Plan value fixes the percentages, the market fixes the recoveries: the reorganised equity split worked down the waterfall, with the valuation fight priced.
In a debt-for-equity swap each impaired class receives reorganised shares in proportion to the value it is still owed after cash and new debt, measured at the plan enterprise value. At a $450M plan value with a $200M takeback loan, a $350M first lien takes 60 per cent of the equity and $300M of senior notes take 34.3 per cent. The plan value fixes those percentages for good; the market then decides what they are worth, which is why the valuation is the most fought-over number in the case.
Worked in full in The Distressed Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Recovery models usually stop at cents on the dollar at a single enterprise value. A creditor receiving equity needs one more step: the number of shares, because shares are fixed at confirmation while the value behind them is not.
| Item | Amount |
|---|---|
| First lien term loan claim | 350.0 |
| Senior unsecured notes | 300.0 |
| Trade claims, same class as the notes | 50.0 |
| New takeback term loan, to the first lien | 200.0 |
| Plan enterprise value | 450.0 |
| Reorganised shares issued to creditors (m) | 100.0 |
Equity value at plan = Plan EV − takeback debt = 450.0 − 200.0 = 250.0
First lien deficiency = 350.0 − 200.0 = 150.0, to be paid in shares
Value left for the unsecured class = 250.0 − 150.0 = 100.0
Absolute priority sets the order. The first lien takes the takeback loan and enough equity to cover the rest of its claim. Whatever is left goes to the next class, shared pro rata by claim: the notes hold 85.7 per cent of the $350.0M unsecured class and the trade creditors 14.3 per cent.
First lien share = 150.0 ÷ 250.0 = 60.0%, or 60.0m shares
Notes share = 100.0 ÷ 250.0 × 300.0 ÷ 350.0 = 34.3%, or 34.29m shares
Trade share = 5.7%
Price per share at plan value = 250.0 ÷ 100.0 = $2.50
In Excel: =MIN(Equity, Deficiency)/Equity for the senior class, and =(1-Senior%)*Claim/ClassTotal for each junior holder.
At the plan value, the notes receive $85.7M of equity on $300.0M of claims: 28.6 cents. That is the recovery printed in the disclosure statement. It is not the recovery anyone will realise.
| Plan EV | Equity | First lien % | Notes % | Notes recovery at plan |
|---|---|---|---|---|
| 400 | 200.0 | 75.0% | 21.4% | 14.3 |
| 450 | 250.0 | 60.0% | 34.3% | 28.6 |
| 500 | 300.0 | 50.0% | 42.9% | 42.9 |
| 550 | 350.0 | 42.9% | 49.0% | 57.1 |
| 600 | 400.0 | 37.5% | 53.6% | 71.4 |
Trade creditors in the same class are entitled to the same treatment per dollar of claim, so in this plan they receive 5.7 per cent of the shares. Plans often give them the option of cash instead, through a convenience class, which leaves the shares with the financial creditors and slightly raises their percentage. The arithmetic is the same; only the holder changes.
The senior class always recovers par at plan value in this range, so its interest in the valuation is not visible in the plan. It shows up when the market values the company differently from the plan.
| Plan EV | Market EV | Notes | First lien | Notes bought at 25, multiple |
|---|---|---|---|---|
| 450 | 450 | 28.6 | 100.0 | 1.14x |
| 450 | 600 | 45.7 | 125.7 | 1.83x |
| 600 | 450 | 44.6 | 83.9 | 1.79x |
| 600 | 600 | 71.4 | 100.0 | 2.86x |
If the company is really worth $600M, a $450M plan value costs the unsecured class, notes and trade alike, 25.7 cents per dollar of claim, $90.0M in total, and hands it to the first lien, which collects 125.7 cents on its claim: $90.0M above par. That is the whole reason seniors argue for a low valuation and juniors for a high one. The shares are allocated on the plan number; the upside belongs to whoever got the shares.
Reading the plan from the junior side. A notes holder who believes the market value will settle near $600M should still prefer to own the shares at a low plan value than to be cut out. The notes recover 45.7 cents rather than 71.4, but 1.83 times on a purchase at 25 is still a return. The objection is worth pursuing only if its expected gain exceeds the cost and delay of a valuation trial.
The common mistake is to forget the management incentive plan. Reorganised companies typically reserve a share of fully diluted equity for management. With an 8 per cent reserve the 100.0m creditor shares become 108.70m fully diluted, 8.70m going to the plan. The notes' stake falls from 34.3 to 31.5 per cent, and their recovery at the $450M plan value falls from 28.6 to 26.3 cents, 2.3 points that never appear in the waterfall. At a $600M market value the diluted recovery is 42.1 cents, not 45.7.
The waterfall that re-identifies the fulcrum as enterprise value moves is in the free workbooks for this case. How the fulcrum migrates is worked in does the fulcrum security move with enterprise value, and the shares a rights offering adds on top in what a Chapter 11 rights offering is worth.
Because a lower plan value gives them more shares for the same deficiency claim. In the worked case a $450M plan value gives the first lien 60 per cent of the equity; at $600M it would get 37.5 per cent. If the company is really worth $600M, the low valuation hands the first lien 125.7 cents on its claim, $90.0M more than par.
The MIP reserves shares for management out of the reorganised equity, so every creditor's percentage shrinks. An 8 per cent fully diluted reserve takes the notes from 34.3 to 31.5 per cent of the company and their recovery at the $450M plan value from 28.6 to 26.3 cents, a cost of 2.3 points.
It depends on the market value of the equity, not the plan value. Notes bought at 25 that recover 28.6 cents at a $450M value return 1.14 times; if the shares come to trade at a value implying a $600M enterprise value, the same notes recover 45.7 cents and return 1.83 times, before time and costs.
This article is one calculation from The Distressed Debt Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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