Mastering the Turnaround

What it really takes to survive a corporate bankruptcy.

July 2008
by Vincent Ryan/CFO Magazine

What awaits companies when they enter the perilous waters of a Chapter 11 bankruptcy filing? Several possible outcomes loom, none easy to achieve nor pleasant to contemplate.

That bleak reality was made worse by the Bankruptcy Reform Act of 2005, which gives companies less time to reorganize and rid themselves of costly lease agreements, trims the deadline for a company's self-formulated rescue plan, and makes it harder to retain key employees. Nervous lenders will likely push to recover debt fast, fearing that the organization's assets are losing luster daily. Second-lien holders, meanwhile, may angle to capture equity.

Who needs the headache of overhauling a balance sheet and dealing with conflicts among creditor classes? There's just too much risk (and cost), some executives say, in trying to navigate through all that. The easier route? Sell the company to one of the many asset-hungry distressed-debt investors circling U.S. corporations, making it someone else's problem. Filing for Chapter 11 can even up the price by lowering the risk for the buyer.

There is another way, however, and that way is the turnaround — a restructuring of the business financially, operationally, or both, that puts it on the road back to health. It can be a long, hard journey. Some CFOs, in fact, would rather exit quietly and find a more stable situation than run that gauntlet.

Turnarounds are achievable, but the odds are not great. Of the 450 large, public-company bankruptcies from 1998 to 2007, only about a third ultimately exited a Chapter 11 intact and resumed life as a going concern.

"The bankruptcy laws do not give companies a fresh start like they used to," says William Lenhart, national director of restructuring services for BDO Consulting. "And the cost of bankruptcy can kill a company. There are a lot of people looking over your shoulders — creditors' representatives as well as financial and legal advisers — who cost money."

There is also the unfamiliarity of the terrain to consider. As Kenneth Buckfire, managing director of investment bank Miller Buckfire & Co., says, "Everything CFOs learned in business school about finance doesn't apply in a restructuring."

A company's odds of success depend in part on whether it needs only a financial restructuring or a total operational overhaul, says Jacen Dinoff, CEO of KCP Advisory Group. "A company that has a profit from operations but negative cash flow has a good chance of getting rid of the sins of the past if it can get the debt load refinanced," Dinoff says. "But the bigger egg is the operational restructuring — that's the one that requires crisis-management skills."

How can CFOs steer companies through such trials? Interviews with crisis-management experts, restructuring advisers, and CFOs who have been through the storm reveal a handful of key steps that better the odds of pulling a company back from the brink — an achievement that almost any CFO would be proud to have on his or her résumé. Given that business-bankruptcy filings in the first quarter of 2008 rose 39 percent over one year ago, to 8,713 (and 9 percent over the final quarter of 2007), this is advice that many CFOs need now. And since many of these tips essentially rectify financial and operational misjudgments made months or years before a Chapter 11 filing, they will help many other CFOs spot trouble in time to avoid a Chapter 11 discussion at all.

1: Avoid Bankruptcy — But Not at All Costs
There's no doubt that bankruptcy can be a long, hard slog. Solutia, the $3.8 billion chemical-business spin-off of Monsanto, spent four years, two months, and 11 days in Chapter 11 before exiting last February. Although the company grew revenues 34 percent while under court supervision, CFO James Sullivan had to file five amendments to the plan of reorganization as creditor committees battled for a bigger piece of the growing recovery. "It was especially frustrating for me," Sullivan says. "I thought the company was ready to come out in 2006. Then the credit markets collapsed in front of us." Solutia had to sue its exit financiers to complete its $2.1 billion emergence financing.

Knowing that, companies often do anything to avoid bankruptcy, but beware of taking extreme actions too late in the game. The time to perform business and operational adjustments is at the first sign of trouble, not when a default occurs, says Lenhart. During high-growth years, inefficiencies creep into processes that can be quickly identified to pare costs, Lenhart says. What is it really costing the company to deliver products and services, and what are customers paying for them? "You can always do something to reduce costs," echoes Charles F. Kuoni III of CRG Partners Group LLC, a turnaround management firm. "Making that an everyday job is how you stay out of trouble."

At the same time, should debt-covenant defaults and excessive delinquencies on payables be present, the CFO should make every effort to avoid creating adversarial positions for key stakeholders. The CFO has to seek support by sharing information in good faith with senior lenders and critical creditors, says Dinoff. The frequency of financial reporting has to rise exponentially. "You don't want the decision to file bankruptcy to be taken from you," Dinoff says.

Still, the CFO has to know at what point it makes sense to capitulate and live to fight another day under Chapter 11. Many executives desperate to avoid bankruptcy wind up hollowing out the business by collateralizing all the assets or selling the company's best assets to raise cash and extend the runway, says Buckfire. One common result: companies without assignable collateral wind up paying exorbitant terms on debtor-in-possession financing. "It takes tremendous discipline to not liquidate and say, 'We'll work it out,'" Buckfire says.

This article has been excerpted from CFO magazine. Read the full article here.

Vincent Ryan is a senior editor at CFO.

© CFO Publishing Corporation 2008. All rights reserved.