Financial Distress

FINANCIAL
DISTRESS
ACF (TERM III)
JAN-MAR 2017
DR. KULBIR SINGH

(IMT N)
ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 1

Kingfisher Airlines
ACF (Term III) Jan-Mar 2017 Dr.

2
Kulbir Singh (IMT-N)
Kingfisher Airlines: 2010 Restructuring
Kingfisher Airlines was established in 2003, owned by United Breweries
Group belonging to Vijay Mallya and his family..
Started its commercial operations in May 2005 with a fleet of four new
Airbus A320 aircrafts and started its international operations two years later.
To 2009 Kingfisher Airlines Ltd was the largest airline company in India.
Through Air Deccan it operated a low cost carrier.
Air Deccan was incorporated in 1995 as a private limited company under the
name of Deccan Aviation.
Air Deccan went public in an IPO during May 2006 - first to start operations
as a low cost carrier.
The companys accumulated losses in 2006-07 were more than fifty percent
of the net worth.
The airline business of Kingfisher Airlines Ltd merged with Air Deccan in April
2008 and the name of the company was changed to Kingfisher Airlines Ltd.
Massive Capital Expenditure Program
In 2005 it ordered five A380s (these were cancelled subsequently), five
A350-800s and five A330-200S for over $3 billion.
During 2008-2010 the company accumulated 67 Airbus aircrafts.
The company heavily used bank loans to finance capital expenditure and
working capital.
To secure these loans, the airline had used as security all its movable assets,
trademarks, goodwill of the company, credit card and Other receivables and
a mortgage on Kingfisher House, the corporate headquarters.
Company pledged its brand as collateral with its lenders for Rs 41 billion.
The loans raised amounted to three times the companys market value.

Kingfisher accumulated losses amounting to Rs 42,010 m between
April 2005 and March 2010.
Reasons:
Crude Oil Prices escalation
During 2008-2010 the company accumulated 67 Airbus aircrafts.
The company heavily used bank loans to finance capital expenditure
and working capital.

KAL :Financing Snapshot (Secured Loans) Rs m
2007 2008 2009 2010 2011

Term loans from banks (Rupee loans) 1797 1546 8068 30,288 42,230
Cash credit facility from banks 1869 172 3479 5073 2825
Short Term loans from banks 1526 2485 4270 4784 NA
Vehicle loans from banks/financial institutions 16 10 4.8 NA NA
Finance lease obligations 22 12 9405 7253 6104
Term loans from financial institutions and
Others 742 629 996 1023 6848
Hire Purchase 1142 1045 NA NA NA
Total 7114 5899 26,222.8 48,421 58,007

7
How and why firms fail?
A business failure is an unfortunate circumstance of a firms
inability to stay in business.
can fail in a number of ways &
can fail due to one or more causes.
Types of Business Failure
Type I: Low/Negative Returns .economic failure
ROA/RONW < CoK
Example: Many Power Generation Companies like Adani Power etc.
(couple of years ago), Gini and Jony, etc.
Can be said Declining firm experiencing economic failure

How and why firms fail?
Type II: Technical Insolvency
Though Asset > Liabilities (Liabilities +NW)
It confronted with liquidity crisis
If able to convert some of its assets into cash within a reasonable
period..
Type III: Insolvency Bankruptcy..bankruptcy
Normally, Asset = Liabilities, that is
Assets = LTL +NW
If NW is negative, then it is possible that
MV of Assets < Liabilities
Claims of Creditors can be satisfied only if
(MV of Assets > BV of Assets) Liabilities
Note: Bankruptcy!!!

Example of Indian companies that can go bankrupt (Altman Z-score )
UNDER STRESS
COMPANIES WITH Z-SCORE LESS THAN 1.81
Company Altmans Z Score
Hathway 1.78
Adani Ports and SEZ 1.71
Shree Renuka Sugars 1.68
Great Eastern Shipping 1.68
Educomp Solutions 1.59
Adani Enterprises 1.53
Bharti Airtel 1.53
Jaiprakash Associates 1.48
JSW Energy 1.43
Cox and Kings 1.41
ITNL 1.39
IRB 1.36
Aditya Birla Nuvo 1.29
Power Grid 1.11
Lanco Infratech 0.88
Indiabulls Power 0.64
Adani Power 0.52
A Z score below 1.8 implies an increased probability of
financial stress.
Source: Morgan Stanley Research
ACF (Term III) Jan-Mar 2017
10
Dr. Kulbir Singh (IMT-N)
Business Failure: Reasons and Facts
Financial distress is the primary cause of business failure.
Often the result of mismanagement, which accounts for more than
50 percent of all business failures.
Overexpansion, poor financial actions, an ineffective sales force, and
high production costs can all singly or in combination cause the
ultimate failure of the firm.
Examples of poor management actions.see Kids Apparel Industry
Jini and Johnny

Economic Activity can contribute to the failure of the firm,
especially during economic downturns.
The success of some firms runs countercyclical to economic
activity..whereas other firms are unaffected.
Example: Iron and Steel Industry is a cyclical business (see article: On
the Edge, Pg. 32, BW, 22 July, 2012)
Fortunes of most firms are positively tied to the business cycle,
so bankruptcy filings always spikes upwards during economic
contractions.
See BIFR & CDR Data next slide

BIFR & CDR Data
The number of firms registered for reorganization with BIFR in year 2008 was 57 which
has increased to 80 in year 2012.
Under CDR Scheme, FY 2008-09, total of 225 cases amounting to Rs. 95,815 crores
were referred to CDR cell, out of which 184 cases amounting to Rs.85, 536 crores were
approved.
Textiles, Steel, Sugar and Chemicals industry.
As on 31st Dec, 2012, a total of 491 cases amounting to Rs. 2,66,885 crores were
referred to CDR cell, out which 362 cases amounting to Rs. 2,11,978 crores were
approved.
Textiles, steel, sugar, paper & packaging, chemicals, infrastructure, power,
pharmaceuticals, and other industries.
As on 30th Sep, 2015, a total of 655 cases amounting to Rs. 4,74,002 crores were
referred to CDR cell, out which 530 cases amounting to Rs. 4,03,004 crores were
approved.
Iron & steel, infrastructure, power, construction,
ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N)
textiles and other industries. 13
Economic Activity..
Interest Rates
What is present RBI policy? And Why it is so?
What is its implication on the industry?
What is its impact on firms already under distress?

Interest Rates
FY 2011-12 FY 2010-11 FY 2009-10
Interest Payout
(Rs. Crore)
4,92,303.9 3,49,170.4 3,08,507.4
Growth (%) 41.0 13.2 3.6
Indias largest company - Indian Oil Corporation (OIC) reported the highest
interest payout of Rs. 5,895 crore among the 913 companies - interest payout
grew 95.4% in fiscal 2011-12.
Companys board in recent meeting gave approval to raise its borrowing limit by Rs.
30,000 crore to Rs. 110,000 crore.
Fastest growth in interest payout in FY 2011-12, Puravankara Projects figures right
at the top with its interest payout grew 4,608 percent to Rs. 192.8 crore, while its
net profit was barely Rs. 129.3 crore on revenues of Rs. 810 crore.
(see article: Up, Up, It Goes, Pg. 38-39, BW, 23 July, 2012)
Maturity
Firms do not have infinite life . Stages of birth, growth, maturity and
decline.
Management should attempt to prolong the growth stage through
research,
development of new products, and
Mergers
Once the firm has matured & has begun to decline, it should seek to be
acquired by another firm or
liquidate before it fails

Financial Distress
What is Financial Distress?
How to Resolve it?

Firm
Assets Financial Contracts
HARD LIQUID HARD SOFT

Not Sufficient to Meet requirement of
assets [FINANCIAL DISTRESS] debt
Mismatch
Resolve the Mismatch?
RESTRUCTURING
both
Plant & Cash Debt Common Stock

Marketable Promise of Payment
Machinery
Securities Non-Payment violation of contract Pref. Stock
Land BH legal recourse to enforce contract
Vehicles
Suppliers/Employees Liquidity
An Excuse
Liquidity Not An 1
ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) Excuse 8
Financial Distress: Restructuring
Restructuring of Assets
Restructuring of Financial Contracts
Restructuring of Both

RESTRUCTURING Firm
Credit
Constraint Asset
Assets Fungibility
Participation
Hard Liquid Market Liquidity Restrictions
(Regulations)
Partially/Wholly cash
SELL
Factors Fraction of Assets Sold
Prematurely
Destruction of R/b Assets Sold & Retained

Firm Value
HIGH Piece-Meal (Sell Asset)
COST OF COST
LIQUIDATION
(Cost of Asset
Reconstruction)
LOW Sell Assets
COST
Going Concern Value
(PV of all Future CFs generd by Assets)
(minus)
Highest Value of Asset Sold Buyer is Higher Value User Going-Concern Competitive
[Cost is +ve] Firm Auction
2
0
RESTRUCTURING Firm
Convert/ Replace Financial Contracts Creditors poorly Informed

(Outsiders)
With
softer Information
terms of HARD SOFT Asymmetry Managers Better
contract Informed
Convert/Replace (Insiders)
(Residual Payments
Creditors True Value of Firm not
known
COMPROMISE
SICA Sec 230
Negotiate Reformulate the

Terms of Contract Holdout Creditors are Diffused
(PRIVATE WORKOUT) Problem
Private IMPEDIMENTS
Reduce Interest Amount
Restructuring
Reduce Principal Amount
Extend Maturity Period
Conflicts of Multiple Layers

Interest of Creditors
2
1
Kingfisher Airlines Restructuring (2010)

22
Kingfisher accumulated losses amounting to Rs 42,010 m between April
2005 and March 2010.
In its meeting held on November 25, 2010, BoD approved a debt recast
package with lending banks with recast included:
1) Conversion of debt of Rs 13.55 billion ($220 million) provided by
lenders into equity
2) Conversion of debt of Rs 6.48 billion ($100 million) provided by
promoters into equity
3) Re-scheduling of repayment of the balance debt to lenders over nine
years with a moratorium of 2 years.
4) Reduction in interest rates.
5) Sanction of additional fund and non-fund based facilities by the
lenders
KAL :Interest Reduction Proposals
Bank Contribution
1 Rs. 10,000 m
Before After Change
Interest Rate 13.50% 13.50% - pts
Principal 10,000m -
Interest Cost 1350 m - -1350 m
Letter of Credit Commission Cost on Rs. 11,250 m - 110 m 110 m
2 Rs. 4500 m repayment of loan
Before After Change
Principal 4500 m -
3 Convert Rs. 12,000 m of Rupee loan to foreign currency loan - 13.5% to 8% interest rate
Before After Change
Interest Rate 13.50% 8.00% -5.5 pts
Principal 12,000 m 12,000 m
Interest Cost 1620 m 960 m -660 m
Impact of Bank Contribution per year 2510 m
24
Founders Contribution
1 Short Term Loans - Conversion to Equity*
Before After Change
Principal 6500 m 2000 m
Interest Cost 780 m 240 m -540 m
2 Conversion of debt instruments to Equity*

Before After Change
Principal 2170 m -
Impact of founders Contribution per year 870 m

25
Persons Acting in Concert**
1 Conversion of debt instruments to Equity*
(Persons Acting in Concert**)
Before After Change
Interest Rate 8.00% - -8.0 pts
Principal 7090 m -
Interest Cost 570 - -570 m
Impact of Persons Acting in Concert per year 570 m

Total Interest Cost Reduction per year 3940 m
*Conversion/subscription to equity shares to be simultaneous with the undertaking of a rights
issue or other raising of capital, and subject to not triggering an open offer under the Takeover
code
**The holders of the debt instruments are persons acting in concert with the founders for the
purpose of issue and conversion of the instruments
KAL: Summary of Operational Restructuring benefits
1 Reconfiguration & Business Model Change
Impact to seat reconfiguration and business model
13,950m
change (1)(2)(3)
2 Discounts (Fuels and others)
Net Impact (@4% of current rates) 2860 m
3 Lease Rental Reduction
Net Impact (10% of current) 1150 m
Total Operational Improvement per year 17,960m
Notes:
1) Aircraft reconfiguration to reduce the number of sub-fleets from nine to five across
A319/320/321/332 aircraft types. The number of seats in the front cabin will be reduced and
more economy seats will be added
2)
The domestic ATVs are estimated to increase by Rs. 600 due to concentrated industry efforts to
pass on the fuel increases, and absorb adverse currency movement
2)
Business model change to Kingfisher Class offering is estimated to provide another Rs. 500 ATV
upside on 60% of the domestic capacity that is currently Kingfisher Red

RESTRUCTURING Firm
Financial Contracts Arrangement (SICA Act) Assets
Reorganization
HARD SOFT of Share Capital LIQUID HARD
Issue New Securities
(Eg. Private Equity)
Compromise
Due to Impediments,
Court-Based TRIBUNAL
Settlements is Better
Arrangement
2
8
Sick Industrial Companies Act (SICA)
SICA (Special Provisions) Act, 1985
Key Legislation Industrial Sickness
What is a Sick Industrial Unit?
Firm (> 5 yrs. Old) ----------> Accumulated Losses > = 50% of NW
Repealed and replaced by SICA (Special Provisions) Repeal Act, 2003.
Reason for Repeal:
Reduce the growing incidence of sickness where managers use
sickness declaration to merely escape
Legal obligations, and
Gain access to concessions from FIs.

SICA
Objectives
Determine the Revival of Close unviable

extent of potential company to release
sickness in an viable blocked investment
industrial unit companies

SICA
BIFR AAIFR
(Board for Industrial & To hear appeal against (Appellate Authority for
Financial (to challenge any order of BIFR) Industrial & Financial
Reconstruction) Reconstruction)
Revival &
Liquidate/Closure
Rehabilitation of
of Non-viable SICA has established two Quasi-
potentially Sick
companies/units Judicial Bodies: BIFR & AAIFR
Units

END

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FINANCIAL

DR. KULBIR SINGH

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 1

ACF (Term III) Jan-Mar 2017 Dr.

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 4

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 5

2007 2008 2009 2010 2011

Total 7114 5899 26,222.8 48,421 58,007

ACF (Term III) Jan-Mar 2017 Dr.

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 8

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 9

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 11

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 12

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 14

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 16

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 17

Assets Financial Contracts

HARD LIQUID HARD SOFT

Resolve the Mismatch?

Plant & Cash Debt Common Stock

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 19

Destruction of R/b Assets Sold & Retained

Convert/ Replace Financial Contracts Creditors poorly Informed

Negotiate Reformulate the

Conflicts of Multiple Layers

ACF (Term III) Jan-Mar 2017 Dr.

2 Conversion of debt instruments to Equity*

ACF (Term III) Jan-Mar 2017 Dr.

Impact of Persons Acting in Concert per year 570 m

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 27

Financial Contracts Arrangement (SICA Act) Assets

Issue New Securities

(Eg. Private Equity)

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 29

Determine the Revival of Close unviable

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 30

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 31

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 32

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