Quickie Bankruptcies: Speed Isn't EverythingLarry Light
Bankruptcy? Southland Corp. would sooner dance with the devil than submit to the hassles and indignities of Chapter 11. Still, the mind-boggling $4.9 billion debt that the 7-Eleven convenience-store chain loaded on to thwart a 1987 hostile takeover was exacting its own hellish toll. Ungodly interest payments were rapidly draining coffers, and losses were mounting.
Then, Dallas-based Southland found a quick way out of the squeeze: a prepackaged bankruptcy, a novel means for corporations in potentially terminal financial distress to avoid many of the problems associated with conventional bankruptcies. Prepacks are becoming all the rage among the walking wounded of 1980s' overleveraging.
'NOT EVEN FUNNY.' Conventional bankruptcy cases typically last years, siphoning off vast amounts in legal fees and management energy as creditors war with management and one another to hammer out a reorganization plan. A company using a prepack can emerge from bankruptcy within a few months--just four for Southland, which exited Chapter 11 on Mar. 5. To do a prepack, the company must put together a plan and secure the approval of a minimum of 51% of the creditors, holding at least two-thirds of the debt before filing for bankruptcy. The plan then needs a bankruptcy judge's approval.
What's overlooked is that prepacks are not a panacea for every troubled company. They require a fortuitous mix of canny planning and enough amenable creditors. Plus, the process risks rushing a company out of court with a half-baked reorganization plan, thus setting it up for another fall.
Prepacks, further, are not always kind to minority creditors. Because they telescope the process, prepacks permit the majority to ram plans down dissenting creditors' gullets more easily than conventional bankruptcies. That may be the fate of minority bondholders of Bally Manufacturing Corp.'s Grand-Nevada casino units, which announced its intention to file a prepack on Apr. 2. With just one-quarter of the debt, the minority would see the interest rates and face values of their 12% and 13% bonds slashed. Backing the plan are owners of higher-ranked first-mortgage 11 1/2% bonds, who have three-quarters of the debt. They keep their paper intact and gain control of Bally's two Nevada casinos. Grouses Mark F. C. Berner of Anderson Kill Olick & Oshinksky, attorneys for the minority bondholders: "Bally's is giving us a fait accompli." Bally has not yet filed its plan.
Still, the prepack idea has attracted many fans. Says Martin J. Whitman, a managing director of Whitman, Heffernan & Rhein, an investment firm specializing in distressed securities: "A prepack can be so superior to other methods of restructuring that it's not even funny."
Prepacks have been around at least since the 1978 overhaul of the federal bankruptcy code. Not until 1986, though, did a major company, Crystal Oil Co., use one. Last year, the idea began taking off. Half a dozen prepacks have been filed recently (table). Reason: The leverage binge of the 1980s created more debt to squabble over and more creditors to do the squabbling, producing a need to fast-forward the system. Tax-law changes last fall, which likely will boost bankruptcy filings by penalizing restructurings outside of Chapter 11, make that need even more acute. And prepacks are welcomed by judges, who want to clear jammed dockets.
The biggest prepack to date, Southland, seems sure to spur the trend. The deal also offers useful lessons for future prepackers. Southland opted for the maneuver after all else failed. For much of 1990, it tried to avoid Chapter 11 by asking creditors to exchange their debt for paper paying much lower interest rates, with some stock thrown in as a sweetener. An owner of a $1,000 Southland bond paying 18% annual interest would get a new bond worth $257 and paying 4%--"taking a haircut," in Wall Street parlance--plus 11 shares of stock. Initially, too many of the company's creditors balked. Southland had to sweeten the deal to win over the required majority.
Lack of adequate creditor support has doomed several prepack efforts. Look at Interco Inc., the St. Louis footwear and furniture maker, which was trapped by the $2.8 billion recapitalization it used to elude a raider in 1988. Although a cash crunch was looming, Interco's bondholders rejected a prepack that they branded too generous to bank lenders. Worse, as its Converse Inc. athletic footwear continued to lose market share, Interco's earnings plummeted inexorably. Interco, which would not comment, filed for a conventional Chapter 11 on Jan. 25.
ENHANCED PROSPECTS. Southland, on the other hand, had the advantage that its basic business remained healthy, and creditors were optimistic about its future. An added bonus was an offer by some Japanese investors, Ito-Yokado Co. and its affiliate, Seven-Eleven Japan Co., to buy 70% of Southland's equity for $430 million.
Even so, negotiating a prepack is a touchy proposition easily derailed in the jostling over money. The group of dissident Southland bondholders who objected to the initial terms of the deal got bankruptcy Judge Harold C. Abramson to disqualify the first creditors' vote approving the prepack. "Not everyone was satisfied with the work that had been done for the bondholders," says dissident David Glatstein, president of Dallas' Barre & Co. investment firm.
The legal delay disturbed the Japanese investors, who set a Mar. 15 deadline to complete the process. "We didn't want this to drag on and lose the Japanese," says Southland's investment banker, Kenneth D. Moelis, a managing director with Donaldson Lufkin & Jenrette Securities Corp. The company finally won the dissidents over by granting creditors warrants for an additional 2 1/2% interest in the company.
Though Southland's current prospects seem sunny, that is not the case for some prepackers who leave bankruptcy protection before they're ready. One is JPS Textile Group Inc. Wheezing under a $460 million debt load from a 1988 leveraged buyout and a shaky business outlook, JPS still was able to win a judge's prepack O. K. on Mar. 21. But life will remain iffy outside Chapter 11. "JPS Textile's plan is a Band-Aid," warns Daniel G. Harmetz, co-manager of the Fidelity Capital & Income Fund, a distressed-securities investor.
To retain their majority stake in the company, Odyssey Partners and other LBO partners appeased creditors by investing some new capital. But they imposed only a light trim on the debt--no reduction in principal and only a 26% reduction in JPS's interest burden. According to company financial records, available cash will then barely cover interest. Considering the textile industry's current woes, some analysts consider the company's cash projections optimistic. A JPS spokeswoman pointed out that the prepack had been backed by nearly all creditors, but she declined to address the company's business prospects.
Although most prepacks have been useful deals for companies and creditors, the major beneficiaries are often so-called vulture investors. These sly souls buy debt--typically at huge discounts--of companies they reckon to be on the verge of Chapter 11. They bet on being able to tender the bonds at higher, court-mandated prices or get equity. Prepacks hasten that happy day. Financier Carl C. Icahn, parlayed his vulture purchase of Southland junk last fall into a 5% stake in the company. "We got a nice return, and we're happy," he says.
SCALPED. The quick returns have not endeared the vultures to long-term bondholders who made their investments at par or close to par and suffered a debilitating haircut. Among those who got scalped on Southland was the California Public Employees Retirement System. Years ago, it bought 15 3/4% notes for close to a face value of $30 million. The pension fund had to swap its old paper for new paper worth one-third as much and paying 5% interest. "I'm not pleased with it, but this does happen sometimes," says Walton Williams, Calpers' junk-bond portfolio manager, who backed the prepack idea as the best of a bad bargain. He still got his money out sooner than he would have under a conventional bankruptcy.
Prepacks are no magic potion. The best you can say is, for some sufferers reeling from Chapter 11 pain, this new treatment can at least get the agony over with quicker and cheaper.