Monday, June 22, 2009

The LBO model on trial

Since it has become fashionable to push around large creditors of bankrupt corporations, a new development is taking place that may redefine the leveraged buyout landscape. Mass media is not covering it - mostly due to a lack of understanding of the potential impact.

The subordinated creditors of Lyondell Chemical are seeking to file a lawsuit alleging that the acquisition of the company by Basell constituted a “fraudulent conveyance”. The leveraged acquisition according to the claim was bound to make the company insolvent the minute it was completed.

From Reuters:
Unsecured creditors of bankrupt Lyondell Chemical Co are seeking approval to sue billionaire Len Blavatnik and the group of banks and advisors that led the petrochemical maker's $12.7 billion leveraged buyout by Basell AF S.C.A in 2007, saying the deal left the company with too little capital to fund operations.
The unsecured creditors are saying that Basell massively overpaid for Lyondell and did it mostly with newly minted debt of $22 billion in secured loans. $12 billion of that went to Lyondell's original shareholders ($1.2 billion to Blavatnik who was a 10% holder.) The rest went to pay pre-existing debt. Nothing improper so far. But the crux of the case is that this much debt "left the company with too little capital to fund operations" and it was bound to go under from the start.

To a large extent the unsecured creditors are right. It was obvious to many from the start that there was a high risk of this much leverage chocking the company. And here is what the unsecured creditors want to do:
From Reuters:
The creditors are seeking the return of billions of dollars of "fraudulently transferred" assets, and say the potential recoveries to the company's bankruptcy estate would be "enormous."
They are trying to extinguish all of the senior secured debt, all $22 billion of it. They are calling the debt fraudulent.

The defendants in the suit are the usual suspects that provided senior financing: Citi, Goldman, Merrill, ABN Amro, UBS, Apollo, Barclays, Deutsche. In addition they named Lyondell’s directors, Basell's directors, and of course Blavatnik who orchestrated the whole thing.

So what does it all mean? Well this debt and this transaction are actually fairly typical of the leveraged buyout deals completed in recent years. Hundreds of billions of LBO transactions resemble the Lyondell buyout. And in most cases (of course after the company fails) one could make the argument that the original shareholders who sold the company got paid hadnsomly, while the excessive leverage choked the company's operating ability.

In the good old days, recoveries on senior bank debt in the case of bankruptcy was modeled to be 80-90%. Even in cases of fraud, recoveries were high. Remember Refco? Senior loans actually recovered at par.

These days DIP financing and rolling of existing debt is much harder to come buy. Asset sales and acquisitions are difficult because financing is not there. Recoveries look more like 50% - 60% or even lower for secured paper.

But now if the unsecured creditors win, the $22 billion of Lyondell loans will be worth:

From First Data to TXU, as we discussed earlier, LBO loans will face a wall of maturities. The Lyondell case may set a nasty precedent that will create a bit of a headache for the holders of hundreds of billions in senior secured LBO debt.

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