Distressed brands are often forced to file for bankruptcy protection or enter administration. On the other hand, private equity firms seek to identify and acquire these undervalued assets.
The goal is to turn the companies around and profit from the investment. Then, how does private equity value distressed assets?
Understanding The Types of Distressed Assets
Private equity investment platforms like Acquinox Capital typically deal with various types of distressed assets, each with unique opportunities and challenges.
Corporate Debt
Corporate debt refers to the financial obligations or loans that a company issues to raise capital. These can include loans, bonds, or other debt instruments. From the firm’s point of view, purchasing corporate debt can be the starting point for influencing or gaining control over the distressed company.
Through debt restructuring, debt holders can negotiate new terms with the company. This allows the firm to work towards stabilising the company and nursing its financial health to a better condition. When successful, debt structuring can significantly improve value appreciation.
Real Estate
Distressed real estates face various issues involving properties. This can include poor management, economic downturns, or primary market conditions that put the real estate into a distressed position. The real estate properties include:
- Commercial buildings
- Residential complexes
- Undeveloped lands
Private equity can invest when these properties face consequences that lead to underutilisation or undervalue. They can reposition, renovate, or improve the management practices to enhance the property’s profitability and overall value.
Equity Stakes
Distressed equity stakes refer to acquiring shares of a company whose stock prices have plummeted due to financial difficulties. The company can provide strategic direction, management expertise, and capital expertise to help it recover and turn the challenging situation into pre-vetted opportunities. When successful, the company can gain equity value appreciation. Exiting through a public offering or sale will also benefit the firm.
Non-Performing Loans (NPLs)
Companies experiencing non-performing loans mean they’ve borrowed but lost the ability to repay. Various sectors can experience non-performing loans, including businesses, consumers, and mortgages. Firms usually buy at a discount and recover the owed amount through legal actions, renegotiation, and restructuring.
Recovering NPLs can be complex and require specialised expertise. However, once recovered, it can lead to significant financial returns.
Estimating The Value of The Company
Many metrics are involved in private equity valuations, but first, the firm would have to determine the company’s estimated value. The two most common choices are:
- Liquidation value: Liquidation value assumes the business will cease operations. It’ll then sell its assets piecemeal, forced to sell as quickly as possible or over a reasonable time. The applicable law may influence this choice, as companies that aren’t on immediate destruction must choose with going concern value.
- Going-concern value: Unlike liquidation value, going-concern value assumes the company will continue operating.
The final choice generally depends on each company’s facts and case. In the bankruptcy process, firms may use both premises. The going-concern value would be the central premise when firms estimate reorganisation. Meanwhile, liquidation value will play its part when considering the best interest of the creditor test.
Asset-Based Approach
The asset-based approach focuses on the company’s tangible and intangible assets. It analyses a company’s break-up value based on its assets while assuming a forced sale within a short period. The firm may also assess the value of brands, intellectual properties, and other intangible assets it can sell separately.
Still, the asset-based approach can differ from case to case. Some companies may be estimated based on their forced sale value by assessing the proceeds generated from settling their liabilities and selling their assets. This assumption assumes worst-case scenarios for companies that are likely unable to continue operating.
The value of a business can also be based on the cost to replace or recreate the company’s assets. However, this estimation doesn’t consider the industry’s value a going concern.
Discounted Cash Flow Analysis
Discounted Cash Flow (DFC) analysis estimates the present value of the distressed company’s future cash flows. As the driving factors behind each distressed company differ, projections would be adjusted based on the company’s circumstances. Cost structure, revenue, and market conditions should be considered.
These adjustments are crucial as they help identify uncertainties and a potential risk assessment. The firm must consider the range of outcomes and probabilities for each action, especially the estimated life of the enterprise.
The required resources to turn the company around would influence this life estimation. Distress may come from economic or financial factors outside the company’s control.
The discount rate should be calculated based on the sector to be re-leveraged, the company’s operating and financial risks, and its active project management strength.
The company’s financial characteristics would then influence the cost of borrowing. These characteristics should be included in the company’s cash flow analysis, which should factor in its leverage, reflecting its ability to service the debt based on industry norms.
Market-Based Approach
A market-based approach compares the distressed company to other companies in similar situations sold or valued recently. This approach considers relevant financial transactions and metrics in comparable sectors.
On the downside, a market-based approach can be challenging, as finding similar-valued companies in specific sectors can be tricky. Firms must make necessary adjustments to account for differences, such as in financial health or other factors they must apply.
FAQ
What Are The Factors Influencing The Value of a Distressed Company?
The factors influencing the value of a distressed company include the quality of management, strategic initiatives, competitive advantages, and market opportunities.
What is Distressed Investment in Private Equity?
Distressed private equity investment occurs when firms invest in troubled companies’ equity or debt. The firms take control of the companies, restructure them, and eventually turn them around to sell or take them public.
How to Tell If A Company is Distressed?
A few apparent signs include a lack of cash flow, high interest payments, bill defaults, extended creditor or debtor days, and falling margins.