“Explain how distressed debt may be used to create equity positions in a leveraged buyout”
Another beautifully ambiguous and vague question. Are they referring to people who are loaning to own, or management buying up the debt at $.20 on the dollar and getting it reinstated, reselling in the secondary and converting the gains to an equity stake? Sheeeeet, there are 30 different scenarios that could make this vague claim. I really hope the exam questions aren’t as open-ended as this and are framed to guide us towards the answer they’re looking for.
derswap07 Wrote: ------------------------------------------------------- > “Explain how distressed debt may be used to create > equity positions in a leveraged buyout” Is it that : Long the distressed debt + short the distressed equity ?
That is the definition-but how does that relate to LBO? I kind of don’t make that connection.
Assume you buy significant amount of distressed debt. Company goes under i.e. chapter 11 bankruptcy. In bankruptcy court since you own significant amount of distressed debt you can affect the outcome (assumption you own the most) of the new capitalization. Most likely you will have to take equity in new company along with some debt. therefore able to exchange debt for equity.
Thanks for the explanation.
still the question is poorly worded/doesn’t make any sense bc it is asking you to relate distressed debt to an LBO and the 2 are unrelated. Buying distressed debt and getting post-reorg equity via the Ch 11 process is unrelated to an LBO transaction
Could also be construed another way… the return characteristics of distressed debt and equity are quite similar. And valuation techniques are the same as well (often high yield analysts are grouped with equity analysts). Buying LBO debt will give you quasi-equity exposure in that company.
Yes it appears that the question is poorly worded, however, in a LBO, the company is loaded down with debt under the assumption that it can be serviced-that is how i thought of it.