European boomfails to arriveInsolvencies aredown – butfor how long?Page 2

Inside »

Bankruptciesat bay in USDefaults have fallenbut signs of stressare mountingPage 3

China playsbackstop roleBig companies arebeing coddled whilesmall fry can failPage 3

Funds move inon weak storesIn retailing, ‘loan toown’ can bringfaster resultsPage 4

Pace of changehits media worldSome groups haveresponded too lateto new trendsPage 4

FT SPECIAL REPORT

Business TurnroundsFriday 21 September 2012 www.ft.com/turnrounds-sept-2012 | twitter.com/reports

The restructuring industry isat an inflection point. Whilethe number of corporate debtdefaults remains below his-torical average, storm clouds

are gathering and could overwhelmvulnerable indebted companies.

Since the global financial crisiscaused a rash of corporate distress in2008-09, determined intervention bygovernments and central banks hasmanaged to calm debt markets, allowmany companies to raise moneyagain, and limit the number of corpo-rate failures.

Although the actions of policy mak-ers were unprecedented in scope,many restructuring and turnroundprofessionals remain surprised at howquickly markets improved, and howfew companies have run adrift as aresult.

“Credit markets virtually shut downin 2008, causing an avalanche ofrestructuring work,” says DavidKurtz, global head of restructuring at

Lazard, the investment bank. “Wethought it would take longer than ithas to recover. I’m still surprised thatcredit markets have remained robustdespite the global economic weaknessand the eurozone’s problems.”

The value of completed debt restruc-turings globally jumped to $335.9bn inthe first half of 2012, according toThomson Reuters, but this was over-whelmingly caused by Greece’s$263.1bn distressed debt exchange.Stripping Greece out, the value fell 30per cent from the same period lastyear to $72.8bn.

Other data corroborate the surpris-ingly muted restructuring market.Moody’s global trailing 12-monthdefault rate for companies rated belowinvestment grade edged up to 3 percent in August – from 2.8 per cent inJuly and 1.8 per cent in the samemonth last year – with 43 companiesdefaulting on their bonds so far in2012.

The rating agency forecasts that the

global default rate will climb to 3.1per cent by the end of the year, butthis is still comfortably below the his-torical average.

“Corporate default rates remain lowand steady,” noted Albert Metz, man-aging director of Moody’s Credit Pol-icy Research, in a recent report. “Ofcourse, there remain risks to theupside, that default counts will accel-erate. But to date, we are not seeingevidence of that.”

However, restructuring industryinsiders say the subdued headline rateof corporate defaults masks moresevere stresses among many smallercompanies that do not issue bondsand therefore do not appear in thestatistics of the rating agencies.

Alan Bloom, global head of restruc-turing at Ernst & Young, says: “Mostof us are astonished at how low thedefault rates are, but there are manysmaller companies that are strugglingunder the radar. The pressure onmany companies is still extreme.

“The economic outlook is poor, andparts of the world that were finearen’t any more.”

These smaller companies are usu-ally funded by bank loans, and canoften come to a quiet agreement withlenders without involving advisers oreven a formal default. As DonaldFeatherstone, head of European turn-round and restructuring at AlixPart-ners, observes: “Not every restructur-ing needs to have a default.”

This has been especially prevalentin Europe, where companies are farmore dependent on bank loans thanin the US. Most continental banks are

loath to cut a company adrift, andhave for the most part continued to“extend and amend” the loans ofstruggling companies.

Although this practice is oftenmocked as “extend and pretend” bysceptics, who say banks should bemore forceful in admitting to losses, ithas kept the levels of corporate dis-tress relatively muted so far.

Yet restructuring professionals saythat European banks – under pressurefrom regulators and investors toshrink – are starting to take a lesssanguine approach. Some have evenstarted to offload their loans to so-called distressed debt investors at adiscount, which can transform thedynamics of a restructuring.

Richard Tett, a restructuring part-ner at Freshfields, the law firm, says:“Banks can wobble about being criti-cised for being nasty. They don’t wantto be known for bringing down com-panies, while some of the funds see

Continued on Page 4

Low failurerates masktough times

Corporate defaults are well below averagebut the minnows are under severe stress,writes Robin Wigglesworth

Frequent fliers: bankruptcy protection is a well-trodden path for US airlines, including American. See Page 3 Bloomberg

‘There are many smallercompanies . . . strugglingunder the radar’

Alan Bloom, Ernst & Young

2 ★ FINANCIAL TIMES FRIDAY SEPTEMBER 21 2012

Andrew BaxterCommissioning EditorAndy MearsPicture EditorChris TosicDesigner

For advertising contactRobert Grange, tel +44(0)20 7873 4418, emailrobert.grange@ft.com

Simon RabinovitchBeijing Correspondent

Vivianne RodriguesUS Capital Markets Writer

Michael StothardCapital Markets Writer

Robert WrightUS Industrial Correspondent

Robin WigglesworthCapital Markets Correspondent

Robert BuddenChief Media Correspondent

Andrea FelstedSenior Retail Correspondent

Richard MilneNordic Correspondent

This year Julian Graves,the health food retailer thatis a sister company of Hol-land & Barrett, collapsedinto administration alongwith Clinton Cards, whichwent into administrationafter its biggest supplier,American Greetings,acquired £35m of debt fromits lending banks.

Barratts Priceless, thefootwear retail chain thatsurvived administration in2009, appointed administra-tors for the second time latelast year while Blacks Lei-sure, the outdoor retailchain, was sold via a pre-pack administration thisyear. Others that havefound themselves in troubleinclude Aquascutum, GameGroup and Peacocks.

One consequence of ahigher number of retail andleisure restructurings thisyear has been a rise in thenumber of company volun-tary arrangements.

Many of these groupshave suffered from havingto pay rent on a largenumber of physical sites,and so have used this toolto renegotiate leases.

“We have seen a rise inthe number of CVAs thisyear, partly because thetypes of companies that arebeing restructured in theretail and leisure sectoroften have large rent pay-ments,” says Bryan Green,president of the UK Turna-round Management Associ-ation.

CVAs have also beenused, he says, because“banks and creditors areincreasingly willing tonegotiate with strugglingcompanies to try to pre-serve value”.

Travelodge and FitnessFirst are two companies tohave used CVAs this year.There is some debate, how-ever about how useful theyare, with some arguing thatthey can delay the problemonly at the expense of thelandlords.

Industry analysts nowexpect a steady rise in thenumber of UK restructur-ings in the coming years,but restructuring profes-sionals expect the mostwork to come from the sec-tors that are already limp-ing along.

of corporate insolvenciesrecorded in the secondquarter of 2012 was inflatedby 156 companies in theSouthern Cross group ofcare homes being declaredinsolvent in June.

The retail sector is in theworst position, however, assofter consumer demandcombines with more struc-tural factors such as compe-tition from online rivals,weighing on profit and driv-ing a number of failures.

Data from the UK insol-vency service showed thatthe number of retail insol-vencies rose 10.3 per centlast quarter even as theoverall number of compa-nies failing dropped. Therewere 426 retail insolvenciesrecorded for the threemonths to June 30, accord-ing to research by PwC,compared with 386 in thesame period in 2011.

“In a more normal envi-ronment where interestrates were higher andreflected true risk of bor-rowing money, the bank-ruptcy rate would be evenhigher for them,” says Jer-emy Lytle, a director at ECIPartners, the mid-marketprivate equity firm.

been another hard hit byeconomic woes, this time bygovernment spending cuts,a fall in property valuesand weak consumer spend-ing. Despite the number ofpeople over 65 exceedingthose under 16 for the firsttime ever, there has beenan overall decline in occu-pancy in care homes.

This is partly due to

squeezed family budgets,but also a reduction in gov-ernment spending withlocal authority budgets forsocial care reduced by morethan £600m, or 8 per cent,between 2011 and 2012,according to an analysis byBTG Restructuring.

Southern Cross was ahigh-profile failure, butsome say it is unlikely tobe the last. The number

The leisure and hotel sec-tor, retailing and healthcarein particular have all seen anumber of high-profile fail-ures in the last year and areall on the watch list ofrestructuring professionalsgoing into 2013.

The leisure sector hasbeen particularly active.One of the most recentrestructurings has beenTravelodge, the debt-ladenbudget hotel operatorbought by Dubai Interna-tional Capital, an invest-ment arm of the emirate, in2006 for £675m in a highlyleveraged deal that includedabout £475m of debt.

The weak consumer envi-ronment left it struggling toservice its substantial debtpile and last month Trave-lodge was taken over by itscreditors – Goldman Sachsand two New York hedgefunds – as part of a debtrestructuring deal to save itfrom administration.

Another in the sector wasFitness First, the UK gymchain that had been boughtby the private equity groupBC Partners for £835m in2005. The chain is nowbeing restructured, too.

The healthcare sector has

The number of corporateinsolvencies in the UK hasfallen by nearly 10 per centin the past year as compa-nies benefit from generoustreatment from banks, thegovernment and the lowinterest rate environment.

Despite a double-diprecession, there were only1,028 compulsory liquida-tions in the past quarter, 22per cent fewer than in thesame period last year,according to data from theUK insolvency service. Vol-untary and non-voluntaryinsolvencies in England andWales are down 8 per centfrom the first quarter of theyear to 4,107.

The substantial drop –when many expected thenumber to have crept up –has prompted worries abouta rise in the number of“zombie” UK companiesthat can service debt repay-ments but have no realisticchance of ever paying itback, and the effect this hason the broader economy.

“There are many UK com-panies out there with veryhigh levels of debt just stag-gering on, unable to investmoney in new productdevelopment but servicingtheir interest payments,”says Adrian Doble, a part-ner at FRP Advisory. “It ismainly because banks donot want to be seen to beforcing the pace of restruc-turing at the moment onlyto suffer the writedownsassociated with that. In alow interest rate environ-ment their motto is ‘a roll-ing loan gathers no loss’.”

The falling number ofrestructurings, however,belies the problems for cer-tain UK sectors that havebeen worst hit by govern-ment spending cuts, thedownturn in consumer con-fidence on the high streetand other sector-specificstructural factors.

Business Turnrounds

Atough combination of gov-

ernment austerity, weak eco-nomic growth and a shrink-ing banking sector in Europehas left many restructuring

professionals eagerly awaiting a greatwall of work coming their way.

Distressed debt funds have beenexpanding their operations, with someaggressive US operators muscling intothe market in anticipation of bigreturns if they can get the right pricefor a savable company.

“We anticipate a lot more distressedopportunities coming from Spain andfrom other peripheral [eurozone]countries given the weak economicconditions and the drop off in banklending,” says Appu Mundassery, amanaging director of Bayside Capital,which opened a dedicated Madridoffice in February.

Standard & Poor’s, the ratingagency, has warned that the Euro-pean banking sector may not be ableto meet the needs of eurozone compa-nies over the next five years.

“The banks in Europe are not in aposition to meet the large refinancingneed over the coming years, and whilesome will be absorbed into the highyield market, a lot of companies willhave to be restructured,” said KeithMcGregor, European head of restruc-turing at Ernst & Young.

And, while the situation for Euro-pean banks has been improved by theloans of more than €1tn from theEuropean Central Bank, the Interna-tional Monetary Fund still estimatesthe banks could shed as much as €2tnof assets by 2013, contracting the sup-ply of credit by 1.7 per cent overall.

European companies also face a so-called “wall” of refinancing in 2013 to2015, where debt issued in the headydays of 2006-2007 starts to fall due.

Many in the industry argue that anumber of the blockbuster leveragedbuyouts of the credit boom will belikely to need restructuring.

But Europe is already two yearsinto its sovereign debt crisis and withthe continent as a whole edgingtowards recession as well as much ofsouthern Europe battling with highunemployment and sharply lower con-sumer confidence, the mystery is thatthe starting-pistol on this wave ofrestructurings has not yet sounded. Infact, in many places, the trend hasbeen in the opposite direction. So farthis year Italy has seen only 12

restructurings worth just $2bn andSpain has seen 43 worth $3.5bn,according to data from Thomson Reu-ters. Both these figures are the lowestsince before the crisis began in 2008.

And, looking ahead into 2013,Moody’s default rate forecasts suggestthat the number of corporate failureswill actually decrease. The ratingagency expects the European specula-tive-grade default rate to fall slightlyfrom 3 per cent today to 2.8 per centin August 2013 on a 12-month trailingbasis, although this is slightly abovepre-crisis levels.

Some among the restructuring pro-fessionals are starting to wonder ifthe great rise in the number of dis-tressed companies will ever happen.

“The wall of restructuring is always18 months away and it has been 18months away for the last five years,”says David Ereira, a partner in therestructuring and insolvency businessat Linklaters, the law firm.

“I think the great jump in restruc-

turings will never happen, although agradual increase in coming years isstill quite likely,” says Mr Ereira.

One reason why the rate of restruc-turing is so low – and some arguecould remain comparatively low forseveral years still – is the low interestrate environment, which allows evencompanies with unwieldy capitalstructures to service their debt.

Few economists think interest ratesare likely to rise in the foreseeablefuture. “If interest rates were higherthere would likely be more companiesout there in need of restructuring thisyear,” says Ben Babcock, Europeanhead of restructuring at MorganStanley. “[But] rates appear unlikelyto rise in the short term, so compa-nies will probably keep that breathingspace for the time being.”

A second major factor is the Euro-pean banks themselves which, due tothe tougher regulatory requirements,weak economic fundamentals and per-haps political pressure are often pre-

ferring to “amend and extend” theircorporate loans rather than force thecompanies into insolvency and takethe short-term hit to their balancesheet. Critics call this “amend andpretend”.

Another factor is the slow speed atwhich these same banks are sellingtheir debt portfolios as part of a moveto reduce their liabilities ahead of newregulations on capital requirements.

Distressed funds – which tend to bemore aggressive about forcing compa-nies to take firm action – want to buybut often complain that the banks areunwilling to sell at a “fair” price.

Despite all these factors there havealready been a number of restructur-ings in continental Europe, includingWind Hellas, Greece’s third-largestmobile telephone company, which hashad to restructure its debt twice inrecent years.

Insolvency professionals say that –although the data are harder to track– there have also been a growing

Paradoxpostponed: Spainand the rest ofsouthern Europeis battling highunemploymentbut so far thenumber ofrestructurings hasbeen low Getty

Boom in going bust fails to arrive – yetContinental Europe Distresssed debt funds and many in the turnround industry are disappointed by the relatively low level ofwork but economic problems in the peripheral eurozone countries could bring increased opportunities, writesMichael Stothard

number of insolvencies and restruc-turings in small and medium businessacross the continent. These SME busi-nesses are the most reliant on bankfunds and in areas most struck by thetroubles, so therefore the most likelyto get into trouble first.

“Pressure will only increase onthese companies as their customersdelay settlement of accounts and sup-pliers demand accelerated payment,”says Scott Pinfield, managing directorat Alvarez & Marsal. “There is still noclear light at the end of the tunnel formany troubled companies acrossEurope.”

But, once again, there is somethingholding back the number of insolven-cies in countries such as Spain, Italyand Greece. This time it is the largelyuntested bankruptcy regime whichmakes lenders more reluctant to takethat route.

In Spain, for example, there is no

set-up for a pre-packaged bankruptcyprocess, which means debt negotia-tions can take longer than in the UK.

Overall, while the distressed cycle isbound to start in earnest at somepoint, it is still far from clear whenthat will be and, in the meantime,many in the industry are disappointedthat the work is not coming throughas they had expected.

“Pure distressed investors are get-ting frustrated, thinking that thereshould be two to three times as manyrestructurings given the economic sit-uation,” says Gina Germano, foundingpartner and distressed specialist atGoldbridge Capital Partners.

But that is not stopping funds pilinginto Europe in anticipation of what isto come. There are currently 16 fundslooking to raise an aggregate €7.8bnfor Europe-focused distressed debt aswell as turnround and special situa-tions, according to data provider Pre-qin. Around €17.9bn has now beenraised since the beginning of 2008.

‘There is still no clearlight at the end ofthe tunnel for manytroubled companiesacross Europe’

Rolling loans gather no loss for banks

Checkout time: Travelodge was taken over by its creditors to save it from administration

Leisure and hotels,retailing andhealthcare have allseen a number ofhigh-profile failures

Contributors »

UK

A falling number ofinsolvencies beliesthe problems formany sectors, writesMichael Stothard

Nokia has been in manyturnround situations in itsup-and-down history. But thestruggle the Finnish groupcurrently finds itself in couldbe its most serious.After largely missing the

smartphone revolution, theone-time largest in the worldmaker of mobile phonehandsets is down on itsluck, outflanked by the likesof Apple and Samsung. SoNokia has tied its fate toMicrosoft, hoping to makethe Windows platform thethird big mobile operatingsystem behind Apple's iOSand Google's Android.But with its most recent

phone launch – that of theLumia 920 (pictured), itsflagship model to run onWindows 8 – widely viewedas disappointing, some arestarting to wonder if Nokiareally can win its latest fightfor survival. With its sharesdown by more than 90 percent from its peak, the usualfunds that look at distressedsituations are starting tosniff around the company.For some observers, this

seems unfair as StephenElop, the chief executiverecruited from Microsoft twoyears ago to rescue Nokia,has done much right in hisrestructuring of the group.“If you look at Nokia and

see what they have done inthe past year you can't faultthem. They have done allthe things you would expectthem to: restructured theoperations, taken costs out,simplified things in thebusiness, and furiouslylaunched new smartphonesinto the market,” saysMichael Weyrich, co-headof the telecoms, mediaand technology practiceat AlixPartners, therestructuring

consultancy.But there is still a sense

that the company couldquickly get into trouble.Credit analysts at Société

Générale noted in the summerthat the Finnish companycould effectively exhaust itscash reserves within littlemore than a year at the rateit was burning cash.That can seem strange as

Nokia ended the secondquarter with net cash of€4.2bn and gross cash of€9.4bn. Although the netcash number was down 14per cent from the previousquarter, all of that was due toa dividend payment. Itgenerated positive net cashfrom its operations, purelydown to a large pre-paymentfrom its well-regarded patentportfolio. But tech industryexperts point out thatcompanies in the sector oftengo bankrupt with significantamounts of cash, pointing toNortel, the Canadian telecomsgroup that went bust in 2009with several billion dollars ofcash.

Mr Weyrich says it isnever a good sign when acompany prominently refersto its cash levels in itsearning reports. He adds: “Itis a costly game they are inand it is a game that ischanging rapidly. You canimprove very rapidly butgiven the market dynamics itcan also go downhill veryrapidly.”For many credit investors,

however, Nokia does nothave enough debt to getthem excited. It has only€3.25bn in debt outstandingfrom four bonds all issued inthe spring of 2009compared with dozens formost companies of thesame size.“They just don’t have

enough bonds to make theminteresting for us. We didplay the credit default swaps[insurance on bonds in caseof default] for a while buteven that is less interestingnow. Really, Nokia is adistressed equity play,” saysthe chief investment officerof one of the world's biggestinvestors in corporate debt.Anecdotal evidence bears

this out with largeproportions of Nokia’sshares borrowed out toshort-sellers. The sharesthemselves have been on arollercoaster ride, falling toa 16-year low in July,before more thandoubling in the spaceof a month.A senior Nokia

executive says: “I reallydon’t know what is goingto happen. I guess thereare going to be lots of

chances for investors asthere will probably be lotsmore ups and downs tocome.”

Richard Milne

Case study Nokia seeks better connection in survival fight

FINANCIAL TIMES FRIDAY SEPTEMBER 21 2012 ★ 3

been there, either throughoperating cash flow orthrough loose bank credit,”he says. “Cash flows aregoing down and govern-ment subsidies are dryingup, so you are beginning toget market pressure.”

In the first half of theyear, non-performing loansgrew by just 1 per centacross the bank sector, butoverdue loans jumped by 29per cent, according to MikeWerner of BernsteinResearch in Hong Kong.

That increase in delin-quent loans and covenantbreaches is creating new

opportunities for businessturnround specialists.

Ted Osborn, leader of thePwC business recoverypractice, says his firm hadbeen marketing its restruc-turing services in China foryears with little success.“Finally some of that isstarting to pay off,” he says.

A branch of one of thenation’s biggest banksrecently contacted PwC toask for help in recoveringloans. “For the first timethey started listening andtaking some of our sugges-tions,” he says.

However, he is doubtfulthat this will be a big newtrend. “The politics

involved at these banks andwith their customers thatare in trouble are very com-plex, and they are typicallysolved behind closeddoors,” he says. “So wethink only a handful ofthese cases will emerge.”

For foreign investors whofind themselves entangledin corporate basket-cases inChina, the question ofrestructuring is a particu-larly vexing one. Because ofrestrictions on China’s capi-tal account, foreign inves-tors often have limitedclaim to the assets of theChinese company.

Instead, they own equityin an offshore entity thathas a creditor-like relation-ship with the Chinese com-pany.

So when the Chinese com-pany runs into trouble,defaults and bankruptciesare not feasible options forthe foreign investor – theirentire investment would bewiped out.

“In many of those situa-tions creditors have taken avery pragmatic approachbecause their debt is off-shore, so taking an aggres-sive approach may not getthem far,” Mr Osborn says.

Mr Naumann says it hasbeen a learning process forforeign investors, with themain lesson being that oncea Chinese company is inserious trouble it is proba-bly too late.

“Legal agreements do notgive you the protection thatyou need,” he says.

“At the end of the day it’sreally about how deeply doyou get involved in compa-nies early on when you seetrouble.”

date the industry and takecapacity out. But sincemost if not all of theseOEMs (original equipmentmanufacturers) are backedby the central governmentor provincial governments,it’s just not happening,” MrNaumann says. “Overall,that hurts the industrybecause it drives down pric-ing and profitability for eve-ryone else.”

But the story of corporaterestructuring in China isnot entirely one of govern-ment control. Smaller, pri-vate companies in sectorsthat are not seen as strate-gically important areallowed to fail. And as theeconomy slows, more andmore of these, from retail-ers to manufacturers andproperty developers, arerunning into trouble.

“In the last half yearwe’ve seen a very signifi-cant uptick, even more soin the last three months, ofsituations that have comeup,” Mr Naumann says.

Arthur Kroeber, manag-ing director of Dragonom-ics, a research firm in Bei-jing, thinks the pace of cor-

porate restructuring willonly increase over thenext year.

“The reason thatthere has not been con-solidation in Chineseindustries over thelast decade is because

the money has always

As the LDK case illus-trates, corporate restructur-ing in China often hingeson the role of the govern-ment.

In the 1990s the centralgovernment was instrumen-tal in pushing inefficientstate-owned enterprises toconsolidate, tolerating a bigspike in unemployment inthe country’s old rust-beltregions in order to modern-ise the economy.

Now, with China experi-encing its worst growthslowdown in more than adecade, government offi-cials have so far refrainedfrom taking such boldmoves, instead coddlingmany companies that mightotherwise have failed.

Ivo Naumann, managingdirector of AlixPartners inShanghai, points to theauto industry as a primeexample. While foreignautomakers are doing wellin China, many Chineseupstarts are struggling withless than 60 per cent capac-ity utilisation, when 75 percent is typically the thresh-old for breaking even.

“Clearly youneed to consoli-

LDK Solar began the yearon a confident note.Already one of China’s big-gest solar-panel makers, itbought a German peer, Sun-ways, in January in a dealthat appeared to burnish itscredentials as a potentialglobal leader in the renewa-ble energy sector.

Appearances were deceiv-ing.

With demand weak,inventories bulging and rev-enues collapsing, it has laidoff thousands of workersand shut most of its produc-tion lines since acquiringSunways. LDK’s US-listedshares have fallen 70 percent this year.

These troubles are hardlyunique to LDK. Throughoutthe global solar industry,companies are sufferingfrom overcapacity.

But unlike its US andEuropean peers, LDK hashad a crucial backstop: thegovernment of Xinyu Cityin Jiangxi province, whereit is based.

In May, Xinyu officialsleaned on state-run banksto provide LDK with anemergency Rmb2bn ($317m)loan. Then in July, the gov-ernment stepped in directly,allocating Rmb500m fromits budget to help LDK payoff loans.

Business Turnrounds

US companies with fragile bal-ance sheets have largelybeen able to bide their timeand avoid potential restruc-turings, and even bank-

ruptcy in 2012, thanks in part to rela-tively stronger economic growth inthe US and the voracious appetite forhigh-yielding debt.

That combination has helped keepUS default rates at low levels, as com-panies have been able to push outwhat could have been a debilitating“wall” of debt maturities in 2013 and2014.

But the outlook has turned slightlymurkier recently, and many restruc-turing experts expect an uptick in thenumber of companies that are forcedto restructure, or fail altogether.

Failures are likely to include compa-nies that have been in long-termdecline, where the combination oftougher competition and lacklustregrowth is the final straw that breaksthe camel’s back – Eastman Kodak’sbankruptcy being one such example.

On the other hand, there are entiresectors that face cyclical challengessuch as the shipping, natural gas andcoal industries.

The questions now are what hap-pens if lingering financial problems inEurope are not addressed, andwhether US debt capital markets –which have remained buoyantthroughout the year – become lessfriendly ahead of the presidential elec-tions and a potential “fiscal cliff” atthe start of the new year.

“It’s been a very good year for thehigh-yield markets, both for compa-nies and investors,” says David Ying,senior managing director and head ofrestructuring at Evercore Partners.“But we may see a pick-up in volatil-ity. Companies should not assumebond markets will remain receptiveall the time.”

Throughout 2012, investors havefunded companies at higher risk ofdefault – this month pushing theiraverage yields to the lowest level onrecord – in exchange for higherreturns than those offered by top tierdebt securities.

“The high-yield bond marketdoesn’t operate in isolation: [it] livesand dies on good credit analysis,”says Mr Ying. “While we are living ina world where benchmark rates arephenomenally low, both companiesand investors have to realise these areunusual times.”

For now, the bet has paid off. Aver-age high-yield debt has returned morethan 11 per cent so far this year, com-pared with 7.5 per cent for invest-ment-grade companies and 1.8 percent for US Treasuries, according toBarclays indices.

Against that backdrop, trailingdefault rates in the US have fallen to2.7 per cent in June from a long-termaverage of 4.5 per cent, according tothe latest available data from Stand-ard & Poor’s.

Jason Thomas, director of researchat the Carlyle Group, says: “There arereasons to be optimistic that the vol-

ume of companies’ maturing claimsshould not disrupt the refinancing of[speculative-grade debt by] cash-gen-erating, solvent businesses, at least inthe US.”

He adds: “In the absence of extrememacroeconomic stress or illiquidity,the volume of maturing obligationsshould not generate default risk thatis independent of the credit quality ofthe borrower.”

However, S&P forecasts that thedefault rate will climb to 3.7 per centby June 2013, implying that 57 specu-lative-grade-rated companies willdefault during the 12 months endingJune 2013.

Restructuring experts say that somesectors still face problems stemmingfrom the recession and financial cri-sis. While upcoming debt maturitieshave been pushed out by a few years,many still have businesses and bal-ance sheets based on the less conserv-ative standards seen before the finan-cial crisis.

Ken Buckfire, chief executive andco-founder of Miller Buckfire, says:“One could argue that in the past yearor so, capital markets have been wide

open to anybody who needed to refi-nance their problems away. But com-panies in bad shape will file for bank-ruptcy, irrespective of what is goingon in the debt capital markets.”

Signs of potential stress for US com-panies are mounting, as the economystruggles to gain traction at a timewhen commodity prices are fluctuat-ing sharply, and labour marketsremain weak.

During the latest reporting season,S&P 500 members were three timesmore likely to say they would missrather than exceed analysts’ expecta-tions of third-quarter earnings. Thatwas the worst guidance ratio since thefinal quarter of 2008.

Perry Mandarino, US businessrecovery services leader at PwC, says:“Many companies have already under-taken action to cut costs from thebottom line and are running leanerthan ever. [But] companies can’t fore-see a market downturn or alwaysknow the true impact of new competi-tion or new industry pressures.”

Mr Mandarino suggests companiesfacing pressure should prepare “con-tingency” plans and be proactiveabout their restructuring strategy.

“If the business is not growing andthe company is leveraged, chances areit will need some sort of restructur-ing,” says Mr Buckfire.

“But before a company just goesahead and files for Chapter 11 protec-tion, it pays to know how to managecreditors and be in position to proposerefinancing solutions

Snap happy:Kitty Kramer, thefirst Kodak girl, in1890, when thepicture for thecompany wasmuch brighter

Defaults fallto low levelbut signs ofstress mount

US Economic growth and demand forhigh-yield debt have kept bankruptciesat bay for now, says Vivianne Rodrigues

‘Companies should notassume bond marketswill remain receptiveall the time’

Government in backstop role

Ivo Naumann:consolidationneeded inauto industry

Smaller, privatecompanies insectors not seenas important areallowed to fail

When AMR, the parent ofAmerican Airlines,announced its August 2012traffic figures on September11, it was quick to trumpetthe speed of its revenuegrowth.The airline’s passenger

revenue per available seatmile (PRASM) – theindustry’s key revenuemeasure – had risen 4.1 percent, against 4 per cent forDelta Air Lines, its biggestrival, only 2 to 3 per centfor Southwest Airlines, thelow-cost carrier, and 1 percent for US Airways. It wasthe fifth consecutive monththat American had come outtop of the PRASM figures.American’s growth was

achieved under what might,at first glance, have seemedto be unpromisingcircumstances. Unlike anysignificant rival during theperiod, it was in Chapter 11bankruptcy protection, afterin November last year itbecame the latest large USairline to recognise that itwould never honour all itsfinancial obligations with itsexisting financial structure.Yet many industry

observers regard American’sstep as long overdue, andlikely to be key to the airlinereaching the same cost levelas rivals that have previouslytaken the well-trodden pathfor airlines throughbankruptcy.There are two things a big

airline can do to have asignificant impact on itscompetitiveness, one senioraviation industry figure says.“You can mark to market

your labour costs and yourairplane costs,” the figure,who declines to be named,says. “Those are the two bigthings in any airline. In abankruptcy, you can do a lotto sort those out.”The main outstanding

question remains whatshape the new, restructuredAmerican Airlines willassume. Tom Horton, AMR’schief executive, said inAugust that merger with USAirways, its smaller rival,could be “an attractiveoption under the rightcircumstances”. The pairhave since signed aconfidentiality agreement tofacilitate detailed talks on amerger.The company now had “a

line of sight” on its post-reorganisation cost structure,Mr Horton said. “In my viewthat paints a picture of avery successful, profitable,productive airline. Thequestion then is, could acombination make us evenstronger? I think that’s alegitimate question.”At the heart of American’s

longstanding problems wasits failure to reformadequately contracts thatawarded staff far betterconditions, pensions andhealthcare provision than are

now industry standard. Itscompetitiveness has laggedbehind since large rivals –including Delta and UnitedAirlines – all sought Chapter11 protection over the pastdecade as they confrontedboth unsustainably highlabour costs and, for some,unrealistically high aircraftleasing costs.American’s labour unions

have all in the past twomonths either accepted new,sharply-trimmed contractsor, in the pilots’ case, hadnew terms imposed by thebankruptcy court.“The long-term success of

American depends on theextent to which it canpromulgate labour savingsnot just in labour rates butindirect labour costs,” thesenior aviation figure says.But the improvements,

everyone involvedrecognises, are unlikely tobe sustained if the US airlineindustry again descends intothe kind of fierce, cost-cutting competition that hasruined its financialperformance over the pasttwo decades.Doug Parker, US Airways’

chief executive, told aconference on September 5organised by Dahlman Rose,the investment bank, thatthe latest figures showedairlines were now succeedingin passing on to passengers

fluctuations in the price offuel. Competition used tomean that during fuel pricespikes fares would fall, asairlines sought the volumesneeded to survive.Mr Parker has previously

suggested that an American-US Airways merger mightsignificantly further theprocess of making theindustry solidly profitable. MrHorton has also praised theeffects of industryconsolidation and thegreater maturity it hasbrought to airlines’ decision-making.Yet, whether the pair

agree merger terms or not,there is little doubt thatsignificant further effort liesahead to ensure thatAmerican’s bankruptcy is thelast for a leading US airline.“I think the US airline

industry has a ways to go tobe more profitable,” MrHorton said in August. “Itshould be more profitable,but I think the trajectory isgood.”

Robert Wright

Case study American Airlines

China

As growth slows,many strugglingcompanies are beingcoddled, writesSimon Rabinovitch

‘[The industry]should be moreprofitable but thetrajectory is good’

Tom Horton, AMR

4 ★ FINANCIAL TIMES FRIDAY SEPTEMBER 21 2012

aggression as a badge ofhonour.

He adds: “Distressed debtfunds tend not to have suchbroad relationships to careabout, and acquiring thedebt at a discount allowsthem a flexibility thatbanks often don’t have.”

Most bankers, lawyersand advisers in the fieldexpect that distressed debtfunds will become a morevisible part of the Europeanrestructuring landscape, asdefaults continue to mountin the coming year – prima-rily caused by the eurozonecrisis.

Even the UK – which hasbenefited from controllingits own monetary policyand emerged as a “safehaven” amid the storm –noticed mounting stressesas the economy entered adouble-dip recession thisyear.

Tony Lomas, chairman ofPwC’s UK Business Recov-ery Services, says: “We areseeing a steady flow of com-panies struggling with hugedebt built up in the boomyears. This is prompting asignificant number of com-panies to enter into restruc-turing conversations”.

He adds: “At the smallerend of the market, bankdeleveraging is making itparticularly challenging forcompanies to access bothbank funding and the bondmarkets.”

Some industries are moreexposed than others.Restructuring experts haveidentified shipping as one ofthe most vulnerable, as thecost of transporting goodshas fallen to near recordlows.

The industry’s woes haveattracted the attention ofdistressed debt funds, butone senior London-basedfund executive comments:“The fundamentals of theindustry are dreadful.

“There’s just way toomuch capacity in the indus-

Continued from Page 1 try. Some of these ships areworth more as scrap.”

The situation looks some-what brighter on the otherside of the Atlantic.

US economic growth mayhave disappointed, but itremains considerablyhigher than that in Europe,and US banks tackled theirdud debts more aggres-sively earlier in the finan-cial crisis.

There has been a spate ofhigh-profile situations –most notably AMR, thebankrupt parent of Ameri-can Airlines; HawkerBeechcraft, the jet makerthat was eventually sold toa Chinese aviation group;and Eastman Kodak, theonce-dominant photographycompany. However, expertssay the overall level hasbeen no higher than usual.

Morgan Stanley’s creditanalysts forecast a defaultrate of 2.9 per cent for non-investment grade debt inthe US, compared with 5per cent in Europe. Citi-group analysts forecast thatEuropean defaults will riseto 6 per cent by the end ofthe year, but remain atabout 2.5 per cent in the US.

“There have continued tobe some larger US situa-tions, but not many,” saysMr Kurtz of Lazard. “Themid-market has been busierthan the larger end. That isno surprise, as they aremore exposed to the weakdomestic US economy.”

Yet even in the US, thereare tentative signs thatrestructuring activity is setto pick up, in part causedby the eurozone crisis spill-ing over into both devel-oped and emerging mar-kets.

Company executives candraw comfort from the bondmarket’s continuing will-ingness to lend, and theslow-motion deleveraging ofEuropean banks – but theyshould not be complacentabout the challenges thatloom over the next year.

Failure datahide hard times

Business Turnrounds

Buyout funds and distresseddebt investors are circlingstruggling retailers as theygrapple with the consumerdownturn, too many outlets

and the inexorable rise of internetshopping.

This year has seen several fundstake control of retailers in a trendthat restructuring experts say is set tocontinue.

In March, OpCapita, the privatelyowned investment firm, bought theUK assets of Game Group out ofadministration, after trying to acquireits debt before the collapse.

A few weeks later, Jon Moulton’sBetter Capital paid £19.5m for all thesecured debt and 90 per cent of theequity of Jaeger, the fashion retailer.Better Capital also looked at JJBSports but did not make a bid for thesports goods retailer.

Acquiring the debt of a distressedretailer “can often be viewed as a no-lose situation,” says Dan Coen, direc-tor and co-head of retail at ZolfoCooper, the corporate advisory andrestructuring services group, formerlyknown as Kroll. If the retailer is ableto repay the debt, the buyer recoupsits outlay plus a little interest.

This is the “worst case scenario”, hesays. The best case, from the buyer ofthe debt’s perspective, is if the com-

pany is in default of its lending facili-ties, and the buyer can take control ofthe business, make tactical use ofinsolvency proceedings, and thenembark on a radical restructuring.

This would allow the buyer “torestructure the business significantlymore quickly and effectively than if ithad to do it solvently”, says Mr Coen.“By cutting store numbers andrestructuring hard, you are ultimatelycoming out with a much stronger and,most importantly, more relevant busi-ness.“

Indeed, Mike Jervis, a partner inPwC’s business recovery services,says: “Almost all the retailers that getinto the distressed space have onething in common. They have far toomany stores.”

He says the “loan to own” route,taking control of the debt, is a “potentweapon” with which to force arestructuring, which existing manage-ment may be reluctant or unable todo.

“If you try to exit from 100-plusstores, it’s going to take you severalyears; it’s very uncertain in terms ofhow much money you are going tohave to put into the deal; it’s going totie up masses of management time,and there is no guarantee of success,”he says.

Mr Jervis says that for a fund to

buy the debt, there has to be a sellerof the facilities in the first place.

Ian Gray, a director at BaronsmeadConsulting, a restructuring advisorypractice, says some banks are shrink-ing their balance sheets.

But buyout funds “are prepared togo further than the banks and do itvery quickly. When they review theseassets, they often look at the insol-vency options.”

Banks may also be concerned, hesays, about the “domino effect” ofinsolvency on other companies towhich they are exposed. A buyoutfund or distressed investor is notlikely to have such exposure.

Alan Hudson, head of restructuringfor the UK and Ireland at Ernst &Young, says distressed retailers alsotend to be heavily operationallygeared, as well as being financiallygeared.

The funds looking at distressedretailers are “coming in with a mind-set of ownership and investment and[are] quite comfortable with opera-tional turnrounds”.

Indeed, OpCapita’s approach is toinject experienced managers into thecompanies in which it invests, in anattempt to improve their performance.

Not all the acquisitions by buyoutfunds or distressed debt investors leadto an insolvency process.

Mr Moulton says Better Capital hasstabilised Jaeger, investing in thebusiness, and providing comfort tosuppliers. “We are pretty optimisticthat it will be a robust and profitablebusiness very shortly,” he says.

Indeed, Mr Gray says, for there tobe a sustainable turnround and recov-ery, it is important for the business tobe viable.

“It is often not just a question ofreducing the debt burden. There canbe little point in buying the debt, evenat a discount, if there is little chanceof a business surviving,” he says.

But if a radical restructuring can becarried out, and a recovery plan exe-cuted, then the rewards can be verylarge.

According to Zolfo Cooper’s MrCoen: “People are still spending. Youhave just got to have the right struc-ture in place to deal with the changein consumer demand. At the centre ofall these big restructurings is a verywell known, trusted, loyal brand,which has lost its way, because it hasbeen operating on a 1980s retail modelin 2012.

“If you can cut back the tail ofunderperforming stores, invest in amulti-channel strategy, and focus onfinancial and operational excellence,you can still in theory run a veryprofitable retail business”.

Better bet:Jon Moulton’sBetter Capitalpaid £19.5m forall the secureddebt and 90 percent of the equityof Jaeger Alamy

Debt fundsmove in onweak stores

Retail The ‘loan to own’ route can bringfaster restructurings, writes Andrea Felsted

‘Almost allthe retailersthat getinto thedistressedspace . . .have fartoo manystores’

From broadcasters to musiclabels and book publishersto newspapers, consumerhabits are changing – andfast. This is creating hugeopportunities for newentrants in the mediaworld. But it also poses sig-nificant risks for the estab-lished media companies.

At the heart of thesechanges lies technologicalinnovation. Whether it isthe growth of ebooks andself-publishing, wider adop-tion of digital video record-ers and time-shifted view-ing or the rapid growth ofonline news and advertisingat the expense of newspa-pers and magazines, manylong-established revenuestreams are being eroded.The responses from compa-nies have been to cut costsand change their businessmodels. But often thesemoves have come too late.

The companies nowundergoing the most dra-matic changes are thoseburdened with debt, operatein structurally decliningbusinesses and have beentoo slow to adapt to the rap-idly changing consumer.Companies that fall intothis category cover a widerange of sectors from news-papers to directories busi-nesses.

Yell, the telephone direc-tories business, is a primeexample. The companyfloated on the London stockmarket in July 2003 with amarket value of approxi-mately £2bn, securing itselfentry into the FTSE 100.But it failed to adaptquickly enough to dramaticchanges in its marketplace,which has seen swaths ofclassified advertisersmigrate online, eroding rev-enues.

Now investors in the com-pany’s £2.2bn of debt – Yellhas been renamed Hibu in abid to capitalise on the dra-matic shifts online – areengaged in a second roundof restructuring talks inless than a year that couldlead them to seizing control

of the directories businessand formalising a hugedestruction in shareholdervalue.

Mecom, the London-listednewspaper publisher thatowns titles in the Nether-lands, Scandinavia andPoland, is another, thoughfar less dramatic, example.The company has beenundergoing a cost-cuttingprogramme that hasinvolved closing a numberof its freesheets.

It is also moving to a dig-ital pay model across itsbest-selling papers follow-ing a review by Tom Tou-mazis, who took over aschief executive last August.

Non-advertising revenues,which includes circulationand consumer sales, havebeen stabilising. But overallrevenues at Mecom’s lastset of results in July fell 8per cent, weighed down bya 14 per cent fall in adver-tising revenues.

The company’s problemsare far from unique. John-ston Press of the UK, theregional newspaper pub-lisher, has responded bymoving many of its titlesfrom daily to weekly publi-cations. Last year the com-pany axed 670 jobs, around11 per cent of its workforce.

Revenues at regionalnewspapers have beensteadily declining over thepast decade as circulationshave fallen and readers

have migrated to the inter-net, damaging advertisingrevenues.

In books, rapidly growingsales of ebooks, pioneeredby Amazon, are affectingpublishers. In some bookcategories such as adult lit-erature and romance,ebooks have been particu-larly successful.

In the US, almost a thirdof adult literature is sold asebooks, up from 22 per centa year ago, according to theAssociation of AmericanPublishers. Those publish-ers too heavily weightedtowards physical bookshave been hurt by thesedevelopments.

In the world of TV thereare different challenges. TVadvertising is holding up inmany markets. But fearspersist that growing adop-tion of digital videorecord-ers will kill the 30-secondadvert and hurt the com-mercial broadcasters.

These challenges and thegreater volatility of ad reve-

nues, are driving somebroadcasters such as ITVdeeper into the world ofcontent ownership wherepopular formats can be soldacross the globe and reve-nues are more stable. ITV isalso moving deeper intotime-shifted TV and intro-ducing micropayments as itseeks to capitalise onchanging viewer habits.

In Italy, Mediaset, con-trolled by former Italianprime minister Silvio Ber-lusconi, has been hit bydeclines in advertising asthe economy suffers amidthe eurozone crisis. Its com-mercial TV arm is alsobeing hurt by technologicalchange as Sky Italia, thepay-TV satellite broad-caster, makes incursionsinto its home turf. The com-pany is implementing acost-cutting plan as it seeksto survive in the digital age.

But not all pressure formedia companies to restruc-ture is coming from widertrends within the industry.Vivendi, the French com-pany whose assets spanmedia and telecoms, hascome under pressure fromsome analysts and investorswho argue the company suf-fers under a “conglomerate”discount, a gap between thecompany’s market capitali-sation and the underlyingvalue of its separate hold-ings.

Vivendi owns ActivisionBlizzard, the video gamesmaker, Canal Plus, theFrench pay-TV group, aswell as telecoms companiesin France, Morocco andBrazil. In April the com-pany launched a strategicreview announcing nothingwas taboo, prompting wide-spread speculation overwhat assets may be sold.

The company exploredthe sale of Activision butfailed to find a buyer at theright price. Jean-René Four-tou, chairman, is under-stood to favour returningVivendi to a pure mediacompany. But, with themarket for mergers andacquisitions subdued, find-ing buyers for its telecomsassets will not be easy.

Until the markets for ini-tial public offerings andM&A pick up, this meansthe restructuring optionsfor most media companieswill remain focused on cost-cutting and seeking to posi-tion themselves for the dig-ital world.

Changing channels bring risks

Game theory: a strategic review by Blizzard owner Vivendihas prompted speculation over asset sales Bloomberg

Companies nowundergoing thebiggest upheavalcover a widerange of sectors

Media

Some groups haveresponded too late toevolving consumerhabits, writesRobert Budden