Inconventionalvaluation,wesubtractthemarketvalueofthe
debtfromfirmvaluetoarriveatequityvalue.Whenvaluing
distressedfirms,wehavetoconsidertwospecificissues.The
firstisthattheshiftingdebtloadatthesefirms,sincethese
firms are often in the process of restructuring and
renegotiatingdebt,canmakeidentifyingthedollardebtdueat
apointintimeahazardousexercise.Thesecondisthatequity
in distressed firms may sometimes take on option
characteristicsand trade ata premium on what discounted
cash flow valuations would suggest is the value.
The Shifting Debt Load
Inadditiontohavingasubstantialamountofdebt,distressed
firmsoftenhaveverycomplicateddebtstructures.Notonly
dotheyowemoneytoanumberofdifferentcreditors,butthe
debt itself is usually complex—convertible, callable, and
filledwithspecialfeaturesdemandedbythecreditorsfortheir
ownprotection.Inaddition,distressedfirmsareofteninthe
processofnegotiatingwithdebtholders,tryingtoconvince
them to changethe termsof thedebtand, in some cases,
converttheirdebtintoequity.Consequently,thevalueofthe
debtcanchangedramaticallyfromdaytoday,thusaffecting
the value of equity, even if the enterprise value does not.
Whenestimatingthevalueofdebtina distressedfirm,we
should consider doing the following:
- Rather than relying on the last available financial
statementsfortheoutstandingdebt,weshouldtryto
obtainan updatedestimateoftheoutstandingdebt.
This may be difficult to do when the debt