Dissecting a Bankruptcy: ATMDirect
February 27, 2008
I thought it might be interesting to dissect a recent bankruptcy sale we were involved with. You might want to catch up by reading my post title, "Section 363 of the U.S. Bankruptcy Code". Those of you who have been following Nicholas Carlson's coverage of the Pay By Touch bankruptcy won't be surprised that the company is running their Chapter 11 reorganization as well as they ran their business. Pay By Touch operated a business unit here in Dallas (Irving) called ATMDirect. Our team spent the past month conducting diligence on the business and ultimately participated in the auction to purchase ATMDirect last week.
The local ATMDirect people (both current and former employees) were very helpful and simply wanted to keep their business up and running. The Pay By Touch people (in general) were less than helpful and at every turn seemed to be erecting roadblocks. The creditors hired a company called FTI to sell off non-core assets like ATMDirect and to reorganize the core operations of the parent company Pay By Touch. FTI installed Thomas Lumsden as 'Chief Restructuring Officer' who, by looking at his CV, seems to be very qualified for the position.
After our first meeting with the local ATMDirect people I was certain we wanted to make an offer for the assets. Evidently Thomas had set a bid deadline, which failed attract even a single bid. I called him and offered to serve as the 'stalking horse' so that an auction could be held. He suggested that he intended to draft his own asset purchase agreement (APA) and that he would be scheduling another auction in a couple of weeks. I suggested that it might be in the interest of the debtor to have one of the bidders (i.e. us) prepare the APA. Thomas didn't agree and in a confusing twist became somewhat belligerent. Our subsequent communication was exclusively electronic, much of it rather silly.
Despite the fact that I was in contact with Thomas on a daily basis, we didn't receive his APA until two business days prior to the deadline for bids. There simply wasn't enough time to get our lawyers to review the document, circulate it to my team and complete it in time for submission to Pay By Touch. Some members of my team assumed this was by design (i.e. the conspiracy theorists in my group), while I simply assumed it was a matter of incompetence. This brings me to my thesis: 'Bankruptcy is inherently chaotic and as a result creates real opportunity for anyone willing to endure the process'. Thomas' sale process was broken and a result there was a good chance very few bidders would be willing to stay in the game resulting in a lower price.
We began digging into the business and we quickly realized that the asset value of the associated personal property (i.e. servers, networking equipment, computers and office equipment) was worth between $300,000 (quick and nasty sale) and $600,000 (current value based on recent ebay sales). Within two weeks we had a buyer willing to pay $475,000 for the equipment. With this information we began attempting to value the associated intellectual property (a lovely patent) ultimately finding an IP litigation boutique who suggested that (depending on the prosecution history) that they would buy litigation rights for the patent for $750,000 at a minimum. It wasn't my intent to immediately liquidate the equipment or sell off the litigation rights of the patent, but these data points helped me understand the minimum value of the assets ($1.2MM). One interesting data point was that Pay By Touch had bought ATMDirect in 2006 for approximately $8MM ($4MM in cash and the remainder in debt/stock).
Working under my two assumptions a) the process was broken and b) the assets were worth $1.2MM I spent my weekend marking up the debtor provided APA. I settled on a total bid of $1MM ($250K in cash and $750K in a 24 month note). My business plan allowed us to attempt to execute on the underlying business (there were significant risk factors) for up-to 24 months and ensured that if the business failed we would break even (on a cash basis, obviously our time would be lost). We were prepared to bid as much as $750,000 cash plus up-to $500,000 in debt for a total bid of $1.5MM (risking around $700K in cash at this price).
The day of the auction arrived and two other bidders were present. After several hiccups on the teleconference Thomas explained to us that the prevailing bid was $1MM cash. This was more cash than I had wanted to bid and after a few moments of consideration I told him we weren't interested in meeting the offer. I was disappointed, but I learned long ago not to bid on emotion. The two remaining bidders remained and Thomas terminate our connection to the conference bridge. To our shock and dismay on Monday we learned from the debtor that the prevailing bidder paid $600,000 cash for the business. The sale hearing had already occurred earlier in the day and as we had assumed Thomas had given us accurate information we had no reason to object to the sale. Had we known the sale went through at the $600K price we would have certainly objected to the sale.
This morning we discussed our options and instead of dragging the process out in court and objecting to the sale we have decided to move on as it is our understanding and belief that the prevailing buyer would have bid as much as $800,000 cash. This bid would have been higher than ours. The only damage seems to have been borne by the creditors. I am no expert, but within fourteen days I was able to secure buyers for key assets for a cash price of $1.2MM; however, after months of 'marketing' and tens of thousands of dollars in legal fees Thomas Lumsden was only able to recover half of that amount. What is wrong with this picture?
Everything, but at the end of the day the important thing to remember is that it is the very process that can create value for you as a buyer. Think about the motives of the parties involved. The seller (i.e. the debtor) is being run by employees who almost certainly don't have a future with the company. How concerned are they going to be with their duty to obtain the highest and best price for the creditors? Not very. Ironically, according to insiders at Pay By Touch, in this case the creditors hired FTI to sell off assets and agreed to pay them a percentage of the sale price. Anyone would assume that Thomas Lumsden would be more than interested in getting the highest and best price for the assets. Again, in this case it was KEY that we understand the motives of everyone involved. For example, I couldn't understand why Thomas wanted to draft the APA instead of having one of the bidders bear this cost. But it didn't take long to figure out that, the costs associated with the process are not deducted from his firm's commission. Secondly, by controlling the APA he was able to control the definitions, definitions that would dictate how much money he would make. Specifically, he defined the purchase price as not only the price paid by the buyer, but by the value of the 'assumed liabilities' (i.e. executory contracts such as the lease). Our fatal flaw was realizing this too late. In our APA we rejected almost all contracts of the seller (the most powerful feature of a 363 sale). We felt that we could negotiate new contracts on better terms. From Thomas' point of view, $600,000 plus the assumed liabilities was more valuable to HIM than $1.5MM without the assuming liabilities. Of course, from the secured creditors perspective, the $1.5MM would have been far more valuable as the assumed liabilities would have never come into play (i.e. none of them were secured).
Turns out the creditors are VERY aware that their interests aren't being protected. Just last week according to Nicholas Carlson, "On Friday, a party of creditors filed a restraining order with a court in Los Angeles to prevent management from "shutting down the operations of Pay By Touch Payment Solutions"- its main business."