Korva is a scroll of the internet’s best ideas.
Distressed debt is a two-way bet
Picture a company circling the drain. Its bonds once traded at par, 100 cents on the dollar, and now trade at 50, 40, or even 30 cents. Investors like Oaktree, Silver Point, and Appaloosa see an opportunity.
They buy the cheap debt because they believe one of two things. Either the company recovers and they make a killing when the bonds go back to par, or it does not recover and they have bought enough debt to effectively seize control.
Restructuring is something else: the emergency surgery, shifting assets around and selling off pieces to keep a bleeding company alive. Bankruptcy is when the music stops, the case goes to court, and a judge decides who gets what. Bankruptcy isn't necessarily the end and can be the beginning of a comeback, and the fight over who gets the scraps and who benefits from a bounce back is what turns into warfare.
Why buy bonds of a failing company?
A bond bought at 30 cents pays off handsomely if the company recovers and repays more. If a restructuring returns 60 cents, the buyer doubles their money. The loss is capped at what was paid. NYU professor Edward Altman has defined distressed debt as yielding at least ten percentage points more than Treasuries.
How can a bondholder block a restructuring?
A class of creditors approves a Chapter 11 plan only if holders of two-thirds in amount of those voting agree. A holder owning more than one-third of a class can therefore block the plan. That blocking position gives the holder leverage in negotiations. Distressed investors often build stakes with this threshold in mind.
Why is bankruptcy sometimes a fresh start?
Chapter 11 was designed to let a viable business reorganize rather than shut down. Congress created the modern version in the Bankruptcy Reform Act of 1978. The business keeps operating while a plan is negotiated. Debt is cut so the company can emerge with a sustainable burden.
More from The Wall Street Skinny
