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This Bankruptcy and Restructuring at Marvel Entertainment Group case study pits shareholders against debtholders after the company filed for Chapter 11 bankruptcy. It highlights equity holder and debtholder conflicts of interest in a situation of financial distress, illustrates the role of vulture investors, and hinges on how one approaches the valuation of a company entering a restructuring plan.
Benjamin C. Esty and Jason S. Auerbach
Harvard Business Review (298059-PDF-ENG)
September 16, 1997
Case questions answered:
- Why did Marvel Entertainment Group file for Chapter 11? Were the problems caused by bad luck, bad strategy, or bad execution?
- Evaluate the proposed restructuring plan. Will it solve the problems that caused Marvel to file Chapter 11? As Carl Icahn, the largest unsecured debtholder, would you vote for the proposed restructuring plan? Why or why not?
- How much is Marvel’s equity worth per share under the proposed restructuring plan assuming it acquires Toy Biz as planned? What is your assessment of the pro forma financial projections and liquidation assumptions? For the valuations, the risk premium is assumed as 7.5% in this case.
- Will it be difficult for Marvel or other companies in the MacAndrews and Forbes holding company to issue debt in the future?
- Why did the price of Marvel’s zero-coupon bonds drop on Tuesday, November 12, 1996? Why did portfolio managers at Fidelity and Putnam sell their bonds on Friday, November 8, 1996?
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Bankruptcy and Restructuring at Marvel Entertainment Group Case Answers
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Executive Summary – Bankruptcy and Restructuring at Marvel Entertainment Group
This Bankruptcy and Restructuring at Marvel Entertainment Group case study pits shareholders (“Perelman”) against debtholders (“Icahn”) in 1997, shortly after Marvel, the leading comic book publisher in the United States, filed for Chapter 11 bankruptcy protection. It highlights equity holder and debtholder conflicts of interest in a situation of financial distress, illustrates the role of vulture investors, and hinges on how one approaches the valuation of a company entering a restructuring plan.
1. Why did Marvel file for Chapter 11? Were the problems caused by bad luck, strategy, or execution?
The company and its three primary holding companies filed for Chapter 11 bankruptcy on December 27, 1996. The main reasons that the company filed for Chapter 11 were:
- Marvel Entertainment Group would violate specific bank loan covenants due to decreasing revenue and profits;
- Perelman’s first restructuring plan included (a) the $350 million investment in the company from the Andrews Group in exchange for 410 million new company shares; (b) the acquisition of Toy Biz; and (c) debt in exchange for equity (the “First Restructuring Plan”), was not accepted by the bondholders; and
- Chapter 11 provided the company with extra time to propose a restructuring plan subject to the approval of the judge instead of direct liquidation in Chapter 7.
From the financial perspective, the company was at the edge of being unable to repay the debt when it fell due. As of September 1996, cash on hand only amounted to $35.9 million, while the current portion of long-term debt amounted to $625.8 million.
On the other hand, Marvel Entertainment Group was unable to generate profit from its core business. The decline in revenue and increase in expenses led to a decrease in profit and even a loss in 1995. The company was financed by high gearing. The high-interest burden from debt financing ate up the profit of the company.
Bad luck – Factors uncountable by the company
- The rise of alternative entertainment: the core businesses, including the comic book and trading card market, were shrinking, leading to a decrease in revenue.
- Unexpected strikes: the trading card market business was affected due to the strikes in professional baseball and hockey.
Bad strategy – Strategy as “diversification of youth entertainment.”
- Aggressive expansion: Marvel Entertainment Group acquired seven other companies in 3 years, including Fleer, Toy Biz, the Panini Group, and four other comic book publishers, which posed a threat to the company’s financial position and liquidity due to the rapid investing cash outflow.
- Unreasonable acquisition: even though the trading card market was declining, the company made an unreasonable acquisition of SkyBox International Inc., a maker of trading cards, at a 25% premium with additional debt, further weakening the financial position and liquidity of the company.
- Mispricing strategy in the comic book business: the company had doubled the selling price and increased the comic book titles, leading to a decrease in sales in the comic book business. While the collectors were not satisfied with the return on investing in the comic books, the increased titles and selling price also disappointed the company’s core readers. It further drove down the sales of the company.
- Leverage on equity-backed financing: Given the strong performance of the company’s stocks, the company issued share-collateralized bonds to support its expansion. Despite the collateral value being higher than the debt value, it left hints of foreshadowing increases to the company’s burden in the event of a drop in the company’s stock price.
- Successful operation model before 1994: The company eliminated unprofitable lines of business and streamlined operations, enhanced the comic book distribution strategy to concentrate on comic book specialty, which yielded higher margins, and substantially improved the company’s profitability before 1994.
Bad execution – Poor management
- Cash flow worsened by dividend payout after the public offer: After selling shares to the public, Perelman used the proceeds to pay a cash dividend instead of supporting the company’s operation and/or improving the financial position.
- Premature negotiation with Fidelity Investments (“Fidelity”) and Putnam Investments (“Putnam” ): Marvel Entertainment Group did not provide sufficient protection to itself prior to the restructuring plan presentation to Fidelity and Putnam, such as signing an agreement in preventing panic selling of the company’s bonds. The huge amount of sales of the company’s bonds showed the lack of confidence in the company’s restructuring plan, causing a drop of 41% in the company’s stock price and deteriorating the debt financing given the usage of equity-backed debt.
- Worsening operating efficiency: The operating efficiency of the company has been decreasing over the years. The gross profit ratio decreased from 49.44% in 1991 to 35.09% in 1995. Even if the company had been inputting more resources into selling and admin expenses, the SG&A expenses to sales ratio increased from 18.59% in 1991 to 27.89% in 1995, and the growth of the net revenue slowed down from 94.44% in 1992 to 61.09% in 1995.
We believe that the problems were mainly caused by bad strategy and bad execution.
Even though Marvel Entertainment Group eliminated…
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