Distressed Investing Report - Turnaround Management Association

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22 • 2010 TMA Distressed Investing Report nnn PREVIOUS with the previous owner, who confessed he didn’t know how to do some tasks and couldn’t bring himself to do others. While Shein’s group sold the second plant at a profit, the investors lost their equity in the first. “We took on financial risk and part of that financial risk was, we had not put sufficient reserves in the deal to allow for that kind of thing to happen,” Shein said. Beyond the Balance Sheet A frequent problem crippling distressed acquisitions, which by nature are more unpredictable, is integration. Brownstein recalled a failed roll-up of two building manufacturers that made similar products and “followed 15 different accounting systems.” “They weren’t getting the advantage of common buying. They weren’t getting the advantage of common tooling,” Brownstein said. “It was just a mess.” One solution: send a member of the deal team to the target company for weeks or months to identify problems that could slip by typical due diligence. Shein once interviewed graveyard-shift workers, and Leon V. Komkov, founding member of special situations private-equity firm Longroad Asset Management LLC, went as far as to obtain a commercial driver’s license. He wanted to validate how many drops per day drivers could make. “When all is said and done, yeah my guys were lazier than they should be and weren’t working as hard,” said Komkov, who overcame union resistance and rode as a passenger. “But the truth is, when you’re sitting at a desk saying, ‘You drive a truck. You pull a hose. You pull the pump. It’s not that hard.’ Yeah, it actually is. There are complexities that you don’t get to see if you’re sitting in an office looking at a balance sheet, instead of driving with a guy in a heating oil truck.” Telltale Signs of Trouble John P. Tatum, a vice president at private-equity firm Prophet Equity, recalled an investment in a retail gift card company foiled by the discovery of a year’s worth or more of overstated inventory accounts. Rehashing things seven months after closing, team members acknowledged that they suppressed doubts about the CFO who had angled to keep his job. “In transactions, you’re always having to make judgments about people…about risk,” Tatum said. “It’s good to actually be listening to your instincts in some ways.” Schoenwetter’s tack for mitigating accounting risks is to track cash, which he said includes determining all of the Howard Brod Brownstein, CTP, The Brownstein Corp. and moderator of “Deal Autopsy—Lessons Learned,” shares a laugh with James B. Shein, Ph.D., Northwestern University Kellogg School of Management, during a light moment on the panel. different places in the balance sheet and income statement where earnings have not translated into cash. “Had people done that in Enron, had people done that in some of these more spectacular blowups, the answers would have been more clear very early on—immediately,” Schoenwetter said. CONTINUED bbb
23 • 2010 TMA Distressed Investing Report nnn PREVIOUS Deals that involve distressed companies require extra scrutiny of such items as recent audits, projections and their assumptions, and historical sales figures. “Are those sales profitable sales? How do you know?’’ Brownstein asked rhetorically. “With due respect to our colleagues in the accounting profession, it may really take a turnaround professional to go in and do a risk assessment for you, in addition to accounting due diligence, so that you really understand what the value of those numbers is going forward.” Changing Markets Dealmakers also should be wary of market risk, which takes into account customer relationships; market share by customer, segment, and product and service; growth opportunities; and competitor behavior since the company’s decline. Shein provided an example of a marriage between two companies that each controlled 25 percent of the market for plastic bags, each with about $30 million in earnings before interest, taxes, depreciation, and amortization (EBITDA). At worst, the deal architects figured on $70 million EBITDA from the combined companies. Instead, they made $30 million EBITDA. Why? The combination pushed a major customer into the arms of Chinese suppliers who offered to absorb transportation costs. The company wound up in a prepackaged bankruptcy because the $30 million EBITDA could not pay for debt used to merge the two, Shein said. “It kind of gets back to a big overarching which is, when all is said and done, pricing of the investment,” Komkov said. “You’ve got to buy right.” And that’s what Komkov’s team appeared to have done when they paid $9 million for a bank’s $45 million stake in a textile plant. Then things went wrong. A key Skadden, Arps, Slate, Meagher & Flom LLP’s global corporate restructuring practice advises companies experiencing financial difficulties, purchasers of and investors in distressed companies, and lenders to and creditors of such companies on complex business reorganizations, troubled company M&A, debt restructurings and financing matters. • “Insolvency Legal Firm of the Year” and “International Insolvency & Rescue Firm of the Year” (Credit Today) • “Bankruptcy Team of the Year” (Chambers USA) • “Restructuring Team of the Year” (International Financial Law Review) • “Restructuring Law Firm of the Year” (M&A Advisor) • “Best USA Law Firm Restructuring Practice” (International Legal Alliance) • “Restructuring Deal of the Year” (Investment Dealers’ Digest) • “Top Bankruptcy M&A Law Firm” (The Daily Deal) Practice Co-Leaders John Wm. Butler, Jr., Jay M. Goffman J. Gregory Milmoe Partner | 312.407.0730 Partner | 212.735.2120 Partner | 212.735.3770 Beijing | Boston | Brussels | Chicago | Frankfurt | Hong Kong | Houston | London | Los Angeles | Moscow | Munich | New York CONTINUED bbb Skadden Palo Alto | Paris | San Francisco | São Paulo | Shanghai | Singapore | Sydney | Tokyo | Toronto | Vienna | Washington, D.C. | Wilmington
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