Environmental experts speak of the natural order of things, a kind of creative destruction in which cataclysms like volcanos and forest fires spawn conditions for future life. A famous photograph after the eruption of Mount St. Helens captured a solitary sprig of green rising from a landscape buried in ash.
It's an apt analogy to what has transpired in bankruptcy and how it increasingly fits into the order of dealmaking. The public face of bankruptcy has always belied what makes it work: backroom negotiation among an often dizzying number of participants. Traditionally, bankruptcy was walled off from normal dealmaking, run by a group of specialists, defined by the stigma attached to insolvent companies. But the very harshness and scale of the current bankruptcy wave has shown just how "normal" Chapter 11 has become, how it has grown into a transitional chapter for many companies not unlike, say, raising venture capital or going public.
This insolvency cycle, in short, represents the full integration of the bankruptcy process into the deal economy. That's the conclusion we drew as we took a hard look at 2009, one of the most significant years in U.S. bankruptcy history.
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What does that mean? Even when filings rise, there's now a fluidity in bankruptcy -- between markets, bankruptcy regimes, practitioners -- that didn't exist before 2008. Not that it's easy, but these days strategic and financial buyers don't stop acquiring when a company heads into Chapter 11; they just move the auction to a courtroom or a lawyer's office. Lenders don't stop lending; they just adjust pricing. They may actually take a bigger role in the borrower's game plan.
Megabankruptcies have been part of every recent bankruptcy up cycle. Southland Corp., LTV Corp. and R.H. Macy & Co. were $1 billion-plus debtors that defined the bankruptcy phase, 1990-'92, of the leveraged buyout cycle of the '80s. The bankruptcy wave of 2001 to 2003 -- caused by corporate accounting scandals and an Internet and telecom bubble -- featured Enron Corp. and WorldCom Inc. But the historic importance of the current cycle, with its bellwether debtors and megafilings, like General Motors Corp., Chrysler LLC and Lehman Brothers Holdings Inc., also suggests how normal it has become. True, bankruptcy brings in a judge as a key decision maker and new rules to follow. But in terms of financing and M&A, the process, while hardly pleasant, can appear less damaging, even routine. Life goes on.
Bankruptcies at GM, Chrysler and Lehman were an unprecedented step for companies of their size and complexity. They were among 88 debtors (including banks put in receivership) in 2009 and 61 in 2008 with more than $1 billion in assets. And the sky didn't fall.
The GM and Chrysler bankruptcies were emblematic. Both were fast, epitomizing the increasingly nomadic nature of companies that are pitching tents in Chapter 11 instead of building homes. The two companies' brief interlude in Chapter 11, measured in weeks, emboldened the government to put up nearly $40 billion in debtor-in-possession financing. Even in good times, taxpayers might have had to foot the bill for the two ailing automakers.
For other companies that filed, the credit crunch wasn't nearly as evident, at least statistically. For all the fears over credit, DIP financing had a banner year. There were 404 DIPs worth $62.4 billion, according to The Deal Pipeline. Both figures were all-time highs, and even when GM's $33.3 billion DIP is removed, the volume of DIPs is a record. Even more telling, calculations by The Deal Pipeline show that, of the financing debtors raised, some 84% of it was "new money" (without GM and Chrysler, it was 56.5%). That means lenders weren't just letting debtors use the money they already lent them; they offered fresh capital, too.
And this isn't true just for DIP financing. Debtors were able to raise a record amount of money in 2009 to exit bankruptcy. Granted, the amount of new money was much less -- just under 26%. But lenders weren't bashful about helping companies leave Chapter 11. There were 150 exit financings last year worth $59 billion, according to The Deal Pipeline. The best years before that were 65 exit financings (in 2008) and $34 billion (in 2007), which weren't really close.
Naturally, pricing and terms were more exacting -- and why not? These companies, after all, were bankrupt, and times were tough. But what is less apparent is that new money was available to bankrupt companies that wasn't there for them before they entered. The reason: The state of play adjusts, pricing risk appropriately.
The same trend can be seen with M&A and auction activity. In 2009, there were 674 bankruptcy auctions, 52% more than the year before (and 4 times as many as 2007's 150), according to The Deal Pipeline. The volume of that activity, based on the listed likely price of those assets, equaled $74.6 billion last year, slightly less than 6 times what it was in 2008 ($12.7 billion) and 2007 ($12.6 billion).
While the numbers are less stark with M&A activity involving bankrupt companies, they are no less staggering. There were 597 M&A deals involving bankrupt companies in 2009, 34% more than 2008 and 88% more than 2002's 318, the peak of the last big bankruptcy cycle. Besides being 6 times 2008's volume, the $265.5 billion in value involving the 2009 transactions was well over twice the $102 billion in 2004, the tail end of the previous cycle.
That activity, of course, didn't fully compensate for the drop in overall M&A, but it certainly helped and is evidence of how dealmaking never really disappears; it just shifts forms and migrates.
This development has been years in the making. Bankruptcy advisory firms during the long lull in filings during the Great Moderation in the mid-2000s reinvented themselves, expanded globally, moved into other bankruptcy-related specialties (forensic accounting, claims processing) and entered businesses outside bankruptcy (M&A and investigative services, valuation assessment, operations consulting).
The bigger the firm, the more impetus to diversify. That a 110-lawyer New York bankruptcy law firm, Kronish Lieb Weiner & Hellman LLP, would join forces with Cooley Godward LLP, a Silicon Valley legal powerhouse, in October 2006 wasn't surprising. Nor is the fact that the new Cooley ranks among The Deal Pipeline's top 10 firms in the number of active bankruptcy cases.
Other factors enabling such fluid movement between the bankruptcy and nonbankruptcy worlds have been more serendipitous. The changing nature of dealmaking dovetailed with bankruptcy reforms instituted in 2005 that imposed a new discipline on debtors and their advisers. Tighter deadlines on such things as exclusivity for proposing a plan and deciding on leases have led debtors and creditors to do more advance work, talking more before the actual filing. So while liquidations have risen, so have prenegotiated, prearranged and prepackaged filings. In other words, M&A negotiations in good times have become little different than those leading up to a filing in bad ones.
M&A is a natural component of bankruptcy. No longer are bankruptcy sales limited to hard assets like a mothballed steel plant. There are intellectual property sales and entire divisions sold under court supervision. On the rise, too, is credit bidding, in which creditors use what they are owed as dealmaking currency. In fact, the transparency required by Section 363 of the federal Bankruptcy Code for auctions doesn't seem to have daunted strategic buyers at all; in 2009, strategics were buyers in 270 bankruptcy M&A deals, up 46% from 2008, according to The Deal Pipeline.
Indeed, while the expense of bankruptcy -- debtor attorneys in the five largest cases in Manhattan in 2009 charged an average of $913 an hour -- is more of a deterrent now to a filing than the stigma of bankruptcy, it's still less than the $1,100 or so topflight M&A lawyers can charge. Even companies seem to feel bankruptcy is an evolutionary phase, not a revolutionary one. In 2009, debtors didn't seem the least bit intimidated about exiting into a recession. Some 331 exits occurred last year, the highest in the decade, blowing away the 207 and 224 in far-friendlier 2004 and 2005, respectively.
Is the worst then truly behind us? Some believe this cycle will last into 2011, with commercial real estate waiting to blow up. But in many ways, it doesn't matter. Bankruptcy is no longer the utter devastation that its reputation implied, but just one dealmaking phase among many.
See the complete Bankruptcy & Restructuring Special Report
"¢ Bust and buy "¢ The new DIPs "¢ This way out "¢ Top billing
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