Marvel Case Study

Case Study of Bankrupt and Restructuring at Marvel Entertainment

Group 1) Why is Marvel in financial distress? Bad luck? Bad strategy? Bad  implementation? When possible, back your claims with numbers. There are several financial problems that compromise Marvel’s financial  distress. Each problem can be explained by one or several reasons.

Over­collateral: The first financial problem of Marvel is that huge amount of  shares are collateralized as its holding companies’ debts. These debts were  secured by 77. 3 million shares in total, accounting for 75.

9% shares of Marvel  as a whole.

Issue Company  Marvel Holding Inc. Marvel Parents  Holding Inc. Marvel III Holding  Inc. Amount   ($ Million)  517. 4   251. 7  125  Due  1998  1998  1998  Secured by  48. 0 million Marvel shares  20. 0 million Marvel shares  9.3 million Marvel shares Table 1. The Debt Financing of Marvel and its holding companies  Though huge amount of shares of Marvel were collateralized, Marvel’s holding  companies cannot repay these debts from their profits. These holding companies  were mainly used for providing legal and financial protection, but not generating  operating profit.

As a result, the repayment of these debts only counted on  Marvel. Reasons of over­collateralized

a. Over confidence. Perelman was over? confident about the future of the  company. Marvel’s holding companies issued three main bonds during  Apr? 93 and Feb? 94, when the stock price of Marvel was quite high and  when the profit of Marvel was significant and still increasing.

b. Over value of IRS (internal revenue service). The primary motive of  these huge issue was to acquire 20 million shares, boosting Perelman’s  ownership more than 80%, which is the low bound of IRS.

c. Intentional Bond Defaulting.

During 1993 to 1994, bonds issued by  Marvel amounted to $894 million, which would mature within 4 years. However, at the same time, the net income of Marvel was just $61. 8  million, 1/12 of bond volume. This goal can hardly be achieved in  traditional industry.

Huge amount of outstanding long­term debt: The second problem of  Marvel was the maturing of Marvel’s long? term debt, which was loaned  mainly from banks.  The long? term debt was mainly the loan from bank, which would be outstanding  within a year. The article didn’t mention the composition of the long? term debt  and why it will mature at the same time. A majority of current portion of long? term debt would be outstanding at March 31, 1997. The amount of current  portion was even larger than Marvel’s Current Assets in total in 1996. Apparently, Marvel was not capable of repaying its long? term debt maturing  within a year. Reasons of huge amount of outstanding long­term debt.

For management team, the long? term loan from bank may not assume to be a problem when then business went well. However, when profit turned  to negative, the bank apparently won’t lend Marvel money anymore  without renegotiation. Such an amount of maturing debt at same time implied great potential  risk of operating mistake. However, the management team may not pay  enough attention on the risk.

Operating Failure: The last problem of Marvel was operating failure. The  previous two problems were solvable if Marvel generated enough operating profit. However, this company was generating negative profit in 1995 and  1996.

Table 3: excerpt from Marvel’s Income report Reasons for operating failure:

a. Bad Luck. The business turned down shortly after the third issuance. This  was the direct reason of loss of Marvel’s core business.

b. Over? aggressive for M&A. The merged companied also accounted for  large portion of financial losses.

c. Executive mistake. The executive team didn’t realize the motive of  booming of this industry.

And executives also neglected the necessity of  core readers. Why did Marvel file for Chapter 11 rather than restructure out? of? court? There are three main reasons that Marvel filed for Chapter 11: Disagreement from active debt holders 2 Marvel offered a restructuring plan to reach an out? of? court agreement, but the  debtors were not satisfied with it. The reasons of disagreement includes:

a. Marvel  was  in  serious  financial  distress  and  could  not  afford  for  a  restructure plan favorable to bondholders.

b. Bondholders,  especially  vulture  investors  expected  for  a  large  part  of  Marvel’s value. Their requirement directly went against shareholders and  Perelman’s benefits.

c. Who  had  the  right  to  propose  restructure  plan. The  holding  companies’ debt holders thought that they should have the right to propose the first  reorganization plan because of their ownership of collateral shares.

d. Objection  of  the  proposal  about  how  to  use  the  equity  investment  from  Andrews. In the Perelman’s proposal, most of equity investment was used  to acquire Toy Biz’s common share. However, the representative of debt  holder, Carl Irans, disagreed with the acquisition.

Less bargain power for debt holders  a.

Lower  requirement  for  proposal  approval:  A  successful  out? court  settlement requires the unanimous support from debt holders. However,  in  the  vote  after  filing  for  Chapter  11,  gaining  support  from  only  a  majority  of  the  claimants  in  each  creditor  class  is  easier  than  from  everyone.

b. Making holding companies debt holders less active: dispersed holding  companies’  debt  holders  appeared  to  be  active  because  of  their  representative,  Paul  Irans. In  the  out? court  scenarios,  the  active  dispersed creditors were more likely to participate in reorganization plan. However,  by  filing  Chapter  11,  Perelman  provided  to  the  creditors  only  the choice between approval & gain little and disapproval & gain nothing.

c. Solve  the  debt  holders’  holding  problem:  In  out? court  settlement  scenario,  each  one  of  the  debtors’  voting  is  vital  to  the  settlement  and  each of them has the incentive to behave opportunistically and hold their  vote  until  he/she  is  the  last  voter,  waiting  the  shareholders  to  pay  premium  to  buy  his/her  vote. While  in  Chapter  11  bankrupt  scenario,  only a majority of the claimants in each creditor class is required. Debtors  were not so much vital and had less incentive to holding.

d. Gain  support  from  Marvel’s  unsecured  debt  holders:  the  unsecured  creditors, who would be fully paid, of course approved for it, too. When it  comes  to  the  debtors,  the  pending  treat  of  liquidation  helps  to  solve  the  hold out problem and behave less opportunistically. e.

Still having chance even claimants reject the proposal: There is still a chance that the bankruptcy judge would approve the plan Strengthening Perelman’s control over Marvel  By filing Chapter 11, Marvel became eligible for DIP financing. Chase Manhattan    3 Bank  agreed  to  offer  Debtor? In? Possession  financing  worth  $100  million  for  Marvel with the contingence that Perelman remaining in control. In the contrast,  in  the  scenario  of  out? of? court  negotiation,  Perelman,  as  the  representative  of  shareholders,  who  are  junior  in  the  claimants  of  the company  to  debt  holders,  will  lose  negotiation  power  and  became  a  less  active  participant  in  the  restructure  plan. In  order  to  make  a  restructure  plan  favor  to  himself  and  shareholders,  Perelman  filed  Marvel  Chapter  11  bankrupt  and  gained  support  from the bank. ) Evaluate the (new) restructuring plan. Assuming that the plan is approved,  will it solve the problems that caused Marvel to be in financial distress? If  yes, how? If not, why not?

Improve Marvel’s Current Ratio.

a. Increase current assets. In the plan, Andrew group infuses $33. 5 million  directly into Toy Biz. In addition, bank provides $52 million cash as a debt  agreement. Also, acquisition of Toy Biz enables Marvel to use its NOLs and  get  deferred  income  taxes  worth  $48. 5  million. In  total,  current  assets  increase by $134 million.

b. Decrease  current  liabilities. DIP financing will be cancelled and $624. 7  million  current  portion  of  LTD  will  be  extended  and  maintained  as  long  term debt. Totally, current liabilities will reduce by $664. 7 million.

c. The  total  amount  of  cash  reaches  $98. 8  million,  which  is  able  to  cover existing $40 million short term debt and $10. 7 million current portion of  LTD. What’s  more  the  Current  ratio  is  improved  from  a  dangerous  low  number  of  0. 4  to  a  fair  number  of  1. 8,  which  is  not  far  away  from  the  normally  acceptable  number  of  2. Thus,  Marvel  will  be  relieved  from  current financial distress.

Increase in Long Term Debt Most  of  Marvel’s  current  portion  of  long  tern  debt  will  be  turned  to  long? term  debt. Along with the promissory note assumed by Marvel from Toy Biz, the long? term debt will be increased to $754. 7 million. This agreement helps to solve the  current financial distress imposed by the huge current portion of long term debt,  but does not solve it completely and radically, only delay the problem of debt.

Get Total Ownership of Toy Biz Nearly 90% of the money infused by Andrews group will be used to acquire Toy  Biz. IAs  indicated  in  the  case,”this  acquisition  will  generate  approximately  $60  million  of  cash  flow  per  year  and  provide  a  large  fraction  of  Marvel’s  revenue. ”  Furthermore, this deal make the group a step closer to “an integrated  entertainment and sports content company” with modest growth to Marvel and  significant growth to Toy Biz. 4  Change the Share Structure Perelman’s  share  maintains  80%  of  the  new  company,  while  the  public  debt  holder get 14. 6%. The price of Perelman’s added shares is $0.  per share. To  sum  up,  if  the  plan  is  approved,  it  will  not  solve  Marvel’s  problem  completed. Its  problem  is  that  Marvel’s  revenue  was  not enough  to  fully  pay  debt  holders’  claimants. Although  the  plan  helps  to  dismiss  Marvel’s  current  problem  of  financial  distress  by  increasing  current  ratio  and  bring  modest growth to Marvel, yet   It fails to solve the long? term debt problem completely, only delays it.  It doesn’t improve the strategy of Marvel, improve its operating efficiency or  have other positive change to its business.

Credit  rating  of  Marvel  has  deteriorated. It  might  not  be  easily get  sufficient  finance to its expansion, to integrate acquisition or to repay long term debt in the  future.

What is your assessment of the pro forma financial projections and  liquidation assumptions? What are the different parties’ incentives to bias  the valuation and in what direction?  Assessment of the Pro Forma Financial Projections—over­optimistic  a. Overoptimistic in Marvel’s Profitability   Bear Sterns projects the net revenue of 1997 is $929.  mill, which is 12% more  than  its  best  performance. And  the  net  revenue  grows  at  a  compound  rate  of  3. 4%  during  1998? 2001. This  projection  is  not  substantial,  because  Marvel’s  main  business? sports  and  entertainment  cards  as  well  as  Children’s  activity  sticker? is likely to shrink rather than growing. Little boys are distracted to other  types of entertainment, like video game. b. Dubious Decreasing of CAPEX and Working Capital  Marvel’s  CAPEX  is  forecasted  a  huge  minus  in  each  year  of  this  period.

This  estimation is not accurate, considering Marvel will have intensive investment in  theme  restaurants,  movie  studio  and  so  on. These  actions  should  increase Marvel’s CAPEX and decrease its free cash flow, instead of decreasing CAPEX in  the projection. c. Improper Refinance of Long Term Debt  The  projection  improperly  assumes  that  Marvel’s  long  term  debt  will  be  refinanced  since  1999. And  its  interest  rate,  which  is  roughly  estimated  by  net  Interest expense/(STD + LTD+ refinanced LTD), goes down from 8. 8%in 1997 to  8. 6% in 2001. Marvel’s credit rating has been lowered to B? and it was suffered