October 7th, 2024 - From Boom to Bust: The Latest on Bankruptcy’s Greatest Hits + A Conversation with Rx Pro, Adnan Riaz!

Welcome to The Cramdown - your source for all news restructuring and distressed investing at Indiana University!

– Matthias Wagner, Evan Patrick, Ryan Gaertner, Malyka Abbas

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News for the Week:

• Bankruptcy Case Study - Pandemic Boom to Restructuring Doom (Wheel Pros)

• Unitranche: The Finance World’s Smoothie—Blending Debt, Not Fruit

• Spirit Airlines Stock Tumbles Amid Bankruptcy Filing Rumors

• Sonder Struggles to Avoid WeWork's Troublesome Fate 

• Fisker: Electric Dreams to Bankruptcy Schemes

• Industry Spotlight: Adnan Riaz - Founder and Managing Partner, Tarbela Capital

Bankruptcy Case Study

Case Overview: Wheel Pros: Pandemic Boom to Restructuring Doom 

Background: 

• Wheel Pros is a leading designer, manufacturer, and distributor of proprietary aftermarket vehicle upgrades and enhancements for trucks, UTVs/ATVs, SUVs, passenger cars, and everything in between.  

• Targeting automotive enthusiasts worldwide, Wheel Pros have a global network of distribution and clientele spanning North America, Australia, and Europe. 

• Offering an extensive range of products including wheels, tires, suspension systems, and other accessories geared towards car enthusiasts. 

Causes for Distress: 

• Much like our coverage of LL Flooring in a previous publication of the Cramdown, Wheel Pros saw the same pandemic boom of skyrocketing sales and heightened demand. 

• Between Government stimulus and increased free time, people were spending like no other and Wheel Pros almost doubled their revenue from 2019 to 2022. 

• Unfortunately, time and time again C-Suites like Wheel Pros’ grossly overestimated the lasting effects of the pandemic. Believing that the pandemic would completely reshape societal and economic norms, Wheel Pros acted as if customers would buy luxury wheels and suspension systems regardless of the economic environment. 

• Believing the booming top lines would stay inflated forever, Wheel Pros acted accordingly. Expanding outside the scope of the Company’s core business and distribution model. 

• Wheel Pros started to expand into the retail location and e-commerce platform space, attempting to hitch a ride on the wave of consumer preferences. 

• While their plan sounded good in theory, the rapid rise of interest rates, persistent inflation, supply chain disruptions, and a decline in customer demand made for an unsustainable debt load. Quickly approaching interest payments, by 2023 it was time for Wheel Pros to start kicking the can down the road. 

The First Kick: September 2023 

• Strapped for cash, Wheel Pros negotiated a deal with lenders to provide additional liquidity as it tried to survive weak post-pandemic demand and consumer spending. 

• Wheel Pros engaged in a “Double-Dip” which provided a secured loan to a borrower, who then uses the proceeds to provide an intercompany loan to an affiliated entity.  

• This additional step gave initial lenders two claims against the ABL priority collateral and TL priority collateral, one direct claim from the first loan, and an additional indirect claim backed by the intercompany loan’s pledge. 

• Providing Wheel Pros with a new $235 million First-In, Last-Out(FILO) facility open to all pre-transaction term loan lenders.  

• Wheel Pros’ new facility has a first lien on the term loan priority collateral and a second-out first lien on the ABL priority collateral. 

• All the pre-transaction term lenders participated in the deal, a small number of the unsecured noteholders did not. These noteholders along with any the unsecured creditor are now pushed even further down the queue for repayment. 

No luck: July 2024 

• Even after the complicated Double-Dip in 2023, Wheel Pros continued to miss revenue projections, they even tried appointing a shiny new exec team. With new management implemented a cost cutting initiative, it still wasn’t enough to meet expectations. 

• In early July, Wheel Pros $1.1b TL due in May 28’ was priced around 77 COD 

• One-week later, Wheel Pros missed an interest payment, and it became abundantly clear it was time to start dialing Houlihan Lokey for the second time in only 1 year. 

Inevitable Filing: September 8^th, 2024 

• Wheel Pros files for Chapter 11 protections, implementing a prepackaged bankruptcy, effectuating a restructuring support agreement supported by a majority of the creditors 

• The debtors plan to negotiate an exit ABL and to sell certain non-core assets like 4WP and Poison Spyder, which were two acquisitions that intended to increase Wheel Pros retail footprint but ended up suffocating and adding to the crushing debt/interest payment load. 

• The prepackaged plan of reorganization will eliminate $1.2bn of funded pre-petition with this breakdown 

• Introducing a DIP financing of $175 million of super priority senior secured at SOFR+4% and a $110 million SOFR+8.5% new money senior secured super priority term loan 

• Wheel Pros received permission from creditors to use thei cash as collateral to maintain operations during the restructuring 

• First Lien Claims were identified as the Fulcrum Security  

• Post organization the First Lien Claim Holders receive 85% of the equity which represents a 52% recovery rate. 

•  $877 million of Junior Funded Debt Claimants will share a $500,000 cash, representing a .01% recovery 

• General Unsecured Claimants will be paid in full to avoid the formation of a Creditor’s Committee 

• Intercompany Claims of $1.26 billion will be discharged without distribution 

Summary: 

• Wheel Pros restructuring effort utilizes a combination of DIP financing, legal maneuvers, equity conversion, and asset liquidation in an attempt to save the automotive empire that once was. 

• After their 2023 restructuring effort, Wheel Pros Double-Dip will join a growing list of failed liability management exercises, proving once again that sometimes no amount of financial engineering can supplement an insufficient business model and insufficient demand. 

News We’re Following

Unitranche: The Finance World’s Smoothie—Blending Debt, Not Fruit

Cloaking straight forward concepts and words with complicated jargon is baked into the finance culture we love to call home. Whether it be “arbitrage” or “tranche”, sometimes the hardest part about learning the basic concepts of finance and restructuring is the constant use of complicated verbiage. One of the latest and greatest of these buzz words is Unitranche, and like most of you, the first time I heard it I was just as scrambled and confused. Much like this article will simplify the concept of a unitranche, the unitranche is a way for investors and debtors to do just the same, Keep it simple. A unitranche streamlines the traditional loan structure by merging senior and subordinated junior debt into a single tranche. Simply blending interest rates offering a middle ground between senior debt and riskier subordinated loans.

Post-financial crisis with stricter lending requirements for the big banks, alternative lenders snatched the opportunity to provide capital where big institutional banks couldn’t. The Unitranche became a win-win in certain scenarios, offering debt investors and direct lenders competitive yields while simultaneously diversifying their risk. Additionally, with institutional lenders taking weeks and even months to negotiate terms, secure syndicate partners, and meet various compliance requirements, sometimes debtors just can’t wait. Between the speed, simplicity, and ability to tailor these unitranche financings to specific borrower needs, debtors are willing to pay the premium. Finestra, a fintech giant, took on the second largest unitranche in 2023 priced at 725bps over SOFR with a six-year maturity. When I said the debtors would pay a premium, I sure meant it. While Unitranche financing is most definitely not the solution for most, alternative lenders alike can salivate at the prospect of funding the next giant Unitranche. So, whether it be your next Rx interview, or you come across Unitranche financing in WSJ headlines, just think keep it simple stupid and remember simplicity sells. 

Spirit Airlines Stock Tumbles Amid Bankruptcy Filing Rumors

This past Friday, shares of Spirit Airlines plunged 37% to a record low after a report that the carrier was discussing a potential bankruptcy filing. The airlines long-term debt and finance leases amounted to $3.06 billion, and they have until October 21st to refinance $1.1 billion in loyalty bonds due next year.

Spirit has been in a constant state of uncertainty ever since the collapse of its $3.8 billion merger deal with JetBlue Airways. The airline has failed to return a profit in the last five out of six quarters, even though they have been cutting costs and trying to attract “premium travelers”.

The future of Spirit Airlines remains uncertain, leaving us to wonder if there is hope on the horizon.

Sonder Struggles to Avoid WeWork's Troublesome Fate 

Sonder, a hotel and apartment rental company, is trying to avoid the same fate as WeWork whose fall proved that leasing long-term and renting short-term can be a harmful business model. Last week, Sonder warned that bankruptcy may be inevitable as financial strain has cast doubt on ability to maintain operations.  

Last November, Sonder adopted a business model similar to the one that led WeWork into bankruptcy- signing long-term leases for apartments and hotels for short-term rentals. Sonder, which operates in over 40 cities across 10 countries, is actively trying to steer clear of WeWork's fate by negotiating with landlords to lower rents or exit certain properties. After experiencing deeper losses last year—$296 million compared to $245 million the previous year—the company has also cut its workforce by 17%, a move expected to save approximately $11 million each year.  

Despite recently raising $146 million and securing a licensing deal with Marriott International, shares have plummeted nearly 46%. Since its launch in 2014, Sonder has expanded its model from furnished apartments to hotels, but like many in the industry, it has never turned a profit. The company has begun restructuring its lease agreements to adopt a more capital-light approach, aiming to enhance cash flow by over $40 million. While its partnership with Marriott marks a significant industry shift, Sonder still faces considerable risks associated with its existing lease obligations. Ultimately, Sonder's ability to adapt will be crucial for its survival in a competitive landscape. 

Fisker: Electric Dreams to Bankruptcy Schemes’

Fisker Inc.'s journey from promising EV maker to penny stock drama just keeps getting wilder. As if going bankrupt wasn’t bad enough, now the SEC has entered the chat, armed with a subpoena and plenty of questions. It's like Fisker was hoping to quietly fade away, but the SEC isn't letting that happen anytime soon.

The company, which couldn’t keep up with production despite all the hype around its Ocean SUVs, is now hoping a bankruptcy judge will sign off on its liquidation plan next week. But the SEC has some serious concerns, mainly because Fisker’s been as quiet as an unplugged EV when it comes to explaining what they plan to do with their records. Fisker’s shareholders, who’ve watched the stock fall from nearly $32 to less than a penny, are understandably feeling more whiplash than an Ocean SUV could ever deliver. Lawsuits are flying, with Henrik Fisker and his team being accused of steering the company right off a cliff. Apparently, it's hard to convince people you're building 23,000 cars when you barely roll out 1,000. Oops.

On top of everything, Fisker’s downfall is a cautionary tale for EV startups that thought hype alone could fuel success. The company went public in 2020 during the electric vehicle boom, riding a wave of investor enthusiasm. At its peak, Fisker was valued at nearly $8 billion, promising a future where their Ocean SUV would be a Tesla competitor. Fast forward to today, and that optimism has evaporated. As the hype around EVs cooled and production issues mounted, the market’s patience ran out. Now, with its stock barely trading for a penny and the SEC digging into its operations, Fisker’s crash is a reminder that bold promises are meaningless without execution to back them up.

Industry Spotlight

Adnan Riaz - Founder and Managing Partner, Tarbela Capital

In this week’s industry spotlight, we feature Adnan Riaz. Adnan attended Indiana University (Class of 2006) graduating with a degree in finance. He started his career at Bank of America Merrill Lynch with roles in Special Situations Sales and Trading as well as Restructuring/Debt Advisory Investment Banking. He then moved on to Morgan Stanley to head their Debt Advisory practice. Since then, Adnan has founded his own shop, Tarbela Capital, which provides unique solutions across various alternative asset classes. Over his career, Adnan has executed over $500 billion in financing, restructuring, workout, and liability management transactions across 35 countries. Adnan is also a lecturer within Indiana’s F210 Investment Banking Workshop Restructuring pathway. Here is our conversation with Adnan!

Q1: You started your career in market risk management, what led you to pursue a career in investment banking?

From an early age, I was drawn to business. Even in grade school, I was constantly looking for ways to make money—whether it was buying gag gifts in bulk from Scout Life Magazine and selling them to classmates, going door to door with Christmas catalogs, or shoveling driveways on snow days. I knew early on that business was my calling. I was lucky to have a high school business teacher, a retired equity trader from Merrill Lynch, who guided me towards a career on Wall Street.

After graduating high school, I attended Indiana University, majoring in finance. I secured an internship at Merrill Lynch supporting the commercial paper trading desk, which led to a full-time role in market risk management in 2006. While I enjoyed working with numbers, the quantitative nature of the role—overseen by PhDs managing the firm’s value-at-risk model—made me realize I wanted to move toward the business side of finance. Unsure whether to focus on sales and trading or banking, I sought advice from Reggie Hayes, an Indiana alumnus and senior associate in M&A at BAML. He pointed me to a lateral opportunity on the capital markets desk, and I jumped at the chance.

I began working in Leveraged Finance at the peak of the LBO boom and continued through the financial crisis, focusing on restructurings. After BAML acquired Merrill Lynch, many of my colleagues moved to Morgan Stanley, and I felt ready for a new challenge. A former colleague who led the high-yield and distressed desk invited me to the trading floor. While I enjoyed the fast pace of sales and trading at a bank, I found it too transactional for my liking.

In 2011, I rejoined my former MD at Morgan Stanley as an associate in the leveraged finance and restructuring team. Despite opportunities to explore different roles within the firm or elsewhere, I stayed because I genuinely loved the work. Each day brought new challenges, from managing risk positions to helping clients solve complex issues. The role allowed me to work on deals around the world and grow my network significantly.

Ultimately, I rose to lead the team, but I started to feel a different pull. The market had evolved, the firm had evolved, and so had I. I realized I wanted to take control of my own future. Alternative Capital was my calling.

Q2: What has been the most surprising aspect of starting your own firm?

The most surprising aspect of launching my own firm has been the profound sense of control I now have over the vision and direction of the business. I anticipated a shift, but I didn’t fully appreciate how liberating—and challenging—it would be to make every decision, whether big or small. Unlike in a larger organization, there’s no safety net or comfort, but this lack of support brings a greater sense of ownership and fulfillment. Another unexpected element has been the wide range of responsibilities I must juggle in the early stages, from strategy and client relations to operations and even logistical tasks. This experience has taught me to be more agile and resourceful than ever.

Q3: With interesting ways to avoid default such as synthetic PIK this summer, what interesting trends are you currently seeing in the restructuring space?

Regarding the restructuring space, several interesting trends are emerging as companies and creditors seek innovative ways to avoid default, similar to the synthetic PIK structures we witnessed this summer. Here are some notable developments:

• Liability Management Transactions:
  These have become increasingly common, with companies employing exchange offers, distressed debt buybacks, and amend-and-extend transactions to push out maturities and reduce debt. It's not merely about buying more time; it’s about enhancing liquidity without triggering defaults.

• Increased Use of Priming Transactions:
  Drop-down transactions have become a hot topic, with borrowers transferring valuable assets into unrestricted subsidiaries, out of reach of existing creditors. These assets are then used as collateral for new financing. This tactic is gaining traction as companies seek liquidity without breaching covenants, but it has also sparked aggressive litigation as creditors push back. Additionally, there are various techniques like uptiers, double-dips, trip-dips, and pari-plus strategies. A significant amount of legal engineering goes into these maneuvers, with many smart lawyers, bankers, and sponsors constantly searching for loopholes!

• Strategic Use of Chapter 11 Prepacks and 363 Sales:
  There’s a growing trend toward quicker and more strategic filings, often utilizing prepackaged or pre-negotiated Chapter 11 bankruptcies to streamline the process. Companies are increasingly turning to 363 asset sales as a way to restructure without enduring a lengthy court process, thus minimizing operational disruption while shedding debt.

• Rise of Private Equity's Role:
  Private equity firms are becoming more prominent in distressed deals, particularly in recapitalizations or taking control of businesses through restructuring. Their involvement often leads to more aggressive strategies aimed at retaining control of assets while minimizing losses.

• Lender-on-Lender Violence:
  This phenomenon involves senior creditors holding different tranches of debt engaging in intercreditor disputes, particularly regarding collateral rights. Conflicts arise when senior creditors seek to prime junior creditors by refinancing or restructuring in a way that favors them. Recently, we’ve seen the emergence of cooperation agreements where lenders collaborate to avoid competing against one another.

• Alternative Credit:
  Private credit lenders are increasingly stepping in to provide debtor-in-possession financing or rescue financing, offering capital at higher costs but with more flexible terms. They are filling the gap that traditional banks are unable to address, reshaping how companies view their financing options during restructuring. My firm is very active on the workout side with alternative credit firms. The negotiations are a bit more straightforward than the public markets and are usually done under the radar. Default rates in private credit are around 5% but there are some firms who have some very challenging positions but in generally the market is robust and performing very well.

Q4: Is there any specific industry you believe will be facing stress/distress in 2024 and 2025?

In 2024 and 2025, several industries are vulnerable due to economic pressures, rising interest rates, and specific sector challenges. Key industries to monitor include:

• Commercial Real Estate:
  The commercial real estate sector, especially office spaces, is grappling with significant challenges stemming from the shift to remote and hybrid work models, along with the impact of AI. Many companies are downsizing their office footprints, resulting in increased vacancies and diminished demand. Higher interest rates are also making refinancing costlier, pushing highly leveraged property owners into distress. There is a big maturity wall that needs to be dealt with and banks have been derisking their balance sheet this year through SRT transactions and/or loan sales. My firm has been very active on this front by facilitating the derisking and providing sponsors / operators with capital solutions. There are a lot of zombie CRE deals out there and we are seeing a lot of sponsors trying to amend and pretend” or give up the keys. This creates a very interesting opportunity for a distressed investor who knows CRE. It is very different from the corporate space!

• Retail:
  The retail industry continues to face headwinds from the growth of e-commerce and shifting consumer habits, worsened by inflationary pressures. Physical retailers heavily invested in brick-and-mortar locations, particularly those in malls, may struggle with declining foot traffic and elevated operational costs. We could see an uptick in store closures and bankruptcies, particularly among middle-market retailers lacking robust digital strategies.

• Healthcare:
  Rising costs, labor shortages, and pressures on reimbursement rates are creating strain within the healthcare sector, particularly for hospitals, skilled nursing facilities, and smaller healthcare providers. Additionally, companies involved in pharmaceuticals or medical devices may encounter legal or regulatory challenges, such as ongoing opioid-related litigation, which could further exacerbate their financial difficulties.

• Technology:
  Although technology is generally seen as a resilient sector, certain subsectors may experience distress due to over-leveraging during the boom years, particularly among smaller or speculative tech companies. High interest rates and restricted access to venture capital could lead to increased restructuring efforts, especially for companies with weak profitability or negative cash flows.

• Telecom:

Telecom is a big part of the high yield market. There are number of large capital structures that are in play right now and some are very levered. You are seeing the Dish saga play out in real time and Lumen played out earlier this year and last year.  

Overall, industries characterized by high capital expenditures, significant leverage, and exposure to shifting consumer behaviors or regulatory changes are most at risk.

Q5: We have a ton of freshman and sophomores who want to pursue a career in RX investment banking, what advice would you give them?

Establish a Strong Financial Foundation

Restructuring is a technical field, so it's crucial to develop a solid grasp of financial modeling, accounting, and valuation from the outset. Familiarize yourself with key concepts such as capital structures, cash flow analysis, and financial ratios. Gaining insights into high-yield covenants, bankruptcy laws, distressed valuation techniques, and debt markets will provide you with a competitive advantage. There are numerous books available that can enhance your knowledge in these areas. Here’s a list of a few that I recommend:

• “Distressed Debt Analysis: Strategies for Speculative Investors” by Stephen Moyer

• “Corporate Financial Distress, Restructuring, and Bankruptcy: Analyze Leveraged Finance, Distressed Debt, and Bankruptcy” by Edward I. Altman and Edith Hotchkiss

• “The Art of Capital Restructuring: Creating Shareholder Value through Mergers and Acquisitions” by H. Kent Baker and Halil Kiymaz

• “Corporate Turnaround: How Managers Turn Losers into Winners!” by Donald B. Bibeault

• “Strategic Restructuring: Building a Resilient Organization” by John C. Camillus

• “The Credit Investors Handbook” by Michael Gatto

2. Stay Informed About Trends

Restructuring is closely linked to macroeconomic conditions, so it’s essential to keep abreast of current events in the economy and credit markets. Monitor news related to distressed industries, corporate defaults, and high-profile restructuring cases. Understanding how industries become distressed and how restructuring deals operate in practice will help you differentiate yourself. Consider leveraging reliable leveraged finance data providers like 9fin, which offers daily updates. Other valuable sources include Reorg Research and Debtwire.

3. Pursue Relevant Internships and Experience

Even if you can’t secure a restructuring-specific internship right away, aim for any finance-related opportunities early in your career. This could include roles in investment banking, consulting, private equity, or credit analysis. Learning about how companies raise capital, manage debt, and navigate financial stress is relevant to restructuring. You can transition into restructuring later, but establishing a strong foundation in finance is essential.

4. Network, Network, Network!

Building a network and fostering relationships are vital, especially in specialized fields like restructuring. Connect with professionals in the industry and seek out alumni who are currently active in this space. Remember that restructuring banking is cyclical and episodic; there will be periods of low activity. It's crucial to remain adaptable. Understanding the market dynamics can serve as a hedge, as many restructuring bankers often transition to roles on the buy-side.

Glossary

Fulcrum Security - The most senior impaired class. It often represents the debt that sits at the tipping point of creditor recovery.

Unitranche - A financing structure that combines senior and subordinated debt into one single loan facility, blending the characteristics of both types of debt. This offers simplicity and faster execution compared to traditional loan structures with multiple layers of debt.

Double-Dip - A financing strategy where a secured loan is provided to a borrower, who then uses the proceeds to offer an intercompany loan to an affiliated entity. This structure gives the initial lenders claims on both the assets securing the loan and the collateral behind the intercompany loan.