landscape: Who Wins at the End of the Game?
Q: In another restructuring article, we mentioned that Blackstone, Lazard, and Houlihan Lokey were some of the top investment banks in this area.
But what makes a top restructuring team, and what do you need as an adviser?
A: Rapport and empathy. A lot of investment banking professionals claim their work is on the client’s behalf, but there are often conflicts of interests – similar to the principal vs. agent dynamic in the insurance sector.
So when a management team picks restructuring bankers, it’s based on the lack of conflicts of interest, the quality of the work the team has done in the past, and how comfortable executives are with the bankers.
Some of it also comes down to the team’s expertise.
Just like there are buy-side and sell-side M&A deals, there are creditor and debtor deals in restructuring. If you’re advising the management team of a company, they’ll almost always prefer teams with more debtor experience.
If you’ve mostly advised creditors in the past, you won’t have as much insight into companies’ operations (which directly factors into the all-important short-term cash flow projections you often create in this industry).
