Distressed Assets: Bargains or Burdens?

Buying a business out of bankruptcy is a risky proposition, but it could earn outsized returns.
Vincent RyanSeptember 16, 2011

Should your company look to acquire the operations or assets of a distressed company? With Chapter 11 filings decelerating but still high relative to where they were three years ago, bargains could await.

This week, SSI Group Holding filed Chapter 11 for the second time in six years. Seafood-restaurant operator Captain D’s LLC became a “stalking-horse” bidder for Grandy’s restaurants, a brand that is part of SSI Group’s portfolio. The proposed $6 million transaction does involve a financial sponsorbut it shows that companies are trolling for distressed assets.

“You don’t have to be a hedge fund to do this,” says one New York-based corporate-restructuring attorney. “Oftentimes strategic investors come to us to talk about becoming a bidder, or part of a syndicate of bidders, for a competitor that is failing.”

Buying assets from a seller that’s in bankruptcy a so-called Section 363 salehas numerous advantages. The buyer purchases only the assets it wants, and those assets are free and clear of any titles. A buyer can also designate which contracts and leases it wants to assume; other liabilities and costs go away. And the asset probably comes at a distressed price.  

On top of that, being the stalking-horse in a 363 sale — the interested buyer chosen by the bankrupt company to make the first bidoffers “serious advantages,” says Jonathan Carson, managing director of Kurtzman Carson Consultants, a claims and noticing agent.

The stalking-horse bidder negotiates transaction terms that establish a baseline for all other bidders. If another buyer wins the auction, the stalking-horse bidder can get breakup fees and reimbursement of expenses, such as costs for due diligence. In the Grandy’s sale, for example, the purchase agreement calls for stalking horse Captain D’s to get a $100,000 breakup fee and $200,000 for expense reimbursement.

Of course, the bankruptcy court has to bless the deal’s terms and the auction’s outcome, which can take months.

Potential takeover targets for buyers include their suppliers and competitors, says Jacen Dinoff, chief executive of turnaround firm KCP Advisory Group. In some cases, suppliers might approach the buyer prebankruptcy, asking it to purchase a portion of the company to keep it in business.

The caveat to any transaction of distressed assets: due diligence is not going to catch all of the legacy issues that exist in the purchased business, so the buyer needs executives skilled in corporate turnarounds to make the acquisition work. Tuning up and integrating a distressed business can take a lot of management’s time  even more than a typical merger.

And buyers never know who is going to come out of the woodwork at the last minute to contest a sale. Last week, a borrower who had defaulted on a loan from Anglo Irish Bank sued the Irish financial institution when it tried to sell a $9.5 billion loan portfolio to Dallas-based Loan Star Funds. The borrower says the loan agreement requires Anglo Irish to retain a 51% ownership interest in the note.

Potential problems such as these are why some experts counsel corporates to stay away from distressed assets altogether. “Strategic buyers usually don’t like to do this,” says Mike Green, chief executive of Tenex Capital Management. “And those that do don’t do it a second time  it’s a defocusing event.”