Assignment 2
3/28/13
A.) . Why is the market value for some of the debt and for the preferred stock less than the face value? What does this tell you about the expectations of the market concerning the prospects (a) for full repayment; and (b) for the company itself? What negotiating power, if any, does this provide to management in a restructuring plan? The market value for some of the debt and preferred stock is less than the face value of the debt because the liquidation value of the company is less than the face value of total debt. Thus, the market value of unsecured debtholder claims decrease in value in relation to the actual value of the company. In this scenario, the firm is undervalued relative to the debt obligation and will result in a lesser market value for certain creditors. Following absolute priority, debt holders of lower priority will receive proportionately less than the face value of debt. This is telling in the fact that the expectations are that full debt repayment is not feasible given the current financial conditions of company. The market is indicating that full debt repayment is highly unlikely, resulting in the company either declaring bankruptcy or enter into an out of court restructuring agreement with its creditors. Lower priority claimholder realize that they are not going to receive full repayment and will be more willing to enter into negotiations on how to restructure the company. This type of claimholder will probably take necessary measure to try to avoid seeing the company declare Chapter 11 bankruptcy, as the results bring about high uncertainty, high costs, and a large time commitment. Restructuring offers a higher repayment possibility. The expectation from the companies stand point is that restructuring is the best option for future operations. They want to continue forward as a going concern. Filing for bankruptcy should be viewed as a last resort and they will do everything possible to avoid this possibility. The management team does have some negotiating power that they can leverage in attempts to avoid bankruptcy. Bankruptcy is uncertain and costly for all parties involved. The most senior lenders will receive full repayment, both those less senior may end up with nothing in a worst case scenario. If the management team can convince its lenders that they are confident in the DCF valuation and the numbers are accurate, it will be most beneficial to all. Additionally, management can even attempt to use this negotiating power to try and lower interest payments and extend the time to maturity outwards on some of its debt. They will have the most success in bargaining with lower priority debtholders as they are in more favor of restructuring.
B. Why is the estimated sale price of Hudson ($500-650 million) considerably less than the DCF value (see spreadsheet) that management expects? What does this discrepancy imply for management’s credibility? For management’s restructuring plan? There are multiple reasons as to why the estimated sales price is considerably less than the discount cash flow value of Hudson, with the first being the matter of time. If Hudson were to be sold, the management team and its creditors would want it to be sold as soon as possible. Any delay in the sale process would negatively affect profits and operations. Customers may become disgruntled and want to look elsewhere, shrinking the market share of Hudson. This could potentially force the company to be sold at a significant discount. A second reason is that the discounted cash flow value incorporates a $125 million cash infusion. This cash infusion increases the operational capabilities of Hudson and this is not reflected in the current sale price. The additional cash is needed in order for Hudson to reach its full potential and ultimately achieve the projected DCF expectations. A third reason is that the market, fair or foul, is associating the troubles and