Avaya Takes a Step, Not a LeapAvaya Takes a Step, Not a Leap

Last Friday, April 14, Avaya announced that it had filed with the court a Chapter 11 proposed plan of reorganization, which specifies how the company would be structured after bankruptcy and how the creditors in the bankruptcy would receive value for their positions (see related No Jitter article). Now what?

As next steps, Avaya is scheduled to present the proposed plan at a hearing on May 25, at which time the judge will review the plan for completeness and understanding. On June 27, the bankruptcy court is scheduled to hold a hearing to review the plan and hear arguments as to why or why not it should accept the plan.

Companies typically follow one of two paths to the end of a bankruptcy and debt relief: They either reorganize or liquidate (sell assets as Nortel did). Clearly, the Avaya team has a strong desire to reorganize and continue as a complete company (less the networking group), and has proposed a plan that accomplishes that.

As part of this proposed plan, in a press release, Avaya stated the following general terms:

This follows the general structure I've discussed in my previous No Jitter articles on Avaya's bankruptcy, but Avaya may face a challenge on some key points.

For example, an official statement provided with the announcement from Avaya CEO Kevin Kennedy suggests that things are still fluid: "We look forward to working closely with all stakeholders over the coming weeks and months to refine the Plan and build consensus." This statement raises a critical question as to whether Avaya has the required creditor support and agreement to the plan as proposed. This is probably because the plan, as proposed, is heavily weighted to the secured creditors and the pension funds.

One interesting point in the proposed plan description document is the value of Avaya (called HoldCo in some of the documents) after bankruptcy, as assessed by advisory firm Centerview Partners. As stated in the plan disclosure:

This indicates the common stock/equity value of the reorganized Avaya is approximately $3.3 billion. The intent of the proposed plan is that this will be distributed to the current bondholders.

In any bankruptcy, creditors hold relative "positions," with first position creditors generally paid in full before second or subsequent positions receive payment. The proposed Avaya reorganization plan treats the bondholder positions significantly differently. In the proposed plan, the cash flow credit facility secured claims and the first lien notes secured claims are both in a secured first position, and together will receive 95% of the equity in the reorganized company and more than $1.4 billion in cash. The second lien holders, while secured, are in second position and will receive no cash and 5% of the equity in the reorganized company.

In the plan disclosure document, the first position is shown at 100.4% estimated recovery, while the second is shown at 11.4% recovery. Clearly the plan is weighted to assuring the first position lien holders recover close to their value while the second position bondholders receive much less. The second position bondholders held about 23% of the debt of the company. One of the challenges to a consensus I have heard mentioned is that some of the first position lien holders also hold second position liens and they may vote/argue against the plan due to the impact on their second lien positions.

Lastly, any unsecured creditors will receive about 10 cents on the dollar of the obligations they hold. However, it is not clear if many such creditors exist. As I understand, Avaya is managing most (potentially all) of the ongoing business obligations through critical supplier payments to assure the business continues to operate normally.

In addition, there have been indications that some of the creditors feel the pension liability should be included in the capital restructuring as part of the final plan. They feel that maintaining the full pension liability while reducing the treatment value of the bondholders is not fair. However, including the pension liability would dramatically complicate the bankruptcy as the Pension Benefit Guaranty Corp. (PBGC) is structured to receive cash, not equity.

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Because of these factors and Kennedy's statement, getting an agreement and plan approval at the requested June 27 hearing is not a slam dunk. Clearly the plan is weighted to the first position creditors; they have a large voting interest to approve the plan and the court may agree that this plan is the best overall outcome.

Seeking Concensus
However, as in any bankruptcy, other factors will come into play and if Avaya had a consensus from the stakeholders already, surely that would have been referenced in the announcement. Even in his official comments, Kennedy indicated reaching a consensus could take weeks or even months. This could lead one to conclude that Avaya has put this proposed plan as a stake in the ground, and that if it cannot reach a consensus then the probability of a continuation of the process or a more negative outcome increases.

That said, prior to the Chapter 11 filing, Goldman Sachs, which Avaya had retained to find a buyer, had not been successful in doing so, neither for Avaya in its entirety nor for the contact center business, at a required price/terms. Therefore, most, if not all, of the secured creditors may see liquidation as having lower value than supporting the ongoing business as defined in the plan. If a consensus doesn't develop by June 27, the court can decide to rule that the plan protects the interests of the secured creditors best, and so approve it. If the court does not approve the plan, then Avaya and the court will have two options: continue to take more time to develop consensus, or move to an asset liquidation process.

Hopefully, Avaya can quickly gain consensus so the court can approve the plan or a derivative on June 27. Waiting 10 weeks for approval/announcement is not desirable if there is an agreement with all stakeholders to the plan. Announcing consensus and agreement of the stakeholders prior to June 27 would demonstrate that the plan is acceptable to the creditors and the hearing is more of a formality. For example, in its bankruptcy, Aspect filed its plan and the hearing to approve it followed very quickly in the process as the parties had agreed in advance and no counter actions came up during the hearing.

However, it is unlikely that the second position lien holders will agree to the proposed plan, so a decision will probably be left up to the court. The first position creditors will have to decide if the plan is an adequate value for their bonds. This requires weighing the uncertainty of the future value of Avaya as an ongoing business versus the risk of a liquidation.

As they become the "owners" of Avaya, the long-term business outlook is critical to this decision. If the first position lien holders conclude that the proposed plan is their best option, they will support the plan... unless they have second positions to protect. The court will have to agree that the rights and interests of the first position lien holders and the pension plans/PBGC are most important and best served by impacting the second position lien holders and other unsecured creditors as this plan proposes.

The second lien holders may try to convince the court there are other options that are not so impactful on their positions or that an alternative allocation of assets is better or fairer. This suggests that the outcome will not be clear until after the hearing on June 27. In fact, the court may well take the arguments at that time and then wait before ruling or even asking for more hearings.

The actual filing of a proposed plan as well as the requesting of a hearing date does set a clear timeline for the next step in the process. If the plan receives approval at the June 27 hearing, Avaya will move forward to complete the restructuring and exit the bankruptcy process. While it will need to complete a number of other steps in the process, Avaya could be on a path to emerge as a reorganized entity as early as August or September or as late as October.

Course Correction
Even if the court delays on a ruling or schedules additional hearings, if the plan receives its approval, there is a high probability that once the plan is approved Avaya will emerge from its reorganization, sans the networking business, as an intact corporate entity. The next challenge would then be re-structuring the actual business and the management team to correct the downward spiral of the last few years. While the current management team has done admirable work in managing the profitability of the ongoing business through cost cutting, price increases, and margin improvements, the underlying challenge of decreasing revenue and installed base erosion remains. This next focus for both the management team and the new owners will be critical as both the revenue and customer impact of the bankruptcy will continue even after the actual process completes. (See my related No Jitter article for a discussion of the options for a strategy to change the Avaya path beyond the simple capital restructuring.)

For Avaya customers and partners, last week's announcement was certainly a light in the tunnel, but without the clarity that it is actually the end of the tunnel. While Avaya met its most recent goal of having a reorganization plan by the middle of April, the fact that the plan has not reached a consensus of support among creditors casts doubt on whether the light is the nirvana of a reorganized Avaya with much lower debt or the potential locomotive of liquidation. Unfortunately for all of us looking for closure on the Avaya bankruptcy process, we are all put into the wait-and-see mode for another 10 weeks.