Strategy is being used in bankruptcy processes involving multiple creditors
10/31/2024
The conversion of debt into equity during company restructurings has firmly established itself as a debt reduction and deleveraging strategy in the Brazilian market. This mechanism has been increasingly employed in major bankruptcy processes, with more creditors, including financial institutions, more comfortable with the idea of becoming shareholders in restructured companies. This approach also enhances the recovery potential of loans previously considered irrecoverable, thereby avoiding more drastic write-offs.
In the case of retailer Americanas, banks became shareholders as part of a debt conversion, a necessary step in efforts to rescue the company, which was embroiled in a fraud scandal. Another example is the logistics company Sequoia. For Brazilian airline Azul, debt conversion is also on the table as a solution to its crisis. This practice is included in Light’s restructuring plan. It is similarly part of the out-of-court recovery plan for 2W.
In Brazil, significant cases of debt conversion first emerged between 2015 and 2016, such as construction firm OAS, in the wake of the anticorruption task force Car Wash. Companies owned by former billionaire Eike Batista also ended up in creditors’ hands, like MPX, now known as Eneva. According to experts, in many instances, conversion was the only viable alternative. In Eneva’s case, the energy sector company managed to recover.
Giuliano Colombo, a restructuring partner at law firm Pinheiro Neto, explains that the trend of converting debt into equity in restructuring processes is on the rise, a shift noticeable after the 2020 amendment to the Bankruptcy Act, which reduced the risks associated with creditors becoming shareholders. “A better legal framework was established, and now the perception is that it’s possible to manage the risk,” he states.
According to Mr. Colombo, before this legislative change, banks historically failed to capture potential operational improvements in companies to which they were creditors. Today, financial institutions feel more at ease participating in conversions, especially in processes involving publicly traded companies, since monetizing shares is easier when they can be sold in the secondary market.
In some negotiations involving conversion, a lock-up period—market jargon for a temporary restriction on selling shares—may be established, although this is not a standard practice.
“Some creditors have the flexibility to receive shares through other vehicles [within the financial institution], such as FIPs [private-equity investment funds],” Mr. Colombo notes. “This perspective shift is here to stay,” he adds.
Mr. Colombo highlights that the effect of conversion is immediate in calculating a company’s value, as debt can be quickly reduced, which also reflects in the value of shares traded on the stock market, since the cost of debt servicing, which was consuming cash flow, is reduced.
The Pinheiro Neto partner also explains that conversion is often a component in restructuring strategies and creditor negotiations, alongside other options like receiving discounted payments or issuing new debt with a longer maturity, allowing creditors to be paid later but without a discount.
Thomas Felsberg, one of Brazil’s leading bankruptcy experts, says that debt conversion is “extremely useful” for adjusting the capital structure of insolvent companies. “Reducing debt can make a company viable. Often, this may even result in a change of control.” Mr. Felsberg notes that conversion is often partial and involves debt considered “unpayable.”
Mr. Felsberg points out that this instrument is quite common in the United States, where notable restructuring successes have involved debt conversion into equity. A well-known example is General Motors, where creditors who converted debt into shares recovered more than those who received cash.
Daniel Lombardi, a partner at G5 Partners, notes that debt-to-equity conversion is not new but is increasingly used in crafting debt solutions for companies undergoing restructuring. He emphasizes that such conversions are complex, especially for commercial banks. Public banks, he reminds, face restrictions on this type of operation.
The G5 executive mentions that there are now funds specializing in special situations, or “special sits,” that lend to companies with mechanisms for equity participation in problem cases and are prepared to take over management—unlike banks. “Commercial banks have less incentive for this solution.”
Mr. Lombardi explains that, within the framework designed to cater to various creditor profiles, debt conversion is one of several options. Other components of a solution can include debt extension and asset sales. These alternatives are pursued when others do not adequately address maturities. “It’s a mosaic of solutions, and debt conversion is one more option,” he says.
Fabiana Balducci, a partner at BR Partners in the restructuring area, notes that a complication in debt-to-equity conversion arises because many fixed-income funds have statutory restrictions against holding shares. Today, she says, many managers are seeking more flexibility to avoid significant write-downs on receivables.
Azul, Light, Sequoia, Americanas, and 2W declined to comment.
*By Fernanda Guimarães — São Paulo
Source: Valor International