From the outside, Chapter 11 bankruptcy can look like an almost magical process. A company previously laden down with borrowings gets to discharge its liabilities and emerge seemingly unscathed.
U.S. miner Arch Coal Inc. had $4.5 billion in net debt and a market capitalization of just a few million dollars when it filed for Chapter 11 in January 2016. After emerging from a nine-month gestation in the courts, it's now worth $1.73 billion and is debt free, with net cash of $31 million.
Toshiba Corp. shareholders appear to hope the same rule will hold true for Westinghouse Electric Co., the nuclear unit that's dragged one of Japan's oldest industrial conglomerates to the brink of insolvency. The stock has rallied 20% in a week, after Toshiba said Westinghouse's board was considering bankruptcy. The unit has filed for Chapter 11 protection in New York, court documents showed on Mach 29.
If the courts are about to give Westinghouse a get-out-of-jail-free card, someone ought to tell the credit markets.
Compare Toshiba's own credit-default swaps to those on Southern Co. and Scana Corp., the two U.S. electric utilities for whom Westinghouse is under contract to build four reactors, and it's clear that investors expect one of the three players to suffer most of the costs. Insuring $10 million of Toshiba's debt against default for five years would set you back about $423,000, compared to $78,000 for Scana and $64,000 for Southern.
Toshiba faces a bewildering array of potential hits to its balance sheet from its nuclear foray, but most of them are either relatively small (such as its 34.6 billion yen (US$311 million) in decommissioning and environmental liabilities), or already factored in (like the 713 billion yen goodwill write down that will leave it with negative shareholders' equity once it reports annual results).
The deal with Southern and Scana is different. Payment guarantees to subsidiaries of the two utilities constitute 90% of the 794 billion yen in parent-company guarantees for which Toshiba has promised to indemnify Westinghouse. Put into English: If Westinghouse fails to build the reactors on time and on budget, Toshiba is on the hook for a sum not much less than the 768 billion yen value of all its factories, machinery and land.
Aside from a bailout by the Japanese government, the sliver of hope for Toshiba shareholders is that the messy bankruptcy process will allow some of those liabilities to be taken on by other players.
The U.S. government, for instance, has made an $8.3 billion loan guarantee to the owners of Southern's reactors. That may complicate the process, the Nikkei reported earlier this month. Moody's Investors Service and S&P Global Ratings in recent weeks have put shareholders in the plants, including Southern and Scana and associated units, on negative ratings outlooks on the possibility they will have to bear some costs.
Creditors of the two utilities seem unconcerned. It's been more than a year since Scana's 4.125% bonds due February 2022 last dipped below par, while the Southern unit that will be the main shareholder in its nuclear plant project, Georgia Power Co., managed to raise fresh debt just last month. Its $400 million of 3.25% notes due 2027, sold at a modest 0.113 cent discount to par, are trading at 98.56 cents on the dollar.
That should be worrying for Toshiba, because there's no magic spell behind Chapter 11. Bankruptcy doesn't make liabilities vanish outright. For the most part, it just reorganizes them, imposes haircuts on junior creditors, and converts a portion from the most stringent form -- debt -- to a milder alternative, equity. If bondholders at Westinghouse's customers are feeling confident, Toshiba shareholders should prepare for a troublesome chain reaction.
By David Fickling