Distress Investing: Principles and Technique »

Martin J. Whitman is Chairman and co-CIO of Third Avenue Management LLC. He has taught courses in value investing and distressed investing for the past thirty years at the Schools of Management at both Syracuse University and Yale University. Whitman is also the author of the Wiley titles Value Investing and The Aggressive Conservative Investor.

Fernando Diz is the Martin J. Whitman Associate Professor of Finance and Director of the Ballentine Investment Institute at Syracuse University. His research specialties are in the areas of trading, derivative securities, and value and distress investing. Diz has written for the Journal of Futures Markets, the Review of Financial Studies, and the Journal of Alternative Investments.

Financial innovation, new laws and regulations, and the financial meltdown of 2007-2008 are just a few of the forces that have shaped, and continue to shape, today's distress investment environment. Combine this with the fact that the discipline of distress investing doesn't always follow what conventional wisdom says, and you can see why it is one of the most challenging areas in finance.

Nobody understands this better than Martin Whitman—the legendary founder of Third Avenue Management LLC and a pioneer in the field of distressed markets—and leading academic Dr. Fernando Diz of Syracuse University. That's why they decided to write Distress Investing. As an outgrowth of annual distress and value investing seminars the two have taught together at Syracuse University's Martin J. Whitman School of Management, this reliable resource will help you gain a better understanding of the essential principles and techniques associated with distress investing and show you how to effectively apply them in the real world.

Divided into four comprehensive parts—the General Landscape of Distress Investing, Restructuring Troubled Issuers, the Investment Process, and Cases and Implications for Public Policy—this book comprehensively covers the practice of buy-and-hold investing in distressed credits, whether it be performing loans or the reinstated issues of a reorganized issuer.

From the recent changes to U.S. bankruptcy code and creditor rights to cash bailouts, you'll quickly learn how to analyze distressed situations such as pricing issues, arbitrage opportunities, tax disadvantages, and the reorganization of funding plans. Along the way, case studies of both large and small distress investing deals—from Kmart to Home Products International—will give you a better perspective of the business.

Critical topics addressed throughout these pages include:

• Chapter 11 bankruptcy and why it's not considered an ending, but rather a beginning when it comes to distress investing

• The "Five Basic Truths" of distress investing

• The difficulty of due diligence for distressed issues

• Distress investing risks from reorganization risk to risk associated with the alteration of priority of payments in bankruptcy

• Valuing companies by both going concern as well as their resource conversion attributes

In today's turbulent economic environment, distress investing presents some enticing opportunities. Put yourself in a better position to excel at this endeavor with Distress Investing as your guide.

Foreword.

Preface.

Acknowledgments.

PART ONE: The General Landscape of Distress Investing.

CHAPTER 1: The Changed Environment.

Trends in Corporate Debt Growth and Leverage before the Financial Meltdown of 2007–2008.

Junk Bonds and the Levering-Up Period.

The Syndicated Loan Market and Leveraged Loans.

Financial Meltdown of 2007-2008.

Principal Provisions of the 2005 Bankruptcy Act as They Affect Chapter 11 Reorganizations of Businesses.

CHAPTER 2: The Theoretical Underpinning.

What Market?

Toward a General Theory of Market Efficiency.

External Forces Influencing Markets Explained.

What Risk?

Capital Structure and Credit Risk.

Valuation.

The Company as a Stand-Alone Entity.

Control and Its Vital Importance.

CHAPTER 3: The Causes of Financial Distress.

Lack of Access to Capital Markets.

Deterioration of Operating Performance.

Deterioration of GAAP Performance.

Large Off-Balance-Sheet Contingent Liabilities.

CHAPTER 4: Deal Expenses and Who Bears Them.

Attorneys and Financial Advisers’ Compensation Structure and the Distribution of the Fee Pie.

Time in Chapter 11 and Number of Legal Firms Retained.

Determinants of Legal Fees and Expenses.

Determinants of Financial Advisers’ Fees and Expenses.

Can Professional Costs Be Excessive?

Appendix.

CHAPTER 5: Other Important Issues.

Management Compensation and Entrenchment.

Tax and Political Disadvantages.

CHAPTER 6: The Five Basic Truths of Distress Investing.

Truth 1: No One Can Take Away a Corporate Creditor's Right to a Money Payment Outside of Chapter 11 or Chapter 7.

Truth 2: Chapter 11 Rules Influence All Reorganizations.

Truth 3: Substantive Characteristics of Securities.

Truth 4: Restructurings Are Costly for Creditors.

Truth 5: Creditors Have Only Contractual Rights.

PART TWO: Restructuring Troubled Issuers.

CHAPTER 7: Voluntary Exchanges.

Problems with Voluntary Exchanges.

The Holdout Problem Illustrated.

Making a Voluntary Exchange Work.

Tax Disadvantages of a Voluntary Exchange versus Chapter 11 Reorganization.

CHAPTER 8: A Brief Review of Chapter 11.

Liquidations and Reorganizations.

Starting a Case: Voluntary versus Involuntary Petitions.

Forum Shopping.

Parties in a Chapter 11 Case.

Administration of a Chapter 11 Case.

The Chapter 11 Plan.

CHAPTER 9: The Workout Process.

Parties and Their Differing Needs and Desires.

Types of Chapter 11 Cases.

Leverage Factors in Chapter 11.

PART THREE: The Investment Process.

CHAPTER 10: How to Analyze: Valuation.

Strict Going Concern Valuation.

Resource Conversion Valuation.

Liquidation Valuations.

CHAPTER 11: Due Diligence for Distressed Issues.

CHAPTER 12: Distress Investing Risks.

Risks Associated with the Alteration of Priorities.

Risks Associated with Collateral or Enterprise Valuation.

Reorganization Risks.

Other Risks.

CHAPTER 13: Form of Consideration versus Amount of Consideration.

PART FOUR: Cases and Implications for Public Policy.

CHAPTER 14: Brief Case Studies of Distressed Securities, 2008-2009.

Performing Loans Likely to Remain Performing Loans.

Small Cases.

Large Cases.

Capital Infusions into Troubled Companies.

CHAPTER 15: A Small Case: Home Products International.

The Early Years.

Growth by Acquisitions.

Retail Industry Woes.

The Fight for Control.

Amendment of Indenture and Event of Default.

The Decision: Prepackaged Chapter 11.

Treatment of Impaired Classes under the Plan.

Financial Means for Implementation of the Plan.

Going-Concern and Liquidation Valuations.

CHAPTER 16: A Large Reorganization Case: Kmart Corporation.

Landlords and Unexpired Leases.

Vendors and Critical Vendor Motions.

Management and KERPs Pre-2005 BAPCPA.

Fraudulent Transfers.

Subsidiary Guarantees and Substantive Consolidation.

Chapter 11 Committees and Out-of-Control Professional Costs.

Blocking Positions.

Buying Claims in Chapter 11.

Debtor-in-Possession Financing.

Kmart’s Plan of Reorganization and Plan Investors.

Investment Performance.

CHAPTER 17: An Ideal Restructuring System.

Feasibility and Cash Bailouts.

Good Enough Rather Than Ideal.

Highly Beneficial Elements in the U.S. Restructuring System.

Goals of an Ideal Restructuring System.

Suggested Reforms.

Notes.

About the Authors.

Index.