Let’s say you want to find out how much equity value a Company will generate post restructuring. If you would be buying all or some bond classes, how much would I get back in X years? Here are some simple models that you can use to calculate the IRR on your investment in X years post re-org based on the equitythat the Company will be able to generate. First you have to make an assumption about when the Company will emerge from bankruptcy. If it’s a pre-packed, it might just take few months, a straight Chapter 11 it might take 1.5 years.

EBITDA Multiple The model is especially useful for Company that plan a restructuring through debt for equity exchange offer with a fairly simple capital structure. The spreadsheet contains “Guidelines” on how to fill in the different cells. The model starts with forecasting EBITDA, EV and debt levels up to the year you decide to sell your investment or the terminal year. You can use the “Exit_EV” sheet to input different multiples and EBITDA levels for the terminal year EV. Once you have picked an appropriate EV, you can drag that number into the “EBITDA_Multiple” sheet to find the equity value. As you can see, the equity value increases over the years and debt decreases, just like in an LBO, and the cash flow sweep is used to pay down a porting of debt each year. Usually in a debt for equity exchange offer, some unsecured debt holders receive a percentage of the new equity, while other creditors or existing shareholders receive warrants or convertible notes, so you have to account for the dilution of your investment. The “Dilution” sheet is filled with numbers for explanation purposes. You have to take the new ownership percentage of your investment and apply it to the equity value on the “EBITDA_Multiple” sheet to find out how much your investment is worth accounting for dilution.  You can then calculate the IRR for each year up to the terminal year and figure out the best scenario. Use the Accudire spreadsheet as an example.

Excel Spreadsheet: Restructuring_Model_EBITDA_Multiple

Please e-mail me for questions at Michelagelo@NotAnAnalyst.com

Target IRR The model is especially useful for Company that plan to restructure their debt through debt for equity exchange with a fairly simple capital structure. The spreadsheet contains “Guidelines” on how to fill the different cells. The main difference with the EBITDA Multiple model is that the Target IRR model will tell you how much you should be paying now for an investment returning X percent (the target IRR) in X years from now. You can determine now if the price of you investment is too high or very low for a specific IRR. All you have to do is calculate the post re-org equity value in year 1 assigned to your bond class and compared it to the discounted equity value for that same bond class in year 1, which is the price you should be paying or the fair price.

We start off by calculating the equity value for each year post restructuring just like we did on the EBITDA Multiple model. Then we take the terminal equity value and we discount it back to the present at the cost of equity. Just like in a LBO, debt is paid down with a cash flow sweep, which increases the residual equity over time. Realizing this, to determine the expected return on equity or cost of equity or discount rate, we must determine the portion of debt/equity in the capital structure each year. There are two formulas that we need to use:

The first one provides the Beta Equity that represents the financial leverage. Beta Equity=Beta Asset/ (Equity / Equity + Debt), where the Beta Asset is the amount of risk in the business which we are going to keep constant at 1

The second one uses the Beta Equity in the CAPM to find the cost of equity. CAPM=RFR + Beta Equity*MRP.

You will need to calculate the cost of equity each year as the levels of debt/equity in the capital structure will be different. Make sure that you assign percentages of ownership to each bond class. The target IRR is the geometric mean of all the discount rates.  So now you have all the ingredients to make your decision. If you want to complicate things but make your model more accurate, you should include dilution. See the EBITDA Multiple model spreadsheet for how to include dilution.

An example: Let’s say that Company ABC has a capital structure with Senior Unsecured, Senior Sub and Junior Sub plus bank debt and the reorganization plan assigns 75% of the post re-org equity to Senior Unsecured holders. You find out that post re-org equity in year 1 is 100, so your investment is worth 75. But is that a fair price? Let’s find out.  Calculate the equity in the terminal year, which is the year you want to sell your position, and discount it back at the cost of equity. Make sure to assign percentages of ownership to each bond class or Senior Unsecured holders in your case. The discounted equity value that you find is what you should be paying for that bond class to get a specific IRR. If the discounted equity value is higher than 75, it means that that you are getting the Senior Unsecured notes at a good price and you will probably get an higher IRR that then target IRR for X years.

Excel Spreadsheet: Restructuring_Model_Target_IRR

Please e-mail me for questions at Michelangelo@NotAnAnalyst.com