Case 025Restructuring and recoveriesHard

Tejomaya Glass is reorganised at an enterprise value of Rs 900 crore: Rs 400 crore of new debt and Rs 500 crore of equity. Seniors owed Rs 700 crore get all the new debt and 60% of the equity; juniors owed Rs 400 crore get 40%. What does each class recover, and is the split fair under absolute priority?

The situation

Tejomaya Glass, a maker of container glass, is emerging from a court-supervised restructuring. The plan values the business at Rs 900 crore and gives creditors Rs 400 crore of new debt and all Rs 500 crore of the new equity. Senior secured creditors are owed Rs 700 crore; junior unsecured creditors are owed Rs 400 crore. Old shareholders receive nothing.

Under the plan, seniors receive all the new debt and 60% of the new shares; juniors receive the other 40%. Seniors are arguing that the Rs 900 crore valuation is too high. Assume the new debt is worth its face value unless told otherwise.

Your task

Work out each class's recovery in per cent, test the split against absolute priority, and explain why the valuation is where the fight will be.

Quick check

At the plan value of Rs 900 crore, what do seniors recover?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

At the plan value, seniors recover exactly 100%, Rs 400 crore of new debt plus Rs 300 crore of equity, and juniors recover 50%, Rs 200 crore of equity. That respects absolute priority only if Rs 900 crore is the right value. If the business is worth Rs 800 crore, seniors recover 91.4% while juniors still get equity, which breaks priority; if it is worth Rs 1,000 crore, seniors get more than they are owed. The fairness question is really a valuation question.

Step 1What does each class receive at the plan value?

Follow the value down the capital structure. Seniors receive the Rs 400 crore of new debt and 60% of Rs 500 crore of equity, Rs 700 crore on a Rs 700 crore claim, a 100% recovery; juniors receive 40% of the equity, Rs 200 crore on Rs 400 crore, a 50% recovery. Note the form: seniors take most of their recovery as debt, which is worth its face value only if the new capital structure is sound.

Where Rs 900 crore of plan value goes, class by classPlan value Rs 900 croreenterprise value on emergenceNew debt Rs 400 croreissued to creditorsNew equity Rs 500 crore100% of the sharesSeniors, owed Rs 700 crore400 of debt + 60% of equity (300)= Rs 700 crore100%Juniors, owed Rs 400 crore40% of equity (200)= Rs 200 crore50%60%: 30040%: 200all 400
Tejomaya's Rs 900 crore of plan value splits into Rs 400 crore of new debt, all to seniors, and Rs 500 crore of equity, 60% to seniors and 40% to juniors, so seniors recover Rs 700 crore, 100%, and juniors Rs 200 crore, 50%.
Step 2What does absolute priority require?

A queue at a counter: nobody behind you is served until you are served in full. Under the absolute priority ruleThe principle that a senior class must be paid in full before a junior class receives anything, unless the senior class agrees otherwise., juniors may receive value only once seniors are paid in full. At exactly Rs 900 crore, seniors are paid Rs 700 crore in full before juniors get their Rs 200 crore, so the plan passes. Strict priority at that value gives exactly the same split, 60% of the equity to seniors.

Step 3Why is the valuation the real fight?

Because the percentages are fixed but the equity's worth is not. If the business is really worth Rs 800 crore, the equity is worth Rs 400 crore, seniors receive Rs 640 crore, 91.4%, and juniors still take Rs 160 crore while seniors are short: priority is broken. Strict priority at Rs 800 crore would need seniors to hold 75% of the equity. At Rs 1,000 crore the reverse happens: seniors receive Rs 760 crore on a Rs 700 crore claim and juniors are short of the 75% strict priority would give them. So seniors argue for a low value and juniors for a high one.

The fixed 60/40 split is fair at exactly one valuation25%50%75%100%seniors, planseniors, strictjuniors, strictjuniors, planplan meets strict priority at 900Below 900: juniors get equitywhile seniors are short7008009001,000True enterprise value, Rs crore
Under the fixed 60/40 split, senior recovery equals the strict priority line only at an enterprise value of Rs 900 crore; below it seniors are short while juniors still receive equity, and above it seniors receive more than their claim at the juniors' expense.
True value, Rs croreSeniors, planJuniors, planSeniors, strict priorityJuniors, strict priority
800640 (91%)160 (40%)700 (100%)100 (25%)
900700 (100%)200 (50%)700 (100%)200 (50%)
1,000760 (109%)240 (60%)700 (100%)300 (75%)
The plan and strict priority give identical recoveries only at Rs 900 crore; at Rs 800 crore the plan overpays juniors by Rs 60 crore, and at Rs 1,000 crore it overpays seniors by the same amount.
Step 4What else would you test before calling it fair?

Whether the new debt is really worth par. If the Rs 400 crore of new debt would trade at 90, seniors' package is worth Rs 660 crore, 94.3%, and they are no longer paid in full even at Rs 900 crore. Also check whether seniors agreed to give juniors something to avoid a fight, which is allowed when a class consents. Rules on distribution differ by country, and India's insolvency code does not apply a US-style priority rule in the same way, so confirm the framework that governs the case.

Where candidates lose it

The usual miss is computing 100% and 50% and declaring the plan fair. The recoveries are only as good as the Rs 900 crore valuation, and that number is exactly what the seniors dispute.

The second is dividing Rs 900 crore by the total claims of Rs 1,100 crore and giving everyone 82%. That ignores priority altogether, which is the one thing the question is testing.

What the interviewer asks next

  • Seniors propose a value of Rs 820 crore. What equity split does strict priority require?
  • Why might seniors accept giving juniors some equity even when they are not paid in full?
  • How would warrants for the juniors help bridge a valuation gap?
  • The new debt carries a 14% coupon on EBITDA of Rs 110 crore. Is Rs 400 crore sustainable?

Company names and figures are illustrative.