In fact, simply going through the bankruptcy process often creates brighter prospects, say CFOs who have done it. "Once we stopped paying interest, we had plenty of [cash] to run the business," says Chiquita Brands International Inc. CFO James Riley. Two years ago, Cincinnati-based Chiquita filed for bankruptcy protection after an $84 million bond payment came due against a cash balance of less than $70 million. The company's problem — namely, an oversized debt load geared to an expansion plan that had been squashed by European Union trade restrictions — "was fixable," and well served by the relief Chapter 11 afforded, says Riley, who joined as CFO in January 2001.
Since most of the debt was at the holding company, Chiquita's 400 operating units were untouched, meaning vendors and creditors were paid in the ordinary course of business, says Riley. Customers stuck with the company. Along with swapping $861 million in debt plus accrued interest for a $250 million new bond issue and 95.5 percent of the new equity, Chiquita was able to write down a profit-draining unit in Panama without violating loan covenants, thanks to "fresh-start" accounting.
Still, 2002 was a tough year for Chiquita, due to global competition depressing banana prices as well as the costs associated with the restructuring. The company ended the year with a fourth-quarter EBITDA that was 72 percent below the previous year's figures. While last quarter saw a healthy profit, Moody's Investors Service analyst Helen Calvelli cautions that the EU may strike again, with a decision expected in 2006 that could curb Chiquita's long-term sales prospects.
Tell It To The Judge
Chiquita's mixed results illustrate the difficulty of assessing postbankruptcy success, particularly in a recession. "You would like to see profits almost immediately after emergence, if you haven't already," says Whyte. "But when whole industries are in trouble, a lot of these benchmarks are hard to talk about." Most companies will argue that their sales figures have been depressed by the recession. And stock prices may not be fair indicators, given the state of the equity markets and the abnormal sell-offs a stock may experience if former bondholders cash out en masse.
But some experts say the vagaries begin in the very plans that get companies out of bankruptcy. "To get a plan confirmed, CFOs make unrealistic assumptions about sales levels, or expenses, or the amount of money needed for capital improvements. That creates a picture of profitability, which makes a confirmable plan," says Tilton. "But too many unrealistic expectations are a recipe for disaster."
Indeed, in Pillowtex's case, sales actually outperformed projections in the latter half of 2002, but nearly every category of expenses was also higher than expected. That's hardly surprising, though, says Hotchkiss, whose research has focused on documenting the differences between projections and reality. In one study, actual profits underperformed projections made at the time of the bankruptcy by a median 80 percent a year after emergence.
The estimated market value for a company, which determines the mix of postbankruptcy debt and equity, is also suspect, since it is the product of negotiations rather than market forces, says Hotchkiss. According to a paper she worked on with Gilson, the equity values estimated by management were overstated by as much as 250 percent and understated by as much as 20 percent, compared with the actual market price. (A higher opening price may be advantageous for creditors that want to cash out quickly, while a lower opening price may be better for options-holders.)
Creditors, of course, bear some blame. Some companies arrive in Chapter 11 beyond resuscitation, thanks to bankers trying to delay write-offs. "In many cases, it's a delay-and-pray strategy, where bankers say, 'I'm going to delay foreclosing and hope they keep struggling along,'" says Hugh Larratt-Smith, a principal at Manhattan-based turnaround firm Trimingham Americas Inc.
On the other hand, the influx of distressed-debt buyers, too, has created pressure on companies to emerge quickly so those investors can then sell off their stakes at a gain. "Distressed investing has become the flavor of the month for a lot of hedge funds. We're seeing a lot of people stepping in just because they're awash in capital."
That doesn't excuse judges for approving overly optimistic plans, says LoPucki. "What causes the failures is that courts are not saying no to bad reorganization plans," he says. If judges forced companies to be more rigorous about proving they had cut enough debt, he contends, fewer companies would fail. But because courts must compete for cases, judges have little incentive to be tough. "They can't just do what they think is right; they have to do what their customers want," he says, like allowing a company to pay prepetition debt to vendors while in Chapter 11 and exit with high debt levels.
The Need To Get Tougher
So what can CFOs do to promote success? "The challenge for a CFO is to stand firm" in hammering out reorganization plans, and point out the risks that come with budgeting with faulty assumptions, says Tilton. "CFOs need to take a longer time horizon than other participants. They need to look past the confirming of the plan and out two years or so."
That's a tough charge, though, since most CFOs say burned bondholders generally hold the power in such negotiations. "Senior lenders had an opportunity to force the company to do whatever they wanted," says Lason's Kearney. He counts himself fortunate that the lenders agreed to take equity, knowing that "they're not paid to take risks; they're there to get paid back."
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