Lesson 3 of 7
Shares that leave Chapter 11
A company emerging from bankruptcy resets its accounts and its share register. See what fresh start accounting does and what the old shareholders received.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- On emergence, a company that qualifies applies fresh start accounting: a new basis of accounting, and a new entity for financial reporting purposes.
- The filing itself warns that statements after the emergence date are not comparable with statements before it.
- Old shareholders are usually far down the queue, and what they receive is written in the plan rather than in any ratio.
Nobody covers a company in the months after it leaves bankruptcy: the history in the data is a different company, the share count is new, and the accounting basis has been reset. All three facts are stated in the first annual report, which is where this lesson reads them.
One emergence, as the filing dates it
- 2020-06-30Plan filedThe debtors filed the joint Chapter 11 plan of reorganization.
- 2020-08-14Plan confirmedThe bankruptcy court confirmed the plan.
- 2020-09-01Emergence dateThe conditions for effectiveness were satisfied, the company emerged, and it adopted fresh start accounting.
What fresh start accounting does
The company states it directly: on emergence it adopted fresh start accounting under the reorganizations topic of the accounting standards, which resulted in a new basis of accounting and the company becoming a new entity for financial reporting purposes. Consequently the consolidated financial statements after the emergence date are not comparable with those before it, and the historical statements are not a reliable indicator of the financial condition or results for any period after adoption.
Every screen that reads a five-year or ten-year history across that date is reading two companies. So is every growth rate, every margin trend and every average.
The valuation the plan carries
Where the new balance sheet comes from
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The plan and its disclosure statement estimate an enterprise value for the reorganised company. Here the estimate was a range of 1.35 billion to 1.75 billion dollars.
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At the emergence date the company put the estimate at 1.59 billion dollars before cash on hand, slightly above the midpoint of that range.
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That value is derived from a valuation, in this case principally an income approach, and then allocated across the assets and liabilities to produce the opening balance sheet.
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Everything reported afterwards, including depreciation and any impairment, is measured against that allocated basis rather than against what the assets originally cost.
What the old shareholders got
Why anyone looks here at all
Three things are true at once after an emergence. The company usually has less debt than it has had for years. The share register is small and held by creditors who did not choose to be equity investors and often sell. And no analyst covers it, because the historical series is meaningless and the name is associated with a failure.
That combination is the reason this corner is worth reading about. It is also why the reading has to start with the plan, the fresh start note and the new share count rather than with any ratio computed from a data feed.
Check yourself
What does fresh start accounting do to the comparability of the statements?
- Nothing, the series continues
- Statements after the emergence date are not comparable with those before it, and the filing says so
- It restates all prior years onto the new basis
Show the answer
Answer: B.
A new basis of accounting is established and the reporting entity is treated as new, so pre-emergence history is not a reliable indicator of anything afterwards.Where does the opening balance sheet's total value come from?
- The market price of the new shares on the first day of trading
- An estimated enterprise value derived from a valuation and allocated across assets and liabilities
- The book value of the predecessor
Show the answer
Answer: B.
The plan's estimate, here 1.59 billion dollars at the emergence date against a range of 1.35 to 1.75 billion, is allocated to produce the new basis.What did the former common shareholders receive in this case?
- The majority of the new common stock
- Two series of warrants, exercisable at a stated price for a stated period
- A cash distribution
Show the answer
Answer: B.
Up to 4,837,821 Series A and up to 2,418,910 Series B warrants went to certain former holders of the predecessor's common stock, with the Series B priced at 83.45 dollars.Sources
- Whiting Petroleum Corporation, Form 10-K for fiscal 2020, filed 2021-02-25: the plan dates, the adoption of fresh start accounting, the statement that post-emergence statements are not comparable, the enterprise value range and the emergence-date estimate, and the Series A and Series B warrant terms.
What this leaves out
- Fresh start accounting applies only when the qualifying conditions are met. A company can emerge from Chapter 11 without it, and then the statements continue on the old basis.
- Recoveries differ in every case. What one plan gave former shareholders says nothing about what another will.
- The figures here are from one filing about one closed situation, and are not a valuation of anything.
- Nothing here is advice about any security.