Case 006Distressed and special situationsHard
A distressed spinning mill needs Rs 150 crore of rescue money that would rank ahead of the existing Rs 600 crore senior loan. What do the existing lenders recover with and without the rescue, and should they agree?
1The situation
Nandavan Spinning Mills owes Rs 600 crore to a group of senior lenders and has run out of working capital. Cotton cannot be bought, two of four lines are idle, and the mill cannot pay its next interest instalment. An adviser values the business today, as it stands, at Rs 550 crore.
A special situations fund offers Rs 150 crore of new money for one year at 15% with a 2% fee, on condition that it ranks ahead of the senior loan. With cotton bought and all lines running, the adviser expects enterprise value to reach Rs 700 crore in a year. If the restart fails, the new money is spent and value falls to Rs 450 crore. There is no other debt; the promoter's equity is already worthless.
2Your task
Work the senior lenders' recovery with and without the priming loan, including the failure case, and say whether they should consent and on what terms.
Quick check
The rescue lifts enterprise value by Rs 150 crore and the new money is Rs 150 crore. Before costs, what does it do to the senior lenders' recovery?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Without the rescue the seniors recover Rs 550 crore, 91.7%; with it they recover Rs 524.5 crore, 87.4%, and only Rs 274.5 crore if the restart fails. New money that lifts value by exactly what it takes creates nothing for them; the priming claim of Rs 175.5 crore must be beaten by the value uplift. Breakeven is an enterprise value of Rs 725.5 crore. They should refuse these terms, and either fund the rescue themselves or demand a share of the upside.
Step 1What happens to the seniors if nobody puts in money?
Start with the plain waterfall. Think of a family that owes Rs 6 lakh on a shop worth Rs 5.5 lakh: the bank takes the shop and is short Rs 50,000, and the family keeps nothing. Enterprise value of Rs 550 crore against a Rs 600 crore claim is a 91.7% recovery, a Rs 50 crore loss, and zero for equity. That is the base the rescue must beat, and it is not a bad base: a mill at half capacity still has most of its value in the building and the machines.
Step 2What does the priming loan take, and what does it add?
A priming loanNew debt that, with the existing lenders consent or a court order, ranks ahead of debt that was there before it. It primes, meaning it jumps the queue. is paid first, so write its claim down before anything else. Rs 150 crore at 15% is Rs 22.5 crore of interest, the fee is Rs 3 crore, so the claim in a year is Rs 175.5 crore. Of the new Rs 700 crore of value, the first Rs 175.5 crore leaves before the seniors see a rupee, which leaves Rs 524.5 crore, less than the Rs 550 crore they had. The rescue adds Rs 150 crore of value and takes Rs 175.5 crore. The seniors have paid Rs 25.5 crore for the privilege of being rescued.
| EV_1 | enterprise value a year after the rescue, Rs crore |
| 175.5 | the priming loan plus a year of interest and the fee |
| 550 | what the seniors recover today without any rescue |
Step 3What if the restart fails?
This is the half of the answer most candidates skip. If the cotton is bought, the lines restart and orders do not come, the Rs 150 crore is gone and the business is worth Rs 450 crore. The priming lender still collects Rs 175.5 crore in full. The seniors fall to Rs 274.5 crore, a 45.8% recovery, against the 91.7% they could have locked in today. So the proposal gives them a small loss if it works and a large loss if it does not. There is no success probability at which they come out ahead; even at certainty the base case is Rs 25.5 crore worse.
| Enterprise value after rescue, Rs crore | Priming loan gets | Seniors get | Senior recovery | Against no rescue |
|---|---|---|---|---|
| 450 | 175.5 | 274.5 | 45.8% | -275.5 |
| 550 | 175.5 | 374.5 | 62.4% | -175.5 |
| 650 | 175.5 | 474.5 | 79.1% | -75.5 |
| 700 | 175.5 | 524.5 | 87.4% | -25.5 |
| 725.5 | 175.5 | 550.0 | 91.7% | +0.0 |
| 750 | 175.5 | 574.5 | 95.8% | +24.5 |
| 800 | 175.5 | 600.0 | 100.0% | +50.0 |
Step 4So what should the seniors do?
Refuse these terms, and say why in one line: new money that lifts value by what it costs is a transfer, not a rescue. Then offer two alternatives. One, the seniors fund the Rs 150 crore themselves on the same terms; in the base case they then collect all Rs 700 crore against Rs 750 crore out, a blended 93.3%, because the interest and fee now flow to them and they keep every rupee of upside above Rs 700 crore. Two, let the fund prime but take a share of the equity, so that the seniors are paid for the risk they are being asked to carry. The limit of the analysis is the adviser's Rs 700 crore: a lender who believes the restart is worth Rs 800 crore reaches a different answer, which is why the breakeven of Rs 725.5 crore is the number to carry into the room.
Where candidates lose it
The usual loss is seeing enterprise value go from 550 to 700 and calling the rescue good for everyone. The priming loan takes the first 175.5 of that 700; the seniors have to work the waterfall, not the headline.
The second miss is forgetting the failure case. A rescue that is slightly negative when it works and badly negative when it fails has no probability of success that saves it, and interviewers wait to see whether you check.
What the interviewer asks next
- The fund offers to prime only Rs 100 crore and lend the rest pari passu with the seniors. How does the waterfall change?
- What would you demand as a senior lender before consenting: a fee, equity, a budget, controls?
- How does an insolvency process change the seniors' ability to refuse?
Company names and figures are illustrative.