Distressed Debt Slides_Melissa Brady

©2016 RSM US LLP. All Rights Reserved.©2016 RSM US LLP. All Rights Reserved.
VALUATION METHODOLOGIES OF
VARIOUS DEBT PRODUCTS
Melissa Brady, CFA
Phone: 212-372-1296
Email: Melissa.Brady@RSMUS.com
Website: www.RSMUS.com
September 26, 2016

©2016 RSM US LLP. All Rights Reserved.
Distressed Debt Overview
• What is distressed debt?
• How does distressed debt differ for the middle
market?
• What are the underlying factors that cause
inefficiencies in the distressed market?
- Complexity
- Illiquidity
- Stigma
- Information asymmetries
- Investor disqualifications
2

Causes
• Aggressive lending (weak terms)
• Macro conditions
• Company performance
• Accounting vs. Reality
• Fraud / negative news
• Covenants / acceleration
• Maturities
• Liquidity
• Bankruptcy / emergence
• Securities prices
• Lack of confidence
• Forced Sellers
3

Distressed Debt Valuation
• Traditional models breakdown and tend to
overestimate value.
• Valuation Approaches
- Income approach using distressed rates of return
- Net recovery approach in assessing collateral
coverage
- Weighted approaches with going concern and
liquidation
- Simulation / scenario approach
4

Recovery Rates
5
• Academic papers
• Studies
• CEPRES Data – Private Debt & Mezzanine
Market Report
• S&P Global Market Intelligence & LSTA
• Moody’s Annual Default & Recovery Studies
• Other

Academic Study: Recovery By Instrument
6
Instrument Type # of Obs. Mean Recovery
Rate
Revolvers 254 82.45%
Term Loans 209 70.49%
Senior Secured Bonds 218 58.90%
Senior Unsecured Bonds 483 52.69%
Senior Subordinate Bonds 148 28.79%
Subordinate Bonds 120 25.79%
Junior Bonds 17 18.36%
Source: Debt Structure, Market Value of Firm, and Recovery Rate by Min Qi and
Xinlei Zhao. Office of the Comptroller of the Currency. Economics Working Paper
2011-2, October 2011. Sample is from Moody’s Ultimate Recovery Rate Database.

Syndicated Loan Study: Recovery Rates
7
Instrument Type Recovery
Rate
Weighted
Recovery Rate
First Lien Term Loans 76.6% 80.7%
Second Lien Term Loans 36.9% 57.6%
All Term Loans 74.4% 80.1%
Secured Bonds 56.3% 55.4%
Senior Unsecured Bonds 43.8% 41.4%
Subordinate Bonds 29.3% 28.7%
Junior Subordinate Bonds 22.8% 26.8%
Source: S&P Capital IQ LossStats & LCD
Recoveries for 410 leveraged syndicated term loans that defaulted between 1998
and 2015 based on LCD’s database.

Recovery Rates by EBITDA
8
EBITDA Level First Lien Term Loan
Recoveries by
EBITDA
(Approximate)
Negative 60%
Positive 77%

Recovery Rates by Industry
9
Industry Recovery
Printing & Publishing 64.8%
Telecom 68.1%
Gaming & Hotel 68.2%
Chemicals 68.8%
Healthcare 69.9%
Utilities 72.9%
Computers and Electronics 73.8%
Automotive 85.8%
Entertainment & Leisure 89.2%
Radio 91.0%

Distribution of Recovery Rates
10
Distribution of First Lien
Recoveries
Recovery
< 50% 25.4%
50% to 70% 12.9%
70% to 90% 11.5%
90% or More 50.2%

Recovery Rates for Balance Sheet Assets
11
Example:
• Cash – 100% recoverable
• Accounts Receivable – 75% to 85% recoverable
• Inventory – 50% to 80% recoverable
• Fixed assets – 50% recoverable
• Intangible assets – 0%
• Prepaid assets – 0%
• Other assets – 0%
The rates above are for illustrative purposes only. Recovery rates vary by
industry and by company.

Example 1 – Plant Nursery Business
12
Balance Low High Low High
Current Assets:
Cash & Cash Equivalents 3,040$ 0% 0% -$ -$
Accounts Receivable 2,973 70% 80% 2,081 2,378
Prepaids 5,225 0% 0% - -
Inventory 250,257 15% 25% 37,539 62,564
Other Current Assets - 0% 0% - -
Total Current Assets 261,495$ 39,620$ 64,943$
Net Fixed Assets 18,368 40% 60% 7,347 11,021
Intangible Assets 12,667 0% 0% - -
Total Other Assets 12,667$ -$ -$
Total Assets Supporting Debt 292,530$ 46,967$ 75,963$
Less: Revolver 31,035 31,035 31,035
Collateral Supporting First Lien 261,495 15,932 44,928
First Lien Term Loan A 75,000$ 75,000$ 75,000$
First Lien Coverage 21.2% 59.9%

Example 2: Sun Block Retail (Part I of II)
13
($ in thousands) Low Range High Range
Valuation Valuation
Balance Adjustments Adjustments Low High
Current Assets:
Cash 80$ 100% 100% 80$ 80$
Accounts Receivable 6,990 75% 85% 5,243 5,942
Inventories 6,018 90% 90% 5,416 5,416
Other Current Assets 2,065 0% 0% - -
Total Current Assets 15,153$ 10,739$ 11,438$
Net Fixed Assets 1,445$ 45% 55% 650$ 795$
Intangible Assets 16,564 0% 0% - -
Brands - N/A N/A 12,496 14,995
Other Assets 964 0% 0% - -
Total Other Assets 17,528$ 12,496$ 14,995$
Total Assets 34,126$ 23,885$ 27,228$

Example 2: Sun Block Retail (Part II of II)
14
($ in thousands)
Low -- High
Available for Paydown 23,885$ 27,228$
Less: Senior Debt 13,322 13,322
Residual Coverage 10,563$ 13,906$
Less: Subordinated Debt 17,854 17,854
Residual Value to Common -$ -$
Subordinated Debt Coverage 59.2% 77.9%

Considerations
• Factors behind market approach limitations.
- Choosing only distressed firms may be
problematic if there is few available.
- Adjust multiple for distress (highly challenging)
• Factors behind income approach limitations.
- Using distressed discount rates of 30% or
higher may overestimate value.
• Use multiple methods, if possible.
15

Example 3: Market Approach – Service Co.
16
Low -- High
Adjusted EBITDA 5,355$ 5,355$
EBITDA Multiple 6.5x 7.0x
Implied Enterprise Value 34,808$ 37,485$
Plus: Sponsor Committed Equity Infusion 2,500 5,000
Plus: Cash 248 248
Available for Paydown 37,556$ 42,733$
Less: Senior Debt 25,249 25,249
Residual Value For Subordinated Debt 12,307 17,485
Less: Subordinated Debt 29,045 29,045
Subordinated Debt Coverage 42% 60%
Valuation Range

Example 3: Income Approach – Service Co.
17
Sensitivity Analysis - Implied Price of Debt Based on Following Concluded Yields
27.00% 28.00% 29.00% 30.00% 31.00% 32.00% 33.00%
71.3% 69.6% 67.9% 66.3% 64.7% 63.2% 61.7%
Concluded Price of Debt (% of Par) 63.2% -- 69.6%

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Distressed Debt Slides_Melissa Brady

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