Unfortunately, even bondholders that take equity tend not to be model investors. "When you emerge and have creditors who have taken stock in lieu of debt, they don't behave like normal investors," says Carter Pate, U.S. managing partner at PricewaterhouseCoopers. "Instead of thinking of capital appreciation, they're looking at capital retrieval."
Motient Corp. CEO Walt Purnell agrees. His Reston, Virginia-based wireless company exited Chapter 11 last year with only 6 percent of its former debt and a revenue stream that had started to increase. When Motient's growth prospects were slowed by the subsequent bankruptcies of two of its top resellers, Purnell turned to his new investor group, which is largely composed of former bondholders.
"Bondholders tend to be pretty conservative people; they hammer you all the time to cut costs because they always think something terrible is going to happen," says Purnell. He was able to win another $12.5 million credit facility from the group, announced in January, but only at the price of deep internal cuts, including a 29 percent workforce reduction.
Customer Concerns
The optimal source of financing, say experts, is a third-party equity investor that is willing to make a long-term commitment and take part in managing the company. Such backing has proven to yield higher rates of success, according to Hotchkiss, because it both imposes discipline on the company to make radical changes and sends a signal "that at least someone is willing to take a bet on the company and stick with it."
Given those indicators, McLeodUSA Inc. is on firm footing. The midwestern telephone company left Chapter 11 in April 2002 with about $3 billion of its original $4 billion in debt erased and access to up to $160 million in exit financing. Its annual interest payments were sliced by about 90 percent, from $365 million to less than $50 million. The company has also enjoyed the ongoing backing of buyout firm Forstmann Little, which now holds nearly 60 percent of McLeodUSA's equity after investing nearly $1.2 billion in the company.
But investors are not the only ones skeptical of a bankrupt company's future. Even in industries where defaults are common, "customers and employees get very nervous," says Chris A. Davis, who led Cedar Rapids, Iowa-based McLeodUSA through the process as chief operating and financial officer and now chairman and CEO. So nervous, in fact, that Davis, current CFO Ken Burckhardt, and their team took pains to contact customers with phone calls and letters to let them know the company's future plans as they began a strategic overhaul that involved selling $1 billion worth of assets and focusing on only the most profitable customers. They also put a significant portion of the creditor-approved $146 million capital-expenditure budget to work on speeding installation times, improving billing accuracy, and fixing network failure points.
Postbankruptcy, McLeodUSA also made an investment in employee training of around $2.5 million. "We made a decision that anyone who touched the customer or the network had to meet new 'star quality' standards," says Davis, which are aimed at improving the quality of customer service. That led to a companywide skill assessment and certification process, which served "as a vehicle to motivate the workforce" as well as a boon for customers, she says.
These efforts seem to have paid off. Only 1 customer of the top 100 McLeodUSA had hoped to keep left during the bankruptcy process, says Davis. Meanwhile, employee turnover has decreased as much as 75 percent, from levels exceeding 100 percent per year in such departments as customer service and sales. "It's an intangible return," says Burckhardt, "but at the end of the day, it's the employees who are going to make us successful."
Wary vendors can also affect a company's efforts to get back on track. Troy, Michigan-based Lason Corp., a document-management firm, is heavily dependent on temporary staffing firms when big projects come along. Since its bankruptcy filing last year, though, credit terms shrank from as many as 45 days to as few as 7, and "we have lost any sort of favorable pricing, since our vendors want to make back the money they didn't get while we were in Chapter 11," says CFO Doug Kearney.
As a result of that filing, which let the company shed 36 of the 76 companies it acquired between 1996 and 1999 and avoid $80 million in earnout payments, Kearney estimates Lason is paying 5 to 10 percent more for staffing services. Meanwhile, lease rates for new properties are "insane," at 18 to 20 percent, according to Kearney, and letters of credit now require 100 percent collateral plus 15 percent in fees, up from the 1 percent in fees the company typically paid prebankruptcy. The heightened costs mean "your hands are tied" when it comes to managing expenses, says Kearney, with no end in sight. "Maybe things will change when we have 18 months of financial performance behind us, but I expect we'll be fighting these issues for a while."
On The Bright Side
Despite the pitfalls, bankruptcy often remains the best hope to reposition a viable company for long-term growth. "If a firm is worth more alive than dead, or liquidated, you can maximize returns to all constituencies if you just give it some breathing room," says Stuart Gilson, a professor at Harvard Business School. His research shows that companies that attempt reorganization outside of bankruptcy court are 50 percent more likely to fail than those that go into Chapter 11. Why? Bankruptcy proceedings require agreement among a smaller majority of investors than most out-of-court deals, meaning more creditors can be forced into forgiving debt.
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