Moving Companies Forward Into the New Normal
In a Q&A with ABF Journal, Jack Butler of Hilco Global provides insight into the state of the restructuring industry in the current economic and political environment and what he sees down the road for capital markets, corporate restructuring and Bankruptcy Code reform.
ABFJ: How are you finding life as a business principal with Hilco Global compared to your former role as head of the corporate restructuring practice at Skadden Arps?
JB: Both organizations have very talented and ethical people who are committed to driving value by being innovative and creative. I spend a lot of time working with investment grade companies as well as distressed businesses and their investors thinking about innovative solutions to help them move forward. I’m having the time of my life helping lead a global organization that acts as an advisor, agent, investor and principal in transactions that maximize value based on our ability to understand every asset class that a company owns and to execute efficient solutions.
ABFJ: You wrote Navigating Today’s Environment after the financial crisis as a guide for company officers and directors. What was the most valuable lesson you learned?
JB: Navigating Today’s Environment is a compendium of 45 conversations with leading restructuring experts about corporate governance and enterprise risk assessment. We wanted to help fiduciaries in distressed situations that are often required to act outside of their comfort zone in distressed situations to deal with unanticipated challenges to their companies’ business models, to their strategic vision, to their liquidity situation and to their ultimate survival.
The book is as relevant today as when it was published a few years back. From 1960 to 2007, companies in the U.S. were managed in an economy where the Dow Jones went from 618 to just over 14,000 and real GDP rose an average of 3.4% each year. Compare that to what our growth has been in recent years: an average of about 2.25% over the last four years with many forecasters estimating about 2.6% per year over the next decade. We’re asking people to manage in a very different economy than what was experienced over the last 50 years.
It’s essential for corporate leaders to understand that they’re in a new normal. It’s not going to be the same business as usual as it was following the last couple of recessions, which really sets the stage for firms like Hilco Global that develop innovative ways to maximize value to be at the table. At the same time, directors and officers should not overreact to the current environment; things have to go on and there are a lot of corporate opportunities out there to be pursued.
ABFJ: What do you think has been the most distinguishing feature of this economic recovery as contrasted from past recoveries?
JB: Companies are continuing to hold onto a lot of cash. They’re not making all of the capital investments or executing the strategic transactions that you’d expect. Overall, there’s still a conservatism that’s holding back the kind of expansion we might hope for. I think many companies are still trying to navigate through monetary policy. The Fed is about to end its investment program and has signaled that it will begin to move towards a more balanced Central Bank environment in 2015.
But what does that mean? It means that in the not-too-distant future, the Fed is going to need to shed trillions of dollars of assets from its balance sheet. It’s going to mean returning to higher interest rates. The cost of capital has been unusually low for an extended period of time, which is going to change over the next few years. Yet while there has been a lot of capital chasing some deals, many middle market and small cap companies still can’t find financing and the capital investment they need to move their businesses forward. One size doesn’t fit all, when you talk about how the economy is moving forward.
ABFJ: Where do you think we are in the current recovery and what do you see down the road for the capital markets and corporate restructuring?
JB: In the short term, we’re going to continue to have a certain level of conservatism in a sustainable market. There is probably going to be a market correction at some point, but there isn’t a unanimous view on when or how that will happen. In fact, there are influential contrarians in the marketplace making a lot of money who believe the equity markets aren’t overpriced and there’s not an unusual credit or equity bubble being created currently. Then again, you have some activist investors who have publicly expressed concerns about asset prices and equity prices reaching a place of full value.
You also have to look at the political environment created by the 2014 mid-term elections and the 2016 presidential election, which are fostering some degree of conservatism and delay across corporate America. Many corporate leaders are concerned about the increasing level of regulation in this country, and believe that it is inhibiting investment and imposing unnecessary costs on businesses. There’s a balance: How much regulation is needed; how much is too much? That being said, we saw one of the most robust M&A markets in recent years during the first half of 2014. We continue to experience robust leveraged and capital markets. And so there are a lot of things going on, at a time where there is not a lot of sustained growth in the economy.
On the restructuring side, there is a lot of activity, but not so much in the courtroom. While actual distress rates are relatively low these days, there are a lot of businesses that are struggling, particularly in the middle market. They no longer believe that Chapter 11 business reorganization cases are a potential solution for them. Investors in larger companies are becoming skeptical of in-court solutions, which they believe cost too much, take too long, foster too much systemic adversity that is often disconnected from the economics and realities of the distressed business, and have recently generated disparate and uncertain outcomes.
Consequently, you’re seeing much more involvement in out-of-court activity and settlements and even state court resolutions to troubled situations as opposed to bankruptcy court. Stakeholders and potential acquirers want to take control of companies in the distressed world and chart out solutions for them that doesn’t require being in a courtroom if they can avoid it. At Hilco Global, while we have developed solutions both to improve the economics and outcomes inside of Chapter 11, we’re also working closer than ever alongside companies and their investors, including private equity firms and hedge funds, outside of the courtroom to maximize value.
ABFJ: You helped lead the American/US Airways merger and the automotive industry restructuring while working with Delphi Automotive. Will you share your insider’s perspective on those deals?
JB: Both the merger of American with US Airways and the restructuring of Delphi alongside General Motors reset the table in their respective industries. And at the end of the day, both transactions created billions of dollars of value for their stakeholders. One of the things that struck me in both transactions was the extraordinary quality and capability of the business leaders and their advisors. In both situations, the levels of trust developed among key players helped to make the deals possible.
The American/US Airways merger was aided by a rising market meeting a business solution that just made sense. The American team executed a remarkable restructuring and the US Airways team understood the merger’s business synergies and how to convince employees to work with them. The fact that investors cheered this final piece of U.S. airline industry consolidation in a rising market meant that everybody won. For example, the economic stake in the new American that old American’s shareholders received is valued at a greater market cap today than the whole of old American at any time in its history. Everybody won: stakeholders, employees, customers, everybody.
While American was aided by a rising market, an improved economy and investor confidence in the transaction, Delphi was reorganized at the bottom of the Great Recession when asset values were only a fraction of normalized values. It was restructured on top of the largest DIP loan default in U.S. history. And yet that business moved through its restructuring under a sound operating plan, reorganized itself in Chapter 11 and generated billions of dollars of value for the DIP lenders who controlled the capital structure. But because they were reorganized in different parts of the economic cycle, far fewer stakeholders in Delphi participated in the upside than at American. The juxtaposition of these two deals is really a textbook study about asset valuations in different stages of the economic cycle.
ABFJ: Do you agree that the business bankruptcy system is broken? As a Commissioner on the ABI Bankruptcy Reform Commission, can you tell us what it is planning to recommend?
JB: The Bankruptcy Code has served us well for a long time, but the world we live in today is a very different world than when the Bankruptcy Code was enacted in 1978. We live in a world where we’re trying to use a tool kit that was developed for a different time. Today, companies’ capital structures are much more complex. Asset values are driven less by hard assets and more by intellectual and intangible property. And there are a lot of things that exist today that didn’t exist back in 1978, like claims trading, derivatives and the kinds of financial structures that support businesses and the capital markets.
Take the earlier restructurings of Chrysler in 1979 and Kmart in 2003 as an example: those transactions involved getting agreements with primarily banks and bank-like entities that were commercial investors that held the debt. Today, when you try to do a transaction, much of the debt in the capital structure is held by other kinds of investors such as hedge funds. Typically, commercial banks hold relatively little direct investment in a lot of capital structures. The Bankruptcy Code was not designed to restructure and rehabilitate companies in the environment in which we live today. I don’t think it is achieving the policy objectives that motivated the adoption of the 1978 Bankruptcy Code, such as preserving jobs, preserving tax bases, rehabilitating viable companies, stimulating economic growth and trying to balance those goals against reasonable creditor expectations.
The Bankruptcy Reform Commission’s goal is to make recommendations to reform the Code to better balance the goals of effectuating the reorganization of business debtors, as well as maximizing and realizing the asset values for creditors and stakeholders. On one hand, how do you fix and preserve the business and preserve jobs? On the other hand, how do you maximize value to make meaningful distributions to stakeholders?
At the moment, the Commission’s study process has wound down and we have begun deliberations to sort out potential recommendations. There are concerns about the increase in cost in Chapter 11 cases, a decrease in recoveries to unsecured creditors, the fact that there are less standalone reorganizations, and that Chapter 11 may no longer work for small and middle market companies in terms of costs and procedural obstacles, among others. During the balance of this year, we are working to take into account all of the remarkable input the Commission has received from its advisory committees, witnesses at field hearings and business organizations that have made contributions, as well as suggestions from leading academics across the country. Our mission is to reconcile all of that input into meaningful reformation of the Bankruptcy Code and move forward into the new normal. We hope to issue our final report later this year.
Megen Donovan is an associate editor of ABF Journal.