Revco Drug Store filed for bankruptcy in July of 1988 and was one of the largest

Question

Revco Drug Store filed for bankruptcy in July of 1988 and was one of the largest bankruptcies in US financial history as well as being one of the largest leveraged buyouts. As recently as 1984, Revco was operating approximately 2,000 stores in 30 states and was taken private in a leverage buy out in 1986 which lead to a significant increase in Revco’s debts from $44.7 million in 1985 to over $700 million in 1986 after the leverage buyout. Eventually, its debt reached $1.3 billion and Revco announced that it could no longer make the interest payments on its debts. Prepare a plan for the firm’s bankruptcy. Be sure to address issues such as whether it would be better for Revco to file for formal bankruptcy instead of private restructuring, what the costs of the Revco bankruptcy will be, and how long you expect before Revco will emerge from bankruptcy.

Explanation / Answer

1. The Direct Costs of Bankruptcy. Formal bankruptcy can be expensive and time-consuming.Re vco
was in Chapter 11 bankruptcy for almost four years and paid out over $40.5 million in direct
bankruptcy costs (2.7 percent of the buyout price).15 Below are some of the direct bankruptcy
fees (in millions).
Law firms
Baker & Hostetler $ 7.5
Fried Frank 3.2
Accounting firms
Arthur Andersen 7.4
Ernst & Young 4.2
Investment bankers
Lazard Freres 3.5
Other 14.3
$40.5
2. The Indirect Costs of Financial Distress. There are many indirect costs of financial distress, including
management distractions, loss of customers, and loss of reputation.The indirect costs of financial
distress may occur whether or not formal bankruptcy is declared.In the case of Revco, financial
distress caused a costly change in management and strategic direction.
3. The Costs of a Complicated Financial Structure. Firms such as Revco that have bank loans, senior subordinated
debt, and junior subordinated debt will have a very hard time getting all claimholders
to agree to an out-of-court settlement.F or a retailer like Revco private agreements are especially
difficult because of the large number of trade creditors.It is axiomatic that the more complicated
a firm’s financial structure, the more difficult it will be to work out private arrangements to avoid
bankruptcy.Conflicts between managers, shareholders, and creditors make reaching a private
agreement difficult.There is a natural tendency for each group to try to gain value at the expense
of the others.

Revco may come out of the bankruptcy after four to five years.

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