Case 076Credit, distressed and capital structureCore

Brellin Textiles is restructuring with an enterprise value of Rs 900 crore, Rs 600 crore of secured debt and Rs 500 crore of unsecured bonds trading at 35. What does each class recover, which is the fulcrum, and what is the upside in the bonds?

The situation

Brellin Textiles, a yarn and fabric maker, has missed two coupons and entered a court-supervised restructuring. The advisers value the business as a going concern at Rs 900 crore, about 6x a normalised EBITDA of Rs 150 crore.

Brellin owes Rs 600 crore of secured term loans with a first charge over its mills, and Rs 500 crore of senior unsecured bonds, which trade at 35 per 100 of face value. Assume absolute priority is respected, no other claims rank ahead of the bonds, and the plan takes about 18 months to complete. Creditors who are not paid in full receive shares in the reorganised company.

Your task

What does each class of claim recover, which security is the fulcrum, and what do the bonds offer at 35?

Quick check

Which class is the fulcrum security, the one where the value runs out?

Worked solution

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

30-second answerThe answer to give first

The secured loans recover 100, the bonds recover 60 and the equity gets nothing, so the bonds are the fulcrum. Rs 900 crore pays Rs 600 crore of secured debt, then Rs 300 crore reaches Rs 500 crore of bonds. Bought at 35, a recovery of 60 is about 71% upside, roughly 43% a year over 18 months, if the Rs 900 crore holds. The price of 35 implies a value of Rs 775 crore.

Step 1In what order does the value reach the claims?

Think of a family that sells its flat after borrowing from a bank against it and from friends on a handshake. The bank, holding the charge on the flat, is paid first from the sale. The friends share whatever is left. The family keeps something only if the friends are paid in full. A restructuring works the same way: value fills each class of claim from the top, and the class where the money runs out is the fulcrum securityThe most senior class of claim that is not paid in full. It usually receives most of the equity in the reorganised company.. Here Rs 900 crore fills the Rs 600 crore of secured loans and leaves Rs 300 crore for the bonds.

Brellin's Rs 900 crore of enterprise value pays the Rs 600 crore of secured loans in full and leaves Rs 300 crore for Rs 500 crore of unsecured bonds, a recovery of 60, so the bonds are the fulcrum and the old equity receives nothing.

Step 2What do the bonds offer at a price of 35?

The bond pays 60 of value for 35 of price. That is 71.4% upside, or about 43% a year if the plan takes 18 months. Notice what the 60 is made of. Because the bonds are the fulcrum, they will mostly be paid in shares of the reorganised Brellin, not cash. The 60 is only as good as the Rs 900 crore valuation behind it, and the bondholders become the new owners who have to live with that number.

The relationship

\text{Bond recovery} = \frac{EV - \text{secured}}{\text{bond face}} = \frac{900 - 600}{500} = 60 \qquad \text{Upside} = \frac{60}{35} - 1 = 71.4\%

EV	going-concern enterprise value, Rs 900 crore
secured	claims ranking ahead of the bonds, Rs 600 crore
bond face	Rs 500 crore of unsecured bonds
35	the bond's market price per 100 of face

What it says in wordsThe bonds get whatever value is left after the secured lenders, spread over their face value; the upside is that recovery over the price paid.

Step 3How wrong can the valuation be before the bonds lose money?

Run the price backwards. A recovery of 35 needs Rs 175 crore to reach the bonds, so the price implies an enterprise value of Rs 600 crore plus Rs 175 crore, Rs 775 crore. Value can fall about 14% from Rs 900 crore before the bond buyer loses money, and every Rs 100 crore of value moves the recovery by 20 points. That sensitivity is the point of a fulcrum: a 10% change in enterprise value is a 30% change in what the bonds get, because the bonds sit on a thin slice of value above the secured debt.

Bond recovery is zero until enterprise value passes Rs 600 crore and then rises 20 points per Rs 100 crore; at Rs 900 crore it is 60, and the price of 35 corresponds to Rs 775 crore, a cushion of 13.9%.

Enterprise value, Rs crore	Secured recovery	Bond recovery	Return on 35
700	100	20	-43%
775	100	35	+0%
900	100	60	+71%
1,000	100	80	+129%
1,100	100	100	+186%

The bond return swings from a 43% loss at Rs 700 crore of value to a 186% gain at Rs 1,100 crore, while the secured loans stay at 100 across the whole range above Rs 600 crore.

Close with the questions that decide the trade, not a verdict. Is 6x the right multiple for a textile business coming out of distress? Could any claim, such as unpaid wages, tax dues or restructuring costs, rank ahead of the bonds and eat into the Rs 300 crore? Will the plan take 18 months or three years? A strong answer says: the bonds are the fulcrum, 35 prices in about Rs 775 crore of value, and the view rests on trusting Rs 900 crore and the timeline.

Where candidates lose it

The common slip is sharing the value out pro rata: Rs 900 crore over Rs 1,100 crore of debt, about 82 for everyone. That ignores the charge the secured lenders hold, overstates the bond recovery by 22 points and misses that the bonds, not the loans, are the fulcrum.

The second is quoting 71% as the return and stopping. The recovery arrives as shares, after a process that can run long, so the annual return and the value cushion are what an interviewer wants next.

What the interviewer asks next

Rs 80 crore of restructuring costs and unpaid wages rank ahead of the bonds. What is the recovery now?
Would you rather own the secured loans at 95 or the bonds at 35, and why?
The plan pays the bonds 20 in cash and the rest in new shares. How does that change your view?
What would make the old equity worth something in this restructuring?

Company names and figures are illustrative.