Recovery analysis
When a company cannot pay, what each creditor gets depends on what the business is worth in distress and where the creditor stands in the queue.
- Value a distressed business and pay its creditors in order
- Turn a recovery into a fair bond price and compare it with the market
- Find the enterprise value at which the unsecured recover in full
- Show how a further fall in EBITDA hits each class
The intuition
A shop closes and its stock is sold for $50,000. The bank, which lent against that stock, is owed $40,000 and is paid first, in full. The suppliers are owed $30,000 between them and share the $10,000 left: 33 cents on the dollar. The owners get nothing. The same $50,000 means very different things depending on where you stand in the queue.
A distressed company works the same way. Its distressed enterprise value is stressed EBITDA × a distressed multiple. Value flows down the capital structure in strict priority: secured lenders first, then unsecured bondholders, then shareholders. Each class's recovery is what it receives ÷ what it is owed, and a bond's fair price is its recovery × 100.
Distressed EV = stressed EBITDA × distressed multiple. Secured recovery = min(secured claim, EV) ÷ secured claim. Left for the unsecured = max(0, EV − secured claim). Unsecured recovery = min(unsecured claim, what is left) ÷ unsecured claim. Fair bond price = recovery × 100.
Why it works
- The conventions here: strict priority, secured before unsecured before equity. Bonds are priced at recovery × 100, with no time value and no interest during the process.
- Distressed multiples are low, often four to seven times EBITDA where healthy peers trade at ten: a forced sale, an underinvested business, customers and staff leaving.
- Value leaves from the bottom up. A fall in enterprise value comes entirely out of the most junior class that still had any recovery.
- Prices show where the market thinks value runs out. Secured loans at 98 say covered; unsecured bonds at 45 say about half.
- The unsecured recover in full only if EV covers every claim ahead of and including them.
- The documents move the queue. Collateral, guarantees from subsidiaries and which company issued the bond decide who ranks where.
| Distressed EV: 100 × 5.0 | $500M |
| Secured: min(300, 500) ÷ 300 | 100% |
| Left for the unsecured: 500 − 300 | $200M |
| Unsecured recovery: 200 ÷ 300 | 66.7%, a fair price of 66.7 |
| Upside at 55: 66.7 ÷ 55 − 1 | 21.2% |
| EV for a full unsecured recovery: 300 + 300 | $600M, or 6.0x EBITDA |
If EBITDA falls a further 20%: EV is $400M, the secured still recover 100%, and the unsecured fall to 100 ÷ 300 = 33.3%.
The formulas
What the business is worth in distress.
Paid first.
What survives the senior claim.
Paid second.
Before time value.
Run it backwards.
Worked example
Enterprise value first, then pay the secured in full before anything goes to the unsecured.
See it move
Same company and the same stressed EBITDA. Change the distressed multiple, each class's debt, a further fall in EBITDA and where the bonds trade.
- Raise the multiple. The unsecured recovery rises until it reaches 100%; the secured stay whole.
- Raise the secured debt. Less is left over, so the unsecured recovery can only fall.
- Raise the unsecured debt. The EV needed for a full recovery rises, and the unsecured recovery can only fall.
- Deepen the further fall in EBITDA. The unsecured recovery after the fall can only fall.
- Raise the bond price. The upside to fair value shrinks, unless the analysis says the bonds recover nothing.
Run it backwards
Same company, reversed: what enterprise value, and what multiple of EBITDA, would the unsecured need to recover in full?
The unsecured are whole once EV covers every claim ahead of and including them: the secured plus the unsecured. Divide by stressed EBITDA for the multiple.
Compare that multiple with what distressed businesses fetch. Well above seven times, the unsecured are impaired in any realistic outcome; the only question is by how much.
Traps
Say it in the interview
“How would you value a distressed company's bonds?”
Check yourself
4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.
Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.
- Distressed EV = stressed EBITDA × distressed multiple.
- Strict priority: secured, then unsecured, then equity.
- Fair bond price = recovery × 100.
- Value leaves from the bottom of the queue up.