How is that possible? It all goes back to a four-fold increase in corporate debt that built up over the last decade. PricewaterhouseCoopers forecasts that 11,000 companies will file for Chapter 11 protection in 2002, up from a record 10,442 in 2001. BusinessWeek Investment Banking Editor Emily Thornton recently spoke with Carter Pate, a managing partner at PricewaterhouseCoopers, about the firm's grim prediction. Here are edited excerpts from their conversation:
Q: Could there really be a record number of companies filing for bankruptcy this year when the economy seems headed for recovery?
A: Bankruptcy is a lagging indicator. What we're seeing is the continuing economic fallout that comes after a period of 9 or 10 years of unbridled growth. In a normal economy, without the home-run stretch that we had, many of the companies you've seen file [for Chapter 11] last year and this year would have been falling off the edge long ago. But [with] a strong economy, many of the companies that were weak to begin with were able to make it through.
You had a contraction that was sharp and difficult, compounded by September 11. These companies go through their cash and borrowing capacity in order to withstand the downturn.
If you saw this coming, you should have taken action last spring. If you waited until October or November to start cutting your excess capacity and inventory, you probably went through a significant part of your working capital.
Q: Will there be any shift in terms of the number of public companies that will go bankrupt this year vs. private companies?
A: I'm forecasting a decrease in public companies, but an increase in the number of private companies. A lot of that is because the management of public companies is usually much more seasoned and has been through downturns before. They know to...prepare with inventory reductions and tighten their credit when they see a recession coming.
Private companies don't react as quickly. Some of them continue to operate as if it's business as usual. So they went through their working capital last year, and this year will be their worst.
Q: In 2001, some large companies with hundreds of billions of dollars in assets filed for bankruptcy. What do you see in 2002?
A: You will see some household names this year. The industries that I'm predicting will have trouble are telecommunications, autos, metal, steel, and then retail.
Q: How would you say this situation differs from the last recession, in 1992?
A: Young managers have no experience with this.... We went through a decade when they didn't have to deal with it. The liquidity crunch for highly leveraged companies is also a huge issue. Right now, getting cash is very hard if you're in a leveraged company.
We're also at a different position in terms of inflation [and the price of goods]. We were at 5.4% in 1990. Now, we're at 1.2%.... That's what is killing chemicals. They can't get price [or margin] increases.
Q: You have said that you expect 100 of the 257 public companies that filed for bankruptcy in 2001 to emerge from bankruptcy in 18 months. Does this include Enron?
A: Enron, along with other companies like it, has introduced a new factor. Most companies that go into bankruptcy must deal with their business model and cash. Enron introduced a third issue -- management prevarication, perceived distrust -- [that has] caused employees and vendors to question everything the company said in the past.
That makes it increasingly difficult. You immediately have to regain the high ground on integrity, which calls for being clear and transparent in everything. The example you're asking about has introduced a number of high-profile management changes to solve that problem. If things weren't bad enough, [Enron has] introduced yet another problem that some companies cannot overcome.
Q: And Global Crossing?
A: Global Crossing is not unlike the other telecommunications companies that will be facing a capacity glut. And they will have to come up with a plan to deal with that.
Q: What lesson can we take away from all of this?
A: People should skip the earnings-per-share calculation on the balance sheet and go straight to cash flow. As a savvy investor, that's the first [thing to look at]. Where is the cash coming from? How is it being generated?
People have a tendency to focus too much on the balance sheet. Understand where the cash comes from in a business...then go back and look at the EPS and the strength of the balance sheet. That's the lesson learned.