Mergers & Acquisitions Journal
The Complexities of Pricing Post-Bankrupt Companies:
Firms may have "clean slates" but they have no solid earnings track records on which to base value
By Joan Harrison
January 1, 2004
A weak economy over the past few years has fueled a slew of corporate bankruptcies. While under Chapter 11 protection, some firms reorganize their operations and try to become profitable again. As these reorganized companies emerge from bankruptcy - relieved of most or all of their debt - a number of them attract the attention of buyers that spot a chance to pick up businesses with virtually "clean slates" at decent prices.
Zeroing in on a fair price to pay for such a company, though, can be tricky, valuation experts say. While the pricing methodologies are typically the same as those used in "regular" acquisitions, they note, there are additional issues to consider.
While companies coming out of bankruptcy often emerge with great assets and few liabilities, looks can be deceiving, says Michael Kayman, a Director in the Chicago office of Conway MacKenzie & Dunleavy, a turnaround management firm. "The company may have cleaned up its balance sheet as far as debt is concerned but it doesn't have a proven track record. People buy normal companies based on history and proved earnings. Companies coming out of Chapter 11 don't have that."
Robert Reilly, a Managing Director at Willamette Management Associates, agrees, adding that while the valuation methods used for former bankrupts are generally the same as those used in regular acquisitions, a buyer would not base its valuation calculations on historical financial data "because they are the data of a company that went into Chapter 11." "A reorganized company is a new entity for legal and accounting purposes, that is why you would restate all the assets to fair market value, for fresh-start accounting purposes. The data a buyer would rely on, therefore, would be forward-looking - projections, forecasts, and budgets - typically that come from the court-approved plan of reorganization," he adds.
A caveat: The detailed, multi-year financial projections issued by companies before their emergence from bankruptcy can be overly optimistic, so they should just be used as a guide to the performance the company's management believes is achievable, the pros say.
"You're buying the company for the value you can create with it, and you'll rely heavily on your employees, customers, and vendors - things that get affected in Chapter 11 - so you'll have to do thorough due diligence so you can assess the proper value," says Ben Duster, a Partner at Masson & Co., a turnaround management and financial restructuring firm.
Some issues to consider include how loyal the employees are; whether managers are aligned; how much erosion there may have been in the customer base; and whether the company is able to secure trade credit from vendors. "Until a company shows that it will be able to make its payments, vendors may be reluctant to give the company trade support. The company may have to put up large deposits, which may have to be financed with bank funds, so that is another cost a buyer would have to build into the valuation equation, because interest would have to be paid on those funds," says Duster.
Despite the abundance of Chapter 11 filings in recent years, shaking the stigma of bankruptcy can be tough. Uncertainties at the post-bankrupt companies pose pricing challenges for buyers. The risks are high because the relapse rate among former Chapter 11 firms is high. Sometimes reorganization is not enough to fix a flawed business, the experts say.
Although it may be hard for buyers to quantify where the value of the company has been impacted, the experts assert that many buyers assume that bankruptcy has impacted the business negatively and apply an "uncertainty discount" when pricing a post-bankrupt target.