Buying a distressed company in bankruptcy can bring a competitive edge


Lorenzo Marinuzzi, Jennifer Marines, Morrison & Foerster, bankruptcy, law, private equity, mergers, M&A, retail
Photo of Jennifer Marines courtesy of Morrison & Foerster

By Lorenzo Marinuzzi and Jennifer L. Marines

On its surface, bankruptcy is designed to provide companies with myriad protections for both debtors and creditors. But taken a layer deeper, bankruptcy can present an incredibly strategic opportunity for buyers in the market to acquire a distressed company or some of its assets.

Companies, especially strong ones with access to capital and a voracious appetite to retain or sharpen their competitive edge, are likely to find the sale of a distressed company and its assets an important and strategic tool, especially in today’s economic environment.

A potent combination — mounting interest-rate uncertainty around the new presidential administration, declines in global economic sectors, looming debt maturities and their subsequent default possibilities, and sweeping changes to the U.S. Bankruptcy Code in the past decade — has created an environment ripe for the acquisition of distressed companies both in and out of bankruptcy.

In the coming years, we will likely see many companies pursuing asset sales through bankruptcy cases to restructure their balance sheets and control the liquidation of their assets.

Because distressed companies do not always have the time or financial resources to bear the process or costs of bankruptcy reorganization, many seek asset sales pursuant to § 363 of the Bankruptcy Code.

For buyers, these 363 sales are extremely attractive because they allow for the expedited acquisition of assets free and clear of liens, claims and other encumbrances and often provide strategic flexibility in both the price and selection of assets available for purchase.

Lorenzo Marinuzzi
Lorenzo Marinuzzi

A 363 sale also empowers financially strong companies and funds to take advantage of their access to capital and target struggling competitors to acquire their most strategic assets — including assets like tax NOLs — with the protection of a court order approving the transaction.

Take the announcement earlier this year that Limited Stores was seeking voluntary Chapter 11 protection. The announcement came at the same time private equity powerhouse Sycamore Partners said it was pursuing an agreement to purchase Limited Stores’ brand name and related e-commerce assets in a 363 sale.

Winning the bid at bankruptcy auction in late February, Sycamore has been provided the opportunity to strengthen its competitive advantage in the retail space without fully acquiring a struggling brand. The $3.5 billion Sycamore specializes in retail and consumer investments, and the assets it strategically acquires will no doubt bolster the fund’s existing portfolio.

The recent saga of specialty retailer Golfsmith and its subsequent sale at bankruptcy auction to industry giant Dick’s Sporting Goods also highlights the many benefits to buyers presented by a 363 sale.

Facing continued declining sales and debt rapidly approaching the $200 million mark, Golfsmith filed a Chapter 11 bankruptcy petition on Sept. 14, 2016, in a Delaware court. Just over a month later, Dick’s walked away victorious from the auction of Golfsmith’s distressed assets, acquiring the company with a winning bid of $70 million.

The 363 sale gave Dick’s a great deal of flexibility both in the price it paid for Golfsmith — $26 million less than when the company was purchased in 2012 — as well as its selection of and plan for the assets it acquired.

Dick’s said it planned to keep 30 of Golfsmith’s 109 retail locations and wind down the rest. The sale will allow Dick’s to complete a swift, streamlined and strategic acquisition of a company that it could easily integrate into its existing business lines, while squeezing out its competitor (and the other leading Golfsmith bidder at auction) Worldwide Golf Shops.

Prior to its acquisition of Golfsmith, Dick’s owned 72 Golf Galaxy stores, the same number that Worldwide Golf operated. Adding the 30 Golfsmith locations brought Dick’s numbers to 102, giving it a major competitive advantage over Worldwide Golf.

Of course, buying a distressed company in bankruptcy may not always be the best option for a purchaser. There are certain advantages to pursuing a sale outside of bankruptcy, including the confidentiality of the proposed sale and its terms, the ability to enforce a no-shop clause against the seller, and more input and control on the seller’s side of the deal. And buying a company outside bankruptcy does not require the (sometimes high) cost of bankruptcy proceedings or Bankruptcy Court approval.

But as the economy becomes more robust, strong companies should take advantage of their position in their sector and start looking at weaker companies in their industry that are struggling to rebound from the recession as potential acquisition targets.

After all, sometimes it’s just easier to buy than compete.

Lorenzo Marinuzzi is global co-chair and Jennifer L. Marines is partner of the Business Restructuring & Insolvency Group at Morrison Foerster LLP.

Photos of Jennifer Marines and Lorenzo Marinuzzi courtesy of Morrison Foerster