A worked rights offering with a backstop premium: the value of the right, the dilution of those who decline, and what happens below plan value.
A rights offering in Chapter 11 is worth the value of the shares the right buys, at plan value, less the subscription price. In an illustrative plan with $450M of equity value, a $150M offering at a 25 per cent discount and an 8 per cent backstop premium, each 100 of unsecured claims receives 47.6 of equity plus a right worth 10 points. Participating lifts the recovery to 57.6; declining leaves 47.6. The discount is not new value: it is a transfer from the creditors who do not subscribe to those who do.
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 →
A company emerges from Chapter 11 at a plan enterprise value of $800M with $350M of exit debt, so the plan values the reorganised equity at $450M. The unsecured class, $500M of claims and the fulcrum of the case, receives the equity. Part of the exit financing is a $150M rights offering to the same class, priced at a 25 per cent discount to plan equity value and backstopped by a group of holders who are paid a premium of 8 per cent of the offering in shares. A buyer acquired claims at 40 and must decide whether to subscribe. Every figure is illustrative.
| Input | Value |
|---|---|
| Plan enterprise value | 800 |
| Exit debt | 350 |
| Plan equity value | 450 |
| Rights offering, new money | 150 |
| Discount to plan equity value | 25% |
| Backstop premium, paid in shares | 8% |
| Unsecured claims in the class | 500 |
| Purchase price of the claims | 40 cents |
Start by dividing the $450M of plan equity between the three groups that receive shares. The offering raises $150M at 75 per cent of plan value, so the subscribers receive shares worth 150 / 0.75 = $200M. The backstop premium is 8 per cent of $150M, $12M of shares. What is left goes to the class as its plan distribution.
Rights offering shares = 150 / (1 − 25%) = 200, or 44.4% of the equity
Backstop premium = 8% × 150 = 12, or 2.7%
Plan distribution to the class = 450 − 200 − 12 = 238, or 52.9%
Value of all rights = 200 − 150 = 50
Now express the class figures per 100 of claim, multiplying by 100 / 500. Each 100 of claim receives 47.6 of equity and a right to subscribe 30 of new money for shares worth 40. The right is worth 10.
Non-participating recovery = 238 × 100 / 500 = 47.6
Participating recovery = 47.6 + (40 − 30) = 57.6
Excel, value of the right per 100: =(RO/(1-Disc)-RO)*100/Claims
For the buyer at 40, declining returns 1.19x. Subscribing means investing 70 in total, 40 for the claim and 30 of new money, for equity worth 87.6: a multiple of 1.25x on the larger amount. The non-participant also ends with 10.58 per cent of the company per 100 of claims bought, against 19.47 for the participant.
Change the discount and something unexpected happens: the participating recovery does not move.
| Discount | RO shares | Equity to the class | Value of the right | Participant | Non-participant |
|---|---|---|---|---|---|
| 15% | 176.5 | 52.3 | 5.3 | 57.6 | 52.3 |
| 25% | 200.0 | 47.6 | 10.0 | 57.6 | 47.6 |
| 35% | 230.8 | 41.4 | 16.2 | 57.6 | 41.4 |
If every holder subscribes, the discount simply moves value from one pocket of the same creditor to the other. What it does is penalise anyone who cannot or will not write the cheque: at a 35 per cent discount the non-participant's recovery falls to 41.4. That is why deep discounts are a feature of offerings backstopped by large funds, and why a creditor with a small position or no new capital should value the claim on the non-participating number. The participant's figure moves only with the backstop premium, which comes out of the class's equity whatever the discount.
The backstop group earns the $12M premium on top of its pro rata share, and usually takes up any shares left unsubscribed at the same discount. Each holder who declines therefore hands part of the 10 points to the backstop parties.
The plan value is a negotiated number. After emergence the shares trade where the market puts them, and a discount to plan value is common. The right is only worth something while the equity trades above the subscription price, 75 per cent of plan value.
| Trading as % of plan value | Equity value | Non-participant | MOIC | Participant (on 70) | MOIC | Right |
|---|---|---|---|---|---|---|
| 100% | 450 | 47.6 | 1.19x | 87.6 | 1.25x | 10.0 |
| 90% | 405 | 42.8 | 1.07x | 78.8 | 1.13x | 6.0 |
| 80% | 360 | 38.1 | 0.95x | 70.1 | 1.00x | 2.0 |
| 70% | 315 | 33.3 | 0.83x | 61.3 | 0.88x | −2.0 |
At 80 per cent of plan value the participant just recovers its 70; the non-participant has already lost money. Subscribing nearly doubles the exposure to the reorganised equity, so it adds return when the plan value holds and adds capital at risk when it does not.
The frequent error is to quote the participating recovery as the recovery: 87.6 cents per 100 of claim, which sounds like an outcome well above a 40 purchase price. It includes 30 of new money. The correct figures are 47.6 for the claim alone and 57.6 for the claim with its right, and the return on the combined investment is 1.25x, not 2.19x. The second error is to value the claim at its share of the $450M before dilution, 90 per 100, as if the rights offering and the backstop premium did not exist. They take 47.1 per cent of the equity between them.
The book's recovery chapters model the form of a recovery as well as its size, and the free workbook for this case prices a recovery paid in a mix of cash and paper. For the step before this one, deciding which tranche receives the equity, see does the fulcrum security move when enterprise value changes.
Divide the new money by one minus the discount to find the value of the shares it buys at plan value, then subtract the subscription price. A $150M offering at a 25 per cent discount buys shares worth $200M, so all rights together are worth $50M; for a $500M class, that is 10 points per 100 of claim.
It is the fee paid to the holders who commit to buy any shares other creditors do not take up, usually expressed as a percentage of the offering and often paid in shares. At 8 per cent of $150M it is $12M of equity, taken from the class's distribution whether or not any holder declines.
Only if it believes the equity is worth at least the subscription price. At plan value, participating lifts recovery from 47.6 to 57.6 per 100 of claim. If the shares trade at 80 per cent of plan value, a holder who bought at 40 and subscribes only recovers its 70 of total investment, and below 75 per cent the right loses money.
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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