Case Study Debrief: Distressed Debt Restructuring, Verso Corp. Verso is our case company. We'll start by taking a look at the paper industry, specifically the risks and the drivers. Then, we'll move on to the company-specific risks. Next, we'll take a look at the restructuring options, followed by an analysis of the cash flows, and the ability of the company to support the debt based on the cashflow forecast. We'll also look at the value of the company if we needed to do a fire sale, and also what we'd expect to get from the business if it were liquidated. Finally, we'll look at all the options and come to an overall conclusion. Let's start by looking at the industry risks first. The pulp and paper industry is a notoriously cyclical industry. Paper consumption is directly linked to GDP. In fact, the rating agencies often put a ceiling rating on this industry because it's so risky, and this reflects the business risk that the whole industry faces. Let's take a look at some of the reasons why. Firstly, the cyclicality generates significantly volatile prices. Paper is a commodity. It means that everything comes down to price. This results in squeezed margins and intense competition, and that competition is not just in the domestic markets. It's globally. It's easy to ship paper, and you can buy it from international suppliers as well as domestic suppliers. The global nature of the business also means that there are fluctuations in foreign exchange rates. So as the dollar moves against other major currencies, this will also affect profitability. It takes a lot of fixed costs to generate pulp and paper, and this also means that the businesses have significant operational leverage. This means that the sector experiences significantly volatile profit margins, and that's before even considering the financial risk. Furthermore, there's some systemic changes in the sector. Increasingly, we're seeing a shift from paper to electronic media, so there's a structural decline in the whole sector. This is sometimes referred to as a secular change. Lastly, there are environmental pressures and concerns about pollution from pulp and paper mills. This means there's likely to be more regulation in the future as environmental rules are tightened, which will have a follow on cost implication. There's a search in the industry for more stable revenue streams and less cyclicality. Furthermore, many firms are trying to reduce their dependence on third parties for suppliers. So increasingly, businesses are seeking to own their own forests and the land to secure production, but this also means that it will increase operational leverage within the business. In addition, pulp and paper mills use a lot of energy, so having a close provision of low cost electricity is a competitive advantage. Businesses like Versos that have high degrees of operational leverage and are cyclical translate into high business risk, and typically that means businesses with high business risk can only support low financial risk. That generally means manageable or lower levels of leverage. And while all this is going on, Verso must be able to manage the environmental pressures that the entire industry is facing.
