Avaya Takes a Step, Not a Leap

Last Friday, April 14, Avaya announced that it had filed with the court a Chapter 11 proposed plan of reorganization, which specifies how the company would be structured after bankruptcy and how the creditors in the bankruptcy would receive value for their positions (see related No Jitter article). Now what?

As next steps, Avaya is scheduled to present the proposed plan at a hearing on May 25, at which time the judge will review the plan for completeness and understanding. On June 27, the bankruptcy court is scheduled to hold a hearing to review the plan and hear arguments as to why or why not it should accept the plan.

Companies typically follow one of two paths to the end of a bankruptcy and debt relief: They either reorganize or liquidate (sell assets as Nortel did). Clearly, the Avaya team has a strong desire to reorganize and continue as a complete company (less the networking group), and has proposed a plan that accomplishes that.

As part of this proposed plan, in a press release, Avaya stated the following general terms:

• Pre-filing debt will be reduced by more than $4 billion
• Restructuring will be achieved through a debt-for-equity exchange in which certain secured creditors would acquire 100% of the equity in a reorganized Avaya
• General unsecured creditors will share pro rata in a cash pool
• Qualified U.S. pension plans, which make up the vast majority of Avaya's pension obligations, will be honored and maintained following emergence from bankruptcy
• Its two collective bargaining agreements and all related agreements will be honored and assumed

This follows the general structure I've discussed in my previous No Jitter articles on Avaya's bankruptcy, but Avaya may face a challenge on some key points.

For example, an official statement provided with the announcement from Avaya CEO Kevin Kennedy suggests that things are still fluid: "We look forward to working closely with all stakeholders over the coming weeks and months to refine the Plan and build consensus." This statement raises a critical question as to whether Avaya has the required creditor support and agreement to the plan as proposed. This is probably because the plan, as proposed, is heavily weighted to the secured creditors and the pension funds.

One interesting point in the proposed plan description document is the value of Avaya (called HoldCo in some of the documents) after bankruptcy, as assessed by advisory firm Centerview Partners. As stated in the plan disclosure:

"...for purposes of the Plan, Centerview estimates that the Enterprise Value including IP of the Avaya Enterprise falls within a range from approximately $5.1 billion to approximately $7.1 billion, with a midpoint estimate of approximately $6.1 billion, which consists of the value of the Avaya Enterprise's operations on a going-concern basis plus the value of intellectual property." The document goes on to say, "Based on assumed debt at emergence (from the reorganization) of $2.0 billion, cash of $350 million, capital leases of $31 million and tax-effected pension and OPEB liabilities of $1.1 billion, and after application of the settlements and compromises set forth in Article III of the Disclosure Statement, the implied range of value for the Reorganized HoldCo (Avaya) Common Stock is approximately $2.3 billion to approximately $4.3 billion, with a midpoint estimate of approximately $3.3 billion."

This indicates the common stock/equity value of the reorganized Avaya is approximately $3.3 billion. The intent of the proposed plan is that this will be distributed to the current bondholders.

In any bankruptcy, creditors hold relative "positions," with first position creditors generally paid in full before second or subsequent positions receive payment. The proposed Avaya reorganization plan treats the bondholder positions significantly differently. In the proposed plan, the cash flow credit facility secured claims and the first lien notes secured claims are both in a secured first position, and together will receive 95% of the equity in the reorganized company and more than $1.4 billion in cash. The second lien holders, while secured, are in second position and will receive no cash and 5% of the equity in the reorganized company.

In the plan disclosure document, the first position is shown at 100.4% estimated recovery, while the second is shown at 11.4% recovery. Clearly the plan is weighted to assuring the first position lien holders recover close to their value while the second position bondholders receive much less. The second position bondholders held about 23% of the debt of the company. One of the challenges to a consensus I have heard mentioned is that some of the first position lien holders also hold second position liens and they may vote/argue against the plan due to the impact on their second lien positions.

Lastly, any unsecured creditors will receive about 10 cents on the dollar of the obligations they hold. However, it is not clear if many such creditors exist. As I understand, Avaya is managing most (potentially all) of the ongoing business obligations through critical supplier payments to assure the business continues to operate normally.

In addition, there have been indications that some of the creditors feel the pension liability should be included in the capital restructuring as part of the final plan. They feel that maintaining the full pension liability while reducing the treatment value of the bondholders is not fair. However, including the pension liability would dramatically complicate the bankruptcy as the Pension Benefit Guaranty Corp. (PBGC) is structured to receive cash, not equity.

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