Skadden www. skadden. com Jefferies & Company, Inc.
Skadden, Arps, Slate, Meagher & Flom LLP March 23, 2004
Corporate Restructuring: International Best Practices Developing
Markets for Distressed Corporate Debt www.jefco.com
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Skadden www.skadden.com www.jefco.com 1 Jefferies &
Company, Inc. >A leading investment banking firm led by one of
the most powerful capital markets trading platforms in the industry
>Principal operating subsidiary of Jefferies Group, Inc. (NYSE:
JEF), a holding company with an equity market capitalization of
over $2.0 billion and over 1,600 employees in 20 offices
worldwide
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Skadden www.skadden.com www.jefco.com 2 Boston Chicago Houston
Los Angeles Newark New York Palo Alto San Francisco Washington,
D.C. Wilmington Brussels Frankfurt London Moscow Paris Vienna
Beijing Hong Kong Singapore Tokyo CANADAEUROPE ASIA AUSTRALIA
Sydney USA Toronto Skadden, Arps, Slate, Meagher & Flom LLP and
Affiliates: A Global Law Firm
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Skadden www.skadden.com www.jefco.com 3 Speakers >John Wm.
Butler, Jr. Partner and Co-Practice Leader Corporate Restructuring
Skadden, Arps, Slate, Meagher & Flom LLP >William Q.
Derrough Managing Director & Group Co-Head Recapitalization
& Restructuring Jefferies & Company, Inc. >N. Lynn
Hiestand Partner Corporate Restructuring and Cross-Border
Transactions Skadden, Arps, Slate, Meagher & Flom (UK) LLP
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Skadden www.skadden.com www.jefco.com 4 Definition of
Distressed Debt >Bank debt, private placements or public debt of
companies that: have defaulted on their debt obligations; have
initiated insolvency or reorganization proceedings; are in such
financial distress that their debt is trading more than 1000 basis
points above comparable US Treasury bonds; OR have debt trading
below 70%
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Skadden www.skadden.com www.jefco.com 5 Scope of Investments
>Distressed Debt Investors (DDIs) invest across distressed
entities capital structure: Bank and bond debt (e.g., typically
defined as distressed debt) Trade claims Equity >Investment
allocations across an entitys capital structure may be used to
hedge risk and to foster change of control transactions
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Skadden www.skadden.com www.jefco.com 6 Sector Analysis
>DDIs invest across industry sectors >Risk analysis includes
prevalence of defaults within industry sector
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Skadden www.skadden.com www.jefco.com 7 Defaults by Sector
Source: Moody's; Fitch; Standard & Poor's; Deloitte &
Touche LLP, Distressed Debt Marketplace: Opportunities &
Challenges as the Economy Improves, Turnaround Management
Association (March 12, 2004)
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Skadden www.skadden.com www.jefco.com 8 Defaults by Volume
Source: Moody's; Deloitte & Touche LLP, Distressed Debt
Marketplace: Opportunities & Challenges as the Economy
Improves, Turnaround Management Association (March 12, 2004)
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Skadden www.skadden.com www.jefco.com 9 Company Analysis
>DDIs also conduct due diligence to analyze company risk:
Depressed or declining markets/sales Shrinking margins Operating
losses/unanticipated losses Cash crunch Covenant violations Aging
accounts receivable/payable Accounting irregularities Management
initiatives
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Skadden www.skadden.com www.jefco.com 10 Historically
Significant Global Defaults 1970s1975198919931997199820022004 Latin
America US REITS US Savings & Loan Crisis; Canada & Mexico
Asian Financial Crisis; Mexico Japan Banking Crisis Russia, CIS,
and Czech Republic Europe Others? Argentina; India; Philippines;
Taiwan; China
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Skadden www.skadden.com www.jefco.com 11 Stages of Global
Development in the Distressed Debt Market Developed, efficient
market Currently developing Early stages of development
Undeveloped
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Skadden www.skadden.com www.jefco.com 12 >Private equity
investors and hedge funds are the major players in the industry
>Mutual funds are newer participants Major Distressed Debt
Investors (DDIs) Cerberus Capital Management Elliott Associates
Soros Fund Management
Skadden www.skadden.com www.jefco.com 14 Vibrant US Distressed
Debt Market Source: Edward I. Altman, Defaults & Returns on
High Yield Bonds: The Year 2002 in Review & the Market Outlook,
NYU Salomon Center Stern School of Business, Feb. 2004
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Skadden www.skadden.com www.jefco.com 15 Forecasts for the US
Market Source: Edward I. Altman, Defaults & Returns on High
Yield Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004
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Skadden www.skadden.com www.jefco.com 16 Distressed Debt is
Cyclical Source: Edward I. Altman, Defaults & Returns on High
Yield Bonds: The Year 2002 in Review & the Market Outlook, NYU
Salomon Center Stern School of Business, Feb. 2004
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Skadden www.skadden.com www.jefco.com 17 Possibilities for
Growth Exist in the US Source: McKinsey Quarterly, 2003 No. 1
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Skadden www.skadden.com www.jefco.com 18 Opportunities Exist in
Other World Markets >With some exceptions (notably, the UK),
these markets are highly undeveloped in comparison to the US market
>Inaccurate or unavailable data provide the greatest obstacle to
market analysis outside the US >As a result, non-performing loan
market data provides best indicator of forward trends in the
international distressed debt market This data may also be more
relevant outside of the US since non-US companies typically use
bank debt as their primary form of financing (due to less developed
public debt markets)
Skadden www.skadden.com www.jefco.com 20 Nonperforming Loans:
Asia (percentage of total) Source: From Cyclical Recovery to Long
Run Growth, World Bank, Oct. 2003
Skadden www.skadden.com www.jefco.com 23 Secondary Market:
Europe Estimated Bank Debt Trading Volume in Europe and the Middle
East (US$ billions) Source: Loan Pricing Corporation. Change in
reporting currency in 2002 USDEUR
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Skadden www.skadden.com www.jefco.com 24 Exceptions to
Undeveloped International Markets >United Kingdom Market has
grown in the past 5 years >Europes cable and telecom industry
Debt more accessible as companies raising capital through corporate
bonds rather than bank debt because these companies do not have the
typical assets banks are able or willing to accept as security For
example, Apollo Advisor invested in the publicly traded bonds of
German cable company Kabel Hessen GmbH
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Skadden www.skadden.com www.jefco.com 25 Value of the Market to
Corporate Restructuring >Provides risk capital to the
marketplace >Offers liquidity >Strengthens banking system
Important as countries prepare for stricter requirements under
Basel II and some countries prepare to open their borders to global
competition under agreements with the World Trade Organization
>Provides a group of investors willing to take creative
recoveries in contrast to traditional banks
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Skadden www.skadden.com www.jefco.com 26 Value of the Market to
Corporate Restructuring >Provides expertise to the procedure
Experienced investors add value by restructuring debt or improving
management of the operations >Provides impartial outsiders
Resolves conflicted relationships, for example where a bank is the
creditor, shareholder and is running the distressed company May be
in a better position to compromise claim
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Skadden www.skadden.com www.jefco.com 27 Many Types of Entities
Cannot Work Out Debt Themselves >Many have constraints which
limit ability to hold bad debt, including: Covenant restrictions
Regulation Risk profiles >Should be more likely to write off
debt/sell at a discount than risk taking an equity stake in a
restructured entity
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Skadden www.skadden.com www.jefco.com 28 Types of Entities
Typically Subject to Bad Debt Constraints >Insurance companies
>Certain investment firms/funds >Commercial and/or public
banks >Collateralized debt obligations (CDOs)
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Skadden www.skadden.com www.jefco.com 29 Why Markets Have
Flourished in North America & the UK >Predictable outcomes
>Permissive trading under Chapter 11 in US Currently not
regulated under Securities Laws >Experienced professionals
>Fair process >Significant returns to DDIs >Developed
financial markets Both in distressed securities and in post-
restructured securities
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Skadden www.skadden.com www.jefco.com 30 Distressed Indices
Performance >Historically distressed debt returns are negatively
correlated with the stock market Source: Edward I. Altman, Defaults
& Returns on High Yield Bonds: The Year 2002 in Review &
the Market Outlook, NYU Salomon Center Stern School of Business,
Feb. 2004; CSFB/Tremont
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Skadden www.skadden.com www.jefco.com 31 Historical High Yield
Spread to Treasury Source: Thomson Financial > Spread correlates
to default risk in market
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Skadden www.skadden.com www.jefco.com 32 Post Chapter 11 Equity
>Post-bankruptcy equities that trade over-the-counter tend to be
overvalued in the plan of reorganization Source: Jefferies (1=Plan
Price) (1=IPO Price)
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Skadden www.skadden.com www.jefco.com 33 Drawbacks of DDIs
>Short investment horizon of some DDIs >Contentious and
aggressive constituencies >Confidentiality and insider problems
>Constantly changing group
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Skadden www.skadden.com www.jefco.com 34 Obstacles to Emerging
Distressed Debt Markets Reorganization/Insolvency Law >Europe:
Reorganization/insolvency law focuses on liquidation Senior lenders
often control the process No consistent reorganization/insolvency
regime across Europe >Lesser-Developed Countries Undeveloped
reorganization/insolvency law: little precedent makes outcomes
unpredictable for investors Outside influences on
judicial/administrative process: political pressure Enforcement of
judgments often difficult
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Skadden www.skadden.com www.jefco.com 35 Obstacles to Emerging
Distressed Debt Markets Regulatory Impediments
>Unaccommodating/inconsistent tax structure For example, in
Germany, the tax law contains provisions unfavorable to distressed
debt investors. Further, the government continually changes the tax
law affecting distressed debt investors, making it difficult to
structure deals >Inefficient government approval process For
example in China, Huarong AMCs first distressed debt sale took
almost 3 years to complete because of government delays
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Skadden www.skadden.com www.jefco.com 36 Obstacles to Emerging
Distressed Debt Markets Transparency >Europe In some countries
banks control the majority of corporate debt so pricing and
transaction information are difficult to obtain >Asia Difficult
to get information from the AMCs, particularly where mass loans are
sold Necessary because AMCs are subject to intense political and
social pressures to favor certain borrowers
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Skadden www.skadden.com www.jefco.com 37 Obstacles to Emerging
Distressed Debt Markets Limited Players >Few players have
expertise to invest Europe: investing requires knowledge across
multiple legal and regulatory regimes Asia: must rely on foreign
investors as domestic investors do not have the institutional
knowledge and resources
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Skadden www.skadden.com www.jefco.com 38 Possibilities for
Growth >The distressed debt market is likely to grow rapidly
over the next few years The availability of distressed debt to
investors will likely increase as governments and banks become
committed to dealing with the problem Investors are seeking new
frontiers as traditional investment opportunities are limited
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Skadden www.skadden.com www.jefco.com 39 Asian High Yield
Issuance >The Asian HY market has yet to show much of a pattern,
but as markets integrate the HY market should develop. Source:
Thomson Financial. Converted to US Dollars
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Skadden www.skadden.com www.jefco.com 40 European and German
Investment-Grade Source: Thomson Financial. Converted to US Dollars
>Due to the scarcity of data outside the US, corporate debt
provides a proxy for predicting future defaults
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Skadden www.skadden.com www.jefco.com 41 European and German
High Yield Issuance Source: Thomson Financial. Converted to US
Dollars > High yield debt provides a particularly useful proxy
for predicting defaults
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Skadden www.skadden.com www.jefco.com 42 Latin American High
Yield Issuance >Having been in emerging doldrums the last few
years, Latin America also has yet to show the development that
European markets have. Source: Thomson Financial. Converted to US
Dollars
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Skadden www.skadden.com www.jefco.com 43 Fund Flows into CDOs
by Region >The growth of CDOs, particularly overseas, indicates
an increasing appetite for alternative fixed income products.
Source: JPMorgan
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Skadden www.skadden.com www.jefco.com 44 International Trends
& Solutions >Denial and fear of selling assets at less than
their originally perceived value >Xenophobia >Establishment
of Asset Management Companies in Asia >Creation of Bad Banks
recently in Germany >Growing understanding of going concern
value vs. liquidation
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Skadden www.skadden.com www.jefco.com 45 New Trends in
Insolvency Laws
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Skadden www.skadden.com www.jefco.com 46 New Trends in
Insolvency Laws
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Skadden www.skadden.com www.jefco.com 47 New Trends in
Insolvency Laws Though it will take time for the spirit of these
reforms to take effect, the regulatory groundwork is in place.
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Skadden www.skadden.com www.jefco.com 48 Examples of Success
>DDIs gained initial successes through litigation arbitrage of
defaulted sovereign debt in emerging markets. As a result,
governments became aware of workouts. (Peru, Russia & Asian
crisis countries) >A consortium led by Morgan Stanley and
Goldman Sachs purchased $1.5 billion in face value of distressed
debt from Huarong Asset Management >Sumitomi Mitsui Financial
Group and Goldman Sachs entered into a $1.2 billion deal
>Dresdner Bank sold 511 million bundle of credits to Deutsche
Bank
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Skadden www.skadden.com www.jefco.com 49 Stages of Global
Development in the Distressed Debt Market Developed, efficient
market Currently developing Early stages of development
Undeveloped