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As the current business cycle swings into volatile territory across the country,
sponsors, lenders, and management teams will be faced with
difficult choices in how to maximize value from troubled
businesses. Amid declining consumer sentiment, investors weary of a
recession, higher interest rates, and increased counterparty risk,
creative solutions should and uncommon strategies should not be
left off the table.
For non-retail companies facing financial distress, the
traditional wisdom is that the value-maximizing solution is to
reorganize. But as the slow demise of generic pharmaceutical
manufacturer Akorn shows, there may be flaws in that thinking. A
postmortem on the company demonstrates that certain characteristics
advantaged a liquidation over a reorganization.
As we enter a new restructuring cycle, understanding these
attributes may mean the difference between maximizing the value of
a troubled company through liquidation today, versus investing the
time and capital pursuing an uncertain turnaround.
The Story of Akorn
In 2017, Akorn was poised for a merger with German pharma firm Fresenius Kabi.
In post-announcement diligence, it became apparent that Akorn had
significant quality control and regulatory compliance issues, as
well as a diminishing financial outlook. Fresenius filed a lawsuit
to terminate the transaction, which they would win. The termination
of the deal and associated issues led Akorn to engage AlixPartners
and eventually file for Chapter 11 in 2020, turning over the
company to its creditors—the preferred path forward at the
time.
Let’s look at why, and how, that strategy played out.
Aside from its manufacturing facilities, Akorn’s primary
assets were its abbreviated new drug applications
(ANDAs)—essentially an approval granted by the FDA to
manufacture generic products without requiring clinical trials.
In the Chapter 11 proceedings, the best-interest-of-creditors
test assumed only six ANDAs would have value to a new owner given
the difficulties of “tech transfer”—in order to
comply with FDA regulation, a potential purchaser would have to
incur significant time and expense to certify a new facility for
manufacture of that product. This put the total liquidation value
of the ANDAs between $76 million and $153 million. In aggregate,
the hypothetical liquidation value of Akorn’s assets was far
below the value provided by Akorn’s pre-petition term loan
lenders in their Chapter 11 credit bid. More importantly, the
credit bid also allowed the new owners of the reorganized business
the opportunity to implement a turnaround plan with the hope of
monetizing the entity in part or in whole post-restructuring.
After emerging from Chapter 11, Akorn rationalized its product
portfolio, selling the consumer health products to Prestige Consumer Healthcare and seven branded
ophthalmic products to Thea Pharma, Inc., allowing the lenders, who continued to hold
take-back paper, to recoup $243 million against their loans.
Fast forward to 2023, and Akorn filed for Chapter 7 on February
23 after attempts to sell the business failed, caused in part by
the Company’s government pricing liabilities owing to the
Center for Medicare & Medicaid Services (“CMS”).
AlixPartners was reengaged to represent Akorn’s term loan
lenders. To all the restructuring professionals’ surprise, the
liquidation in Chapter 7 recovered $309 million of
value from Akorn’s ANDAs and other asset against $184
million of secured debt.
While Chapter 7 is a “dirty word” for restructuring
professionals, it has proven to be the value-maximizing outcome in
this instance. So, is Akorn an anomaly or is there something to be
learned regarding when to seek a liquidation? And, if the assets of
the business were so valuable in this case, why didn’t the
whole-company sale processes yield greater value?
The macro environment influences valuations of individual
assets
The 2010 Affordable Care Act and the 2012 Generic Drug User Free
Amendments were intended to boost the dwindling number of generic
pharmaceutical manufacturers and reduce price pressure for
consumers. However, in the years that have followed, the opposite
has occurred. Generic drugs now typically compete in markets with
limited competition, with two being median
number of suppliers in a market, and 40% of markets supplied by
only one manufacturer.
Further, the number of active drug shortages in the U.S. reached
a peak of 295 at the end of 2022 (a five-year high).
Between 2021 and 2022, new drug shortages increased by nearly
30%.
An ongoing shortage of pharmaceuticals means that certain
products produced by Akorn—pediatric albuterol and the antidote for lead poisoning for
example—are in high demand.
Akorn’s products, which were typically unique dosage forms
of common molecules, were no exception. A buyer, in many cases
could expect a monopolistic or duopolistic market position or could
defensively purchase an ANDA to protect their improved market
position with Akorn’s demise. Prices for entry into a market
with a limited number of competitors is significantly higher than
those for a competitive market.
Finally, in 2020, the COVID-19 pandemic drove slowing purchases
of generics by the large pharmaceutical wholesalers as they sought
to carry less inventory in the initial months of pandemic
uncertainty. At the time, this radically impacted Akorn’s
financial performance during the 2020 Ch. 11 proceedings.
Wholesaler purchasing patterns would not “normalize” till
Q4 2020 after Akorn had emerged from bankruptcy. This
understandably placed downward pressure on the ANDA values in the
2020 hypothetical liquidation value.
This squeeze on generic pharmaceutical supply, and the exit from
the pandemic, drove the higher valuation of the ANDAs during
Akorn’s second bankruptcy. Overall, Akorn’s product
portfolio proved highly valuable to the right purchasers.
For chronically troubled businesses, liquidation may be the
best result
Akorn has always been troubled, beginning with the attempted
merger with Fresenius Kabi. In a precedent-setting court case, the
Delaware Chancery Court found that Akorn’s lack of quality
controls and a precipitous decline in financial performance
following the consummation of the merger agreement amounted to a
Material Adverse Effect (“MAE”).
Following the termination of the merger agreement, Fresenius
filed a motion for summary judgment seeking claims and damages of
$123 million. At the time of Akorn’s 2020 Chapter 11 filing,
the court was still reserving decision on $74 million. There was
also securities class action litigation from Akorn’s equity
holders. All of the above triggered events of default under
Akorn’s term loan credit agreement.
Unrelated, but also noteworthy, John Kapoor, former majority
shareholder in Akorn and chairmen of the board, was sentenced to prison for opioid
racketeering.
Leading up to the 2023 Ch. 7 filing, Akorn sought a
going-concern sale of all of its assets. This did not prove
fruitful, as it was discovered that Akorn under-rebated certain
U.S. government drug purchasing entities (Centers for Medicare
& Medicaid Services, Veterans Affairs, etc.) to the tune of $80
million over the last 10 years. This liability was assumed in the
credit bid of the 2020 Chapter 11 filing by new Akorn via the
labeler code (an FDA-assigned code to drug manufacturers).
Due to Akorn’s operational, quality control, and
record-keeping issues, there was always a cloud over the valuable
assets of the business. This made it easier for potential
whole-company buyers to discount the purchase price.
Sales processes heavy on financial buyers may result in
going-concern values below the liquidation value
In the run-up to both Akorn’s 2020 Chapter 11 filing and the
2023 Chapter 7 procedure, a going-concern sale process was
performed. In both instances strategic, financial, and
sponsor-backed pharmaceutical companies were on the outreach
list.
The sales process in 2020 did not generate any bids in excess of
the first lien term loan ($861.7 million). In 2023, the same thing
occurred. However, the subsequent Chapter 7 auction generated
proceeds of $309 million, far in excess of the pre-petition secured
debt.
Financial, and sponsor-backed buyers traditionally are not the
highest bidders, given the lack of potential synergies that can be
generated by a transaction, and private equity’s love of buying
things on the cheap. A process heavy on these buyers, with a target
with a lot of “hair” on it, may generate whole-company
bids below liquidation value—as it did in this case.
Biases should be re-examined
Other than retail, where liquidations are more common, the bias
is to reorganize a troubled company. This is commonly reflected in
the best interests of creditors test, which has an unspoken rubric
that is fairly difficult to throw stones at:
- Cash and marketable securities: 100% recovery value.
- Asset-based loan advance rates are typically leveraged for
recoveries on current assets (75-85% for accounts receivable,
55-65% for finished goods inventory, with lower values for raw
materials next to 0% recovery on work-in-process) - Other current assets are typically valued near 0% (a prepaid
expense) or 100% (a tax refund receivable) - Non-current, non-real estate tangible real property is
typically assigned recoveries of 15-25% - Any owned real estate leverages a recent appraisal report that
can be easily obtained - Intangible assets (though more subjective with multiple
valuation methodologies) are allowed to have significant reliance
on management’s judgment
This rubric rarely results in a best-interest-of creditors test
where the value is remotely close to that delivered in a
reorganization. The subjectiveness of a forecast supporting a
reorganization (often up and to the right!) and of a liquidation
analysis can allow for unfeasible plans to shape reorganizations
and “on paper” recoveries to
creditors.
With increasingly common Chapter 22 filings (and in this
instance, a Chapter 18), creditors are playing out the option,
knowing that for the reduced cost of a pre-packaged or prearranged
filing, they can reinvest as the reorganized owner of the business
in the hope of a turnaround and future lucrative transaction. The
fallback option is always a liquidation.
The key assumption here is that value generated in a liquidation
remains consistent whether pursued out the outset or delayed until
the “option” has expired. But this might not be the case.
Akorn’s Ch. 11 took place during depths of the COVID pandemic,
whereas in 2023, the more stable macro environment likely yielded a
more engaged buyer universe. This, in addition to the contracting
supplier universe, showed the timing was right in this
instance.
Finally, beyond rethinking value, restructuring professionals
should reevaluate their willingness to work in Chapter 7.
Greenhill, the Lenders’ investment banker in the 2020 Chapter
11 and the debtors’ investment banker pre-2023 Chapter 7
filing, stayed on to market the assets in Chapter 7. Leveraging
their familiarity with the estate and universe of buyers, their
continued retention generated significant value to creditors.
The right fact-pattern for liquidation
In summary, there are several elements to understand in
determining whether reorganization, or liquidation is the value
maximizing path forward:
- Know your value: Businesses with high-value
assets, and small monopolistic or duopolistic market positions, are
attractive to strategic purchasers in a liquidation. A purchaser
has a pretty high incentive to bid top dollar for the assets they
want if they are buying entry to a consolidated market. - Understand idiosyncratic issues: Business with
a lot of “hair” and lurking liabilities may be difficult
to completely “clean” in a restructuring (Akorn’s
government pricing liabilities were unknowingly assumed through the
credit bid APA in the 2020 Chapter 11) - Understand the buyer universe: A going-concern
purchaser may discount their purchase price beneath liquidation
value to compensate for perceived risk—especially if they are
a financial purchaser lacking the benefits of synergies. - Update your priors: Given all the above, a
2023 reorganization of Akorn would have been a value destructive
transaction. Further, as generic drug markets became tighter, and
shortages more acute, the recovery value in a liquidation likely
improved over time.
And finally, unrelated to the company and process specific
attributes above:
- Know your stakeholders: Having the
stakeholders willing to let the case go to a Chapter 7 is
essential. Beyond knowledge for creditors, management teams and
debtors’ advisors should understand when these attributes are
present in a business seeking to reorganize and offer up compelling
and feasible alternatives to liquidation in reorganization
proposals.
There tends to be a bias that the best way to preserve and/or
enhance value is to restructure as a going concern believing (or is
some cases hoping) that the business can be improved and value will
be maximized in a future transaction. But it may be the case that
achieving maximum stakeholder value for a company destined for
liquidation hinges on reaching that conclusion sooner rather than
later.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
