Pre Read Assignment

FINANCIAL MANAGEMENT – II

Case
Oaktree: Pierre Foods Investment – Managing Financial
Distress
(PRA-3)

SUBMITTED TO
Prof. Kanagraj

Submitted by: GROUP 4 (Section A)

Archita Jain B23014
Gajjar Vandan D B23024
Kriti Tyagi B23028
Pankaj Rai B23033
 TABLE OF CONTENTS

CASE SUMMARY....................................................................................3

LIST OF ISSUES IDENTIFIED................................................................3

ALTERNATIVE SOLUTIONS...................................................................4

OPTIMAL ALTERNATIVE........................................................................5

CONCLUSION.........................................................................................5

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 CASE SUMMARY
This case revolves around Oaktree, a prominent global investment management firm
specializing in diverse credit strategies. Established in 1995 by a collaborative team
with a history dating back to the mid-1980s, Oaktree underwent rapid expansion,
accumulating $55 billion in assets by 2008. These assets comprised funds from
corporate and public pensions, endowment foundations, insurance companies, and
private individuals, with offices located in Los Angeles, New York, Stanford, and other
cities.
Oaktree's special situation group engaged in debt and equity investments targeting
middle-market companies facing distress, dislocation, or dysfunction, leading to
undervaluation. The company aimed to gain control or significant influence over such
entities and actively manage them, adopting a private equity-like approach to deliver
value. Oaktree believed this strategy allowed them to acquire companies at more
favorable prices compared to traditional auctions or conventional private equity
processes.
The case delves into the investment strategy commonly pursued by distressed
investors, particularly after the 2008 financial crisis, where many companies grappled
with poor liquidity and limited access to credit. The focal point is Pierre Foods, a
manufacturer and distributor of processed and precooked protein products. Despite its
extensive experience, sales growth potential, and dominant market position, Pierre
Foods faced challenges due to increased production costs and unsustainable leverage
post-crisis. Oaktree Capital Management seized the opportunity to leverage its
distressed debt securities investment strategy, ultimately acquiring a controlling equity
stake in Pierre Foods.

ISSUES IDENTIFIED
(a) The central challenge highlighted in the case centers around the decisions facing Oaktree
concerning its investment in Pierre Foods. The options include pursuing immediate equity
control, leading to the majority of the reorganized company's equity being claimed by secured
debtholders.

(b) Another alternative entails receiving only a partial recovery of the secured debt amount
disbursed, coupled with the sharing of equity with the remaining senior subordinated
debtholders.

(c) The final available option involves negotiating with Pierre Foods to initiate bankruptcy
proceedings, leading to the sale of the business and opening the process to competitive
bidding.

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 ALTERNATIVE SOLUTIONS
 Alternative 1: Negotiate to obtain equity for its senior secured
claims.
The initial option for Oaktree Capital Management involves securing equity through the
conversion of their senior secured claims, representing 90% of the Term Loans totaling $204.3
million. Should the conversion occur at par value (1:1), Oaktree would emerge with a
controlling stake in Pierre Foods post-restructuring. The scenario unfolds as follows:
Actual Equity (after Oaktree Stake of
Particulars Term Loan
2007 Conversion Equity Oaktree
)
Shareholder's $ 150.19 $ 227.00 $ 377.19 $ 204.30 54%
Equity

However, there are concerns of cram-up by the senior subordinate holders if they convince
that the price increase and cost savings would boost the cashflows and the pro forma senior
secured leverage ratio will reach market levels of 4.0x or below.
If we consider the improvements suggested during the due diligence of Bain & Co., the
leverage ratio will be 3.3x on proforma performance as shown below:

After After
Pro Improvement Chang Improvement Chang
Particulars Actual Forma s e s e
2007 2007 2007 A 2007 PF
$487.8
Revenue 0 $615.80 $513.80 $26.00 $641.80 $26.00
-
$344.2
COGS 0 -$439.30 -$328.20 $16.00 -$423.30 $16.00
$143.6
Gross Profit 0 $176.50 $185.60 $42.00 $218.50 $42.00
Selling, General &
Admin -$84.80 -$108.00 -$84.80 $0.00 -$108.00 $0.00
Depreciation &
Amortization -$30.40 -$39.50 -$30.40 $0.00 -$39.50 $0.00
-
$115.2
Total SG&A 0 -$147.50 -$115.20 $0.00 -$147.50 $0.00
EBIT $28.40 $29.00 $70.40 $42.00 $71.00 $42.00
EBITDA $58.80 $68.50 $100.80 $42.00 $110.50 $42.00
PF Adj. $0.00 $7.90 $0.00 $0.00 $7.90 $0.00
EBITDA Adjusted $58.80 $76.40 $100.80 $42.00 $118.40 $42.00
Capex -$8.70 -$13.40 -$8.70 $0.00 -$13.40 $0.00
FCF (Adj. EBITDA -
Capex) $50.10 $63.00 $92.10 $42.00 $105.00 $42.00

$367.3
Debt 4 $367.34 $367.34 $367.34

Leverage Ratio 6.25x 5.37x 3.65x 3.33x

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Nonetheless, Oaktree's concerns regarding the cram-up strategy employed by senior
subordinate holders are not valid for several reasons:
(a) Oaktree holds a "blocking position" in the senior subordinate debt class, enabling it to
obstruct the restructuring plans of these debtholders and thus impede efforts to secure an
equity position in Pierre.
(b) Competitors of Oaktree, purportedly acquiring senior subordinate debt, stand to gain from
the conversion of senior secured debt, as their claims would have the highest priority after the
equity conversion. The conversion provides more liquidity to Pierre, making subordinate claims
more secure.
(c) Contrary to Oaktree's apprehensions, competitors never intended to acquire a controlling
stake in Pierre. With their current holdings amounting to $77.5 million (representing 62% of the
subordinate debt), ownership of the company remains unattainable for them. Therefore, the
implementation of a cram-up strategy by them seems highly unlikely.

 Alternative 2: Negotiate to reinstate the senior secured claims

and to obtain equity for its subordinate claims.
The second alternative available with Oaktree Capital Management is to reinstate the claims
and obtain equity for subordinate claims. The equity % gained will be as follows:
Actual Subordinat Equity Oaktree Stake
Particulars e (after
2007 Equity of
Notes Conversio Oaktree
n)
Shareholder's $ 150.19 $ 125.00 $ 275.19 $ 47.00 17
Equity %

This option fails to provide Oaktree with a controlling stake, thereby not aligning with the
objective of investing in Pierre's long-term debt. Furthermore, it would only result in a par
recovery of their senior secured position.
 Alternative 3: Negotiate to file for Bankruptcy and sell the
business, allowing Oaktree to “credit-bid” with senior secured
claims.
The third option available to Oaktree Capital Management involves negotiating with Pierre to
initiate bankruptcy proceedings and sell the business, enabling Oaktree to "credit-bid" using
senior secured claims. However, the due diligence report indicates that Pierre's liquidity
challenges are temporary, with an anticipated reversal within the next 180 days. This makes it
highly improbable for debt holders to be granted the option to convert their claims into equity.
Additionally, alternative avenues exist to infuse liquidity into the company, such as the potential
approval by the bankruptcy court of a "debtor-in-possession" financing of $16 million. This
financing would take precedence over the existing term loan and revolver. Moreover,
considering the estimated cost of approximately $15 million for bankruptcy proceedings, this
option becomes unattractive for Oaktree.

OPTIMAL ALTERNATIVE
Based on the preceding analysis, it appears that alternative 1, involving the negotiation to
convert senior secured debt into equity, aligns most effectively with Oaktree Capital
Management's investment objective. This objective revolves around investing in distressed
companies at significant discounts, leading restructuring efforts to secure a controlling equity
stake, and ultimately realizing substantial returns upon exit.
Contrary to Oaktree's concerns regarding the cram-up strategy of senior subordinate holders, it
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is crucial to note that Oaktree holds a "blocking position" in the senior subordinate debt class.
This implies the ability to impede the restructuring plans of these debtholders, thereby
thwarting attempts to acquire an equity position in Pierre.
The remaining two alternatives fail to yield a controlling stake for Oaktree in Pierre, and the
prospects of achieving exponential returns are highly uncertain and improbable given the
constraints imposed by the bankruptcy code.

CONCLUSION
Consequently, considering the analysis, it is advisable for Oaktree Capital Management to
engage in negotiations for the conversion of senior secured claims into equity, thereby
securing a controlling stake of 54% in Pierre Foods. While the temporary cost benefits and
price increments may enhance the company's liquidity, pursuing a cram-up strategy is not
technically feasible for senior subordinate holders, especially since Oaktree holds more than
1/3rd of this class. This situation increases the likelihood of the senior secured debt being
categorized as fulcrum securities, presenting an opportunity for private equity-like sponsors.