Preem, a large oil refinery, has issued underwater bonds to which high yield bond fund Proventus Capital Partners (PCP) has invested. Amidst the financial crisis and as maturity approaches, Preem seems unlikely to be able to refinance. Thus, PCP is faced with whether to push for bankruptcy proceedings in a European court or opt for out of court renegotiations. This case study also discusses the difference between liquidity problems and solvency problems as well as weighing bankruptcy vis-a-vis an out of court restructuring, and on how to deal with negotiations between creditors.

Bo Becker; Annelena Lobb; Aldo Sesia

Harvard Business Review (213008-PDF-ENG)

August 22, 2012

### Case questions answered:

- What is Preem worth?
- What is a reasonable long-term capital structure for the company/Corral? What is the current capital structure?
- What would be the outcome for the company’s creditors and owners in a bankruptcy?
- What should PCP do? Propose a plan and outline the steps Sachs and Thelin should take.

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## Preem (A) Case Answers

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### What is Preem worth?

There are several ways of determining the value for Preem. We used the DCF approach, trading multiples, and transaction multiples (see Appendix for calculations). As there is no cash flow forecast available, and we are only given indications for EBITDA and Capex in the long run, we went for a perpetual cash flow valuation. This includes $400m of EBITDA, $120m of Capex, and depreciation (to avoid infinite big/small balance sheet). As in the past, an extremely volatile oil price resulted in inventory write-downs, and therefore volatile working capital, we opted to leave the change in NWC at zero for simplicity reasons.

The low amount of cash is assumed to be of operating nature as the company is cash-strapped already and hence excluded from net debt. A range of discount rates and perpetual growth rates have been used, providing a range of roughly $2.1bn to $6.4bn with a midpoint of $3.1bn for a WACC of 9% and a growth rate of 3%. For the trading multiples, we looked at the P/S and EV/EBITDA multiples.

Due to extreme outliers, the median was preferred for both scenarios and resulted in a range of $3.8bn to $7.0bn, depending on the respective denominator used. As last year’s EBITDA of $736m has been distorted by oil price movements, the most reasonable value ($3.8bn) is the one derived by using the long-term expectation of $400m of EBITDA. Regarding previous transactions, only one transaction delivered an appropriate multiple (Gazprom), even though one has to consider that this transaction occurred prior to the financial crisis and current struggles in the industry.

### What is a reasonable long-term capital structure for the company/Corral? What is the current capital structure?

In order to come up with a reasonable long-term capital structure, we looked at the peers of Preem. In particular, we looked at the leverage ratios, Debt/EBITDA ratios, as well as the ratio of cash and inventories to debt. Preem’s current capital structure entails leverage of ca. 90% when using the Enterprise value of $3.1bn from the DCF and $2.8bn in debt.

The peers of Preem show a significantly lower median leverage of about 39%. Moreover, the industry Debt/EBITDA has a median of 3.4 (average is distorted by outliers), which compares to Preem’s 7.1. Moreover, the median industry debt coverage by cash and inventories amounts to 88.4%, while Preem can only cover 45.2%. These comparisons show that Preem is…

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