Case Study Debrief: Distressed Debt Restructuring, Verso Corp., part two. Let's now look at Verso in more detail. We're going to break down the risks into two categories. Operational risks and financial risks. Let's start with the operational risks. Verso has relatively limited product diversification, so it's particularly vulnerable to changing demand for specific products. It also has a relatively high customer concentration, and it's got less exposure to the faster growing markets outside the United States. Unfortunately, it also has cost issues because its workforce is highly unionized. And that's particularly in comparison to some of its international competitors. There's also risk in the ability to increase synergies from the recent NewPage acquisition. Turning to the financial risks, Verso has significant financial leverage. And when you're looking at restructuring each tranche of the financing, the lenders need to agree on a restructuring plan. You'll often need at least 75% of the creditors to agree in one specific creditor class. For example, senior versus subordinated. One of the best examples of where this was a problem was with Argentine sovereign debt where hedge funds held out for many, many, many years and prevented a full restructuring from taking place. As a business moves towards restructuring, it's important that it maintains its liquidity. This often means that the existing creditor base is lumped together in something called a creditor in possession, which effectively ring fences all those claims and puts them into one pot. This means that new financing can be lent to the business so at least the business is kept going operationally. Fundamentally, if the business is maintained as a going concern, it typically means that there's going to be more value for the creditors than if it's liquidated. You can see from the chart on the left that Verso's leverage compared to its peer group is absolutely extreme. Verso has debt to LTM EBITDA of around 13.8 times while the nearest comparable has just three. Now, this is reflective of the NewPage acquisition, which increased debt significantly and has been very slow to integrate with major hits to earnings and unachieved synergies and operational advantages. So either we have to reduce the debt or increase the EBITDA. And certainly, in the short term, the only real option is to reduce the debt because clearly, this is just completely unsustainable. This will impact greatly on its debt capacity.

We're going to take a look at the three main options for restructuring, and we're going to prioritize them according to the ones which are going to deliver the most value for the creditors. Generally speaking, restructuring will result in the maximum value for the entirety of the creditor group. This doesn't always work because the junior creditors often get completely wiped out. So we have a number of different choices within that restructuring option. First, we can ask the creditors to write off the loan. In other words, just plain forgive the loan. Secondly, we can ask the creditors to extend the maturity of the debt. We can incentivize them to do this by increasing their interest rates. We can also ask them to convert some of the interest into a non-cash component to relieve the cashflow strain on the company. This is typically called paid in kind or PIK. So this means that we won't necessarily have to pay the interest in cash, but it will just be rolled up into the loan balance, which will increase over time. Alternatively, we can look at converting some of the debt into equity. It's often a difficult negotiation. And in situations, the junior holders often won't benefit very much from that resulting transaction. So it's the senior lenders that hold all the cards. Another option, rather than restructuring is to just sell the business. However, it's not quite as simple as it may seem 'cause you need to sell the business quickly. And oftentimes, the business is in some type of distress so it's likely that you're not going to get the best price. Certainly not the price from a willing buyer and willing seller. Effectively, what you're doing is a fire sale. So it's reasonable to assume a discount to recent transactions in the sector. The last option is to liquidate the business. And this is where we take the assets and sell them individually. It also means that there would be no goodwill value in the business. And again, you're probably going to get a discount because you're selling the assets in distress and in a shortened period of time.