Second Acts

Just a year ago, executives at Pillowtex Corp. thought they could finally look forward to a good night's sleep. Following an arduous bankruptcy process, lenders to the $1 billion maker of Fieldcrest towels and sheets had agreed to slice its $1.1 billion debt load to $205 million and leave the company with access to more than $100 million in exit financing. With Wal-Mart as its biggest customer and substantial backing from Oaktree Capital Management, the former Fortune 500 company seemed to have a bright future.

"This marks the beginning of a new chapter in this company's history," promised then-president Tony Williams upon the court confirmation of the confirmation of the reorganization plan in May 2002. Indeed, during its 18 months in bankruptcy, Pillowtex had managed to close six plants, shed about half of its assets, and aim for a $9 million profit by the end of 2002. In 2001, by comparison, the Kannapolis, North Carolina­based company had lost $200 million.

Yet soon after its fresh start, Pillowtex was in trouble again. Asian competitors had stolen market share and kept prices in the industry low, resulting in another $26 million in losses. By September, CFO Michael Harmon was renegotiating with lenders to ease the company's loan covenants and avoid a technical default. By March 2003, he had to repeat the process. Now, absent a buyer or additional waivers, another bankruptcy filing is a strong possibility, Pillowtex concedes in its most recent 10-K.

This is not an unusual story. One-third of the companies that emerged from the last great wave of bankruptcies in the early 1990s have had to restructure or refile within five years, according to an analysis by Boston College finance professor Edith Hotchkiss. Preliminary results for the current crop of companies emerging from bankruptcy show similar trends. "Overall, we still see a 20 to 30 percent failure rate for large public companies," says UCLA Law School professor Lynn M. LoPucki. With a record number of companies emerging from court protection in 2002, and more to come in 2003, more implosions may be on the horizon.

Among the next crop of emergers will be the three largest bankruptcies on record — WorldCom, Enron, and Conseco. But discerning which companies will make it and which will implode is not an exact science. "Any company that has just gone through a bankruptcy is still in a very delicate condition, somewhat like someone who has just suffered a severe heart attack. They might be out of bed, they might even be back at work, but they're not 100 percent yet," says Bettina Whyte, president of the American Bankruptcy Institute and principal at New York­ based turnaround and crisis-management firm AlixPartners LLC.

In fact, it's very hard to gauge the health of a company that has just emerged from Chapter 11. For one thing, it can take up to two years for a company to recover from a bankruptcy and fully implement the necessary restructurings. Moreover, historical factors such as a company's asset size or the speed of its initial demise provide few clues about its ability to generate profits after bankruptcy. There's also the possibility that emerging from bankruptcy simply signals a failure to attract a buyer, not financial stability; many of the 600-plus companies that have filed for Chapter 11 in the past three years have come from industries in desperate need of consolidation, such as telecommunications, airlines, steel, and textiles.

Reasons To Relapse
Gathering historical clues about relapses is difficult, because much about bankruptcy has changed since the last Chapter 11 boom, when 125 companies filed between 1990 and 1993. In particular, the average number of days a company spends under bankruptcy protection has decreased from 741 in 1990 to 367 in 2002, due in large part to the rise of prepackaged or prenegotiated cases, according to LoPucki's Bankruptcy Research Database. In addition, more companies are opting to sell off their major assets within the protection of Chapter 11, and then dissolve.

What hasn't changed, however, is the major warning signal for a relapse; namely, too much debt. Former bondholders tend to press for too much debt, experts say, because they stand a better chance of recouping their losses with notes than with new equity. But steep interest payments or a rapid amortization schedule can hamstring efforts to rebuild operations. In the end, debt "may be the straw that breaks the camel's back, especially if your projections are too rosy, or you were expecting the economy to rebound in the fourth quarter last year," says New Jersey­based bankruptcy attorney Richard Tilton.

Not only can debt siphon funds away from growth, it may be an obstacle to obtaining additional capital. That was the case at Pittsford, New York­based Mpower Communications Corp., a local telephone and Internet service provider that came out of bankruptcy with 10 percent of its original $650 million debt load last July. "We got through the bankruptcy quickly, but emerged with a plan that was still in need of cash," says CFO Gregg Clevenger. Potential investors balked, though, at $51 million in secured debt due in October 2004.

"They were saying, if you need $35 million to $50 million to fund the business and you have $50 million coming due in 18 months, what I'm really doing is giving you money to pay your debt," recalls Clevenger. Mpower was finally able to buy the 2004 noteholders out at a discount and sell assets for cash to fund the repurchase, a process that was completed nearly nine months after its Chapter 11 exit.

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