Why Distressed Debt Is the Greatest Thing Since Sliced

Bread

Wharton 3/27/2013

Staying Power

• In 20 years, what is most likely to be around?

– Facebook?

– Google?

– Bankruptcy?

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Why Do Companies File?

• Companies file for bankruptcy for three reasons:

– They have run out of liquidity

– They will soon run out of liquidity

– They will eventually run out of liquidity

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Distressed Debt Analysis = A Puzzle

• Analysis of bankruptcies is really a study of three things

– Rational Actors’ Assessment

– Sources of Value

– Value Leakages

• Despite the complexity, you are working with MORE perfect information in distressed

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A Very Hard Puzzle

• If it was easy, everyone would do it:– Voluminous documentation (credit

agreements, indentures, plans, SOFAs, etc.)

– Org charts and capital structures (who has first right to what)

– Guarantees, security, pledges, etc.

• While everyone is focused on exit multiples, spend time looking for opportunities and pitfalls of value creation

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Rational Actors’ Assessment *

• Analysis of bankruptcies is also study of people and their motives:

– Maxim #1: People, especially management teams, want to get rich

– Maxim #2: The bankruptcy code grants significant power to management teams

* Peter Lupoff, Founder of Tiburon Capital Management and my former boss coined the phrase

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Overseas Shipping Group (“OSG”)

• Global leader in energy transportation

• Crude, U.S. flag operations

• Filed for BK in November 2012

• What are analysts focused on?– Exit multiple

– U.S. flag divestiture

– Tax claim

• Holdco Debtor: “Overseas ShipholdingGroup, Inc.”

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Quick Detour: SOFAs

• Statement of Financial Affairs

• Schedule of Assets and Liabilities for a single Debtor on a non-consolidated basis

– Real property/assets

– Creditors holding secured claims

– Creditors holding unsecured claims

– Executory contracts / leases

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Overseas Shipping Group

• Between 2/26/2013 and 2/27/2013 OSG filed docket items 553-922 (Over 350 items): All SOFAs and Schedules of Assets/Liabilities

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Corporate Structure

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Capital Structure Consideration

• Bonds structurally subordinated to bank facilities for any value at subsidiaries

• Bonds essentially pari with bank debt for all value at holdco (cash, JV equity)

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Bond Pricing

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Overseas ST Holding LLC

• Subsidiary of OSG Bulk Ships, Inc. (“OBS”)

• Assets: ~$340M

– $96M Interco Receivable

– $245M of Vessels

• Liabilities: ~$160M

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Overseas ST Holding LLC -Liabilities

• Listed in the $160M of liabilities at Overseas ST Holding LLC was a very curious entry:

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Interco Liability = Asset for Holdco

• Creditors of OSG ST Holding LLC should recover par (huge overcollaterization)

• Therefore, Overseas Shipholding Group, Inc. creditors just recovered an extra ~$115M

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Conclusion

• The more complicated the case, the more opportunities to uncover:

– Hidden gems of value

– Hidden sources of value destruction / leakage

• More importantly, the more complicated the case, the less likely analysts are looking at it, especially in smaller situations -> Alpha.

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