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Pinewood Mobile Homes and Debt ObligationsTerm Paper

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¶ … Pinewood's financial distress a result of unfortunate circumstances or poor strategies/decisions adopted by the CEO during the expansion period? Was the asset-restructuring program implemented by Walker after 2008 effective in meeting the company's cash needs?

Pinewood's expansion coincided with the housing bubble of the early 2000s and when the housing market crashed in 2007-8, Pinewood was found in dire straits. It had increased its debt load beyond what it could afford to do (in hindsight). Thinking that the housing boom would go on forever, Pinewood execs saw their situation as low-risk. Following the crash, Pinewood's CEO was forced to liquidate some of its non-core assets in a move to keep the company afloat as cash-flow had gone negative after years of being so positive that it had been (traditionally) able to finance expansion without leveraging itself too haphazardly. With the onset of the bubble, the CEO had attempted to overreach and expand even more -- and so he took on debt to finance this expansion: in short, it was an attempt to capture more market share -- but the market was over-inflated and largely fictitious thanks to the irresponsible lending practices of the banks at this time. Thus, what the CEO was really taking on debt to finance was his company's own demise.

The situation did not improve over time as Pinewood was forced to suspend dividends and the debt was coming due. Its revolving door of credit was closed by 2010 and the stock was collapsing. The issuance of new stock compelled absolutely no one. Pinewood looked finished. It could do one of two things: service its debt or finance new operations. An asset sale was in order. However, buyers wanted them at great discounts. Bankruptcy was another option: it would stave off the banks and give the firm time to locate better buyers. An exchange offer and a restructuring of debt/assets was another proposal. But this would simply dilute the shares already in existence. Therefore, it was dilution, bankruptcy, or privatization. Dilution would at least allow Pinewood to live to see another day -- but would it ever really matter to shareholders? Once bitten, twice shy is the maxim that could be applied here.

Thus, the financial distress that Pinewood experienced was a combination of unfortunate circumstances and poor strategies and decisions made by the CEO during the expansion period. The asset-restructuring program implemented by Walker after 2008 was not effective in meeting the company's cash needs.

2. What are the advantages and challenges of an out-of-court restructuring, compared to a Chapter 11 filing? Did Walker make a mistake by not accepting the acquisition and asset purchase offers?

The advantages of an out of court restructuring are that Pinewood gets to avoid the legal burdens of filing for Chapter 11 and it gets to maintain oversight of what is left of its business (that isn't sold off in order to pay creditors). The disadvantage of this sort of restructuring is that buyers are not willing to pay fair market value: they see blood and want "distress" prices -- that is, they Pinewood at bankruptcy prices -- and Pinewood is not willing to sell itself at bargain-basement prices. Plus, it would be left without its core product line, meaning its value to shareholders would be greatly diminished.

A Chapter 11 filing would at least keep foreclosure from triggering. Debts would be suspended. New financing could be begun. However, the firm's reputation would be broken and the time and cost put into the legal proceedings would be high. The firm would also have to give up some of its strategic control to creditors.

There is really no great solution to Walker's situation. He might have accepted the asset purchase offers, but he would have essentially been selling the company at a great discount, and the core components of the firm's success would have been liquidated. However, there is no other choice if one is viewing it as a situation of survival. Also, it might be considered that in spite of the sale, Walker could still rebuild from the ground up, just as the family did when it founded the company. Walker had gotten in over his head in the housing boom and now he had to pay the price by liquidating his core assets or go out of business completely via foreclosure. Selling off assets would keep the company from going bankrupt and at this point that might be the best choice. Debts would be repaid -- and the stock would likely appreciate as a result. Thus, Walker may have made a mistake by not accepting the asset purchase offers and allowing the firm to be acquired by others.

3. What is the enterprise value of Pinewood if the exchange offer is accepted?

a) The real value of Pinewood is $574.7 million. This is the value of its total assets. Its sales growth data for the whole of the 21st century is difficult to contextualize because of the bubble that preceded the pop. The housing recovery never really took off again post-2008 and indeed the global economic recession looming in the wings is enough to prompt any buyer to consider that the real value of Pinewood may not even be as high as its asset worth. Thus, the original offer of $545 by the group of Wall Street investors in 2010 was probably the best offer that Walker could expect to get. Obviously, the secondary offers were not even close to this one and the company was back to fumbling its problems and attempting to save itself even as the ship was breaking up.

In short the enterprise value of Pinewood is really exactly what the market is willing to pay for it and no more. If the exchange offer were accepted, the real value would diminish considerably because of dilution while the EV would increase, making this a costly transaction. The company would dilute shareholders through the exchange offer and the value of the company in terms of real dollars measured by stock would plummet, with likely de-listing from the NASDAQ occurring as predatory shorts smelling blood would pile into a short-position and drive the stock into the ground. As the number of shares outstanding would multiply exponentially, the EV, which is the market cap plus debt, minority interest, preferred shares -- minus cash/equivalents, would be closer to $750 million.

b) Using the APV method would require the firm to begin to be valued without debt/leverage. The value of tax savings on interest payments would be assessed and then the impact of the borrowing would be assessed based on the likelihood that the firm goes bankrupt anyway and what that would cost.

To assess the situation the following formula may be applied:

Pinewood's (unlevered) value =

With FCFF0 signifying the cash flow post-tax and ?u serving as the equity cost (no leverage); g is the growth rate that is expected over time. Estimating the growth rate over time remains difficult as there is little in the way of any housing normalcy left to the market considering the run-up to 2008, the bust and the pieces of the market that pretend to be picking back up through over-inflated prices. In short, who is buying? Housing is currently a way to store cash flight (see what Chinese investment has done to the housing market in Canada for instance).

Regardless the beta of the firm can be assessed by the following formula:


unlevered = Pinewood's beta (unlevered)

current = Pinewood's equity beta

D/E = Debt/equity ratio t = Pinewood's tax rate

Beta can therefore help to determine the cost of Pinewood's equity (unlevered).

However, it is assumed that there will be a tax benefit to the payment of debt interest. Depending on the tax rate, it can be viewed in the following formula as:

Finally, there must be some estimation of the impact of going bankrupt for Pinewood and what the default risk stands to be. The likelihood of default is significant in Pinewood's case and the formula for assessing this risk may be assessed as:

Pinewood's common equity beta sits at 2.79 and the market risk premium is at 6.10%. The 10-year t-bill rate is 3.41% and the EV comes out to $754.5.

c) The recovery for each class under Walker's plan, based on this EV

b. In executing your analysis, use the APV method. You can use the peers in Exhibit 6 to assess the asset beta of Pinewood. Assume the corporate income tax rate is 35% going forward. The MRP is 6.1% and the 10-year treasury rate is 3.41%.

c. What is the recovery for each class under Walker's plan, based on your enterprise value?

The recovery under Walker's plan requires too many assumptions based on an unstable market in which conditions are impossible to predict. The failure of Pinewood to predict the bubble in the first place shows that any discussion of recovery at this point is far too early. An LBO may be of… [END OF PREVIEW]

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