Thursday, May 21, 2009

Is District Court a Better Venue for Chrysler's First Lien Lenders?

I attempted to respond to this post on the Credit Slips blog, but it was too long (I only present the first part of my answer there). That post discussed the papers filed by White & Case on behalf of the Indiana Pensioners. Here is my full response.

I think the White & Case strategy is a risky, but interesting attempt to change the terrain of the conflict.

It would appear to me that there is some doubt that the Indiana Pensioners’ position would be given much weight in the Bankruptcy Court because they have a very small percentage (0.62 percent) of the overall loan. I believe their hope is that, by changing venue to the District Court, they will receive a full hearing.

The argument to the District Court appears to be that these pensioners were holders of the first lien loans and that their rights have been violated because the other holders of the loan have been coerced by the Treasury department to accept a deal that provides less value that they would have otherwise been entitled to. Now they are being forced to accept less than their claim is worth.

The problem I see with this argument is that, as I interpret it, they are saying Chrysler abdicated their fiduciary responsibility to their lenders by having Treasury negotiate on their behalf. One obvious issue there is whether the debtor has a fiduciary responsibility to creditors. The argument in favor is that creditors are stakeholders, but even if there was a zone of insolvency issue, it isn't clear that debtors are obligated to make sure that all claims holders are treated properly in a negotiation (that would seem to fall to the courts and the creditors themselves).

It seems to me that if the argument is that Treasury overstepped their authority by taking over the negotiation, the actionable party would be Treasury. Then you have to ask the Government’s permission to sue them, and that’s probably not a winnable case.

Perhaps they could argue that Treasury was acting as an agent AND as an enforcement agent of the Government so there was a lack of “good faith” in the negotiation? This would allow them to unwind the transaction under 363(m), right?

What do you think?

As for the $2 billion value, there really hasn’t been much that I’ve seen arguing another number. One might expect that the Indiana Pensioners would retain their own expert to support a different value, and perhaps this will happen.

The justification of the $2 billion valuation by the Debtor is somewhat shaky. Greenhill's logic in the fairness opinion is that, since Chrysler wouldn't be able to continue as a going concern without the Treasury's money, and since the Treasury's money wouldn't be available without the transaction, then using the liquidation value is "fair."

The Greenhill fairness opinion relies on valuations conducted by Capstone (Greenhill is clear that they conducted no valuation work in their engagement). Capstone heavily qualified their estimates, noting that a liquidation of this sort would be unprecedented.

In any event, isn’t a liquidation value supposed to represent the lowest reasonable recovery for a claim, not necessarily the equitable value?

My background is in valuation and investment banking, but I don’t have enough information to perform a valuation analysis for Chrysler since they’ve been private for so long (the only materials available have assumptions built in that I don’t feel comfortable relying on –they could be too optimistic or pessimistic and I have no basis for judging).

What we do know is that the Government told the UAW that the value of the fully diluted share of NewChrysler given to the VEBA is worth $4.25 billion (there is also effectively a call issued by the VEBA to Treasury with a strike price that starts at $4.25 billion and increases by 9% per year – if this were considered it would imply a higher valuation for the 55% interest since the VEBA would be short the call and the $4.25 billion value of their interest is presented as being net of the attached call). If you extrapolate the $4.25 billion relating to 55% of the NewChrysler, this implies an initial value of the equity of $7.727 billion. NewChrysler is also assuming a liability to the VEBA of $4.587 billion and at least $0.5 billion of US/Canada debt. That equates to a business enterprise value of $12.814 billion for the business enterprise value. Let’s assume that the other assumed obligations are effectively current liabilities as I believe they all relate to the ongoing business (payables to suppliers, etc.).

Let’s exclude working capital items, which we will say for arguments sake balance out – even though there will probably be positive working capital – they are assuming inventories, etc. The right ride of the balance sheet would be (in billions):

VEBA Liability$4.587
Assumed US/Canada Liability$0.500
Fiat Equity$2.704
VEBA Equity$4.250
US Treasury Equity$0.618
Canada Equity$0.155

Now the right side of the balance sheet needs to provide an equal amount of assets and we have:
Cash (let’s assume this)$2.000
Old Chrysler Assets$2.000
Fiat Intangible Asset$2.704
We are missing $6.111 billion of value!

Is that some intangible created by moving the old assets to NewChrysler, or is that value that should be attributed to the assumed Chrysler assets? Remember, the book value of all of the assets is $39.3 billion.

I don’t know the answer, but I believe there probably is an argument that the assets that are being assumed by NewChrysler are worth more than the $2.0 billion being paid – and they are all part of the security to the first lien lenders.

Someone might argue that Chrysler was aggressively marketed over the last several months and no other credible offer was made. It isn’t clear that the assets were being offered free and clear of liabilities or if there was an attempt to sell the company’s parts separately. We do know that the tight timeframe and rules of bidding in this accelerated 363 sale make it very difficult for another bidder, or group of bidders, to participate in the auction.

We’ll have to see how the case winds its way through the two courts now (and perhaps the Court of Appeals at some time in the future).

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