Friday, 24 November 2017

    How a trustee board bought its sponsor

    Kodak pension scheme trustees took an innovative approach in the face of a billion-pound deficit and the collapse of the parent company, writes David Blackman

    Sat in a Manhattan boardroom, Ross Trustees directors Andrew Bradshaw and Steven Ross had to pinch themselves.

    They were in New York because they were involved in negotiations to secure funding from Kodak, whose pension scheme their firm acts as independent trustees for.

    But it’s a situation that Bradshaw and his boss Ross became strangely familiar with as they criss-crossed the Atlantic in pursuit of a groundbreaking deal that led to a small band of UK trustees owning one of the world’s best-known businesses.

    With the new Kodak Pension Plan (KPP) scheme up and running, Scheme Insight explores how the deal was done and the implications for other schemes.

    The saga begins more than six years ago when Kodak – traditionally a generous employer – found that its pension scheme deficit had ballooned to $2.8bn on a buy-out basis. As part of a deficit reduction deal hammered out in 2008, US Eastman Kodak agreed to guaran­tee the scheme. In itself, the paren­tal company agreement was “not that unusual”, according to Bradshaw.

    However, the deterioration in the finances of the KPP coincided with a rapid downturn in the 130-year-old sponsor’s wider fortunes as technological changes led to consumers abandoning its staple film products.

    And the picture darkened less than a year later when US parent company Eastman Kodak entered the US Chapter 11 insolvency process.

    The trustees became concerned about where the money was going to be coming from

    “Kodak UK didn’t have the financial wherewithal to support the scheme,” says Bradshaw. “Of course, the trustees became concerned about where the money was going to be coming from.”

    Given that Kodak’s deficit equated to between 10 and 15% of the Pension Protection Fund’s total liabilities at the time, the lifeboat fund was also worried, as was the Pensions Regulator.

    KPP, advised by accountants Grant Thornton and solicitors Hogan Lovells, submitted a $2.8bn claim to cover the scheme’s liabilities after the sponsor entered Chapter 11. As the company’s largest unsecured creditor, the trustee board became involved in the process. They were a KPP independent trustee chairman Stephen Ross took the co-chairmanship, alongside Wal-Mart, of the company’s unsecured creditors’ committee. This put the trustees at the heart of the Chapter 11 process, which gives companies much more time to sort themselves out than UK insolvency law.

    Eastman Kodak wanted to use this breathing space to clear the UK pension scheme’s claim with the proceeds from the sale of the company’s intellectual property, which was expected to raise $2-3bn. However, in the middle of 2012 it became apparent that the bids were significantly lower.

    The market sensed a fire sale

    The trustees’ seat on the creditors’ committee meant that they knew how serious the situation was. “We would get reports on what was happening. The market sensed a fire sale,” says Bradshaw.

    At this point, Kodak began to haemorrhage business. By the end of 2012, Eastman Kodak faced running out of cash. Until then, Eastman Kodak had not been very interested in talking to the pension scheme.

    “It became apparent that we wouldn’t be able to sort out our problems via conventional means,” says Bradshaw.

    As the sponsor was in no position to offer cash, the trustees looked for alternative funding structures, such as a bond-like instrument, payable over 30 years. The germ of the eventual deal sprang from the fact that the pension fund’s cash needs were less pressing than those of the company’s other creditors.

    “They didn’t have a lot of cash and we didn’t need the $3bn upfront as we could take a longer-term view,” says Bradshaw.

    TOUGH DECISIONS

    The trustees’ choice was to act or sit back and watch the business shrivel up, triggering an inevitable entry to the Pension Protection Fund.

    “At that point we threw our hats in the ring, which is when things got really interesting,” recalls Bradshaw.

    Eastman Kodak had already decided to split itself into two businesses. The company’s legacy personal and document imaging business, including photographic paper, fairground pictures scanners and kiosks, was put into one of the businesses.

    The trustees submitted a bid for the document imaging business, which still generates a steady source of income, particularly in the US, even though parts of the business face long-term decline.

    But the board had a big persuasion job on their hands. First, they had to convince themselves that buying the company made sense. John Kiely, managing director at Smithfield Consultants says: “[Ross] needed to take the board with them, many of whom had never done M&A before.”

    An acquisition of this scale and complexity had never been done before

    Then they had to win over their fellow creditors and the company. “Eastman Kodak were worried that [the trustees] wouldn’t pull it off, as an acquisition of this scale and complexity had never been done before,” says Bradshaw.

    Finally, the PPF and the Pensions Regulator, both of whom had to be convinced that the proposed deal would put the scheme on a sound footing, could turn the deal down at any point.

    Eastman Kodak, meanwhile, had its own deadline: it needed to complete the Chapter 11 process by September 2013. A key element of the deal involved a reduction in benefit entitlements, for which the membership’s consent was needed.

    The risk for Eastman Kodak was that if the deal with the trustees collapsed due to an adverse vote, the firm would be even less well placed to find an alternative buyer. “They’d have lost other purchasers that far down the line,” says Bradshaw.

    To win the company’s backing, the trustee board agreed that the acquisition of the business would be unrelated to the changes in benefits.

    Bradshaw says: “We pressed go and all had the busiest three to four months of our careers in terms of the volume of work that we had to do.”

    The trustees delegated negotiating authority to Ross, Bradshaw and financial director Phil Gibbons. To help allay the US partners’ regulatory concerns, the KPP trustees paid for Stephen Soper, who was at that point the Regulator’s executive director for defined benefit regulation, to fly to New York.

    The regulator approved the pension’s scheme acquisition of the imaging business in April under a regulated apportionment agreement, which released Kodak from its pension obligations.

    The people running the company are the people that understand the business

    The board acquired the business, which is now known as Kodak alaris, for $325m. In return, the scheme dropped its $2.8bn claim against the company, which was then able to emerge from the Chapter 11 process. The trustees then secured the backing of 94% of the member­ship’s liabilities for the deal.

    So how does a pension scheme owning its own company work? Kodak alaris will have its own executive board.

    “The trustees will become a majority shareholder with a non-executive position, but the people running the company are the people that understand the business,” says Bradshaw. “There’s a close relationship, but it’s clear that we’re responsible for the pension scheme and the Kodak alaris board are responsible for running the business.”

    THE RISE OF KPP2

    One of the last pieces in the jigsaw was last month’s establishment of two new schemes.

    The minority of members who voted against the new arrangement will enter the PPF, along with £60m of the scheme’s assets in the form of cash. The main new scheme, known as KPP2, will retain 94% of the scheme’s assets in line with the outcome of the vote that led to its establishment. Kodak alaris forms about half of the new scheme’s assets, with the balance largely made up of private equity and absolute return funds.

    But isn’t having half a scheme’s assets invested in one company an unacceptable concentration of risk? The implosion of UK Coal following another groundbreaking asset-backed deal illustrated the pitfalls of such arrangements.

    We’re reliant on contributions from Kodak alaris over a long time, it just so happens we own it

    While acknowledging that the Kodak structure is an unconventional one, Bradshaw argues that the underlying arrangement isn’t that unusual. “We’re reliant on contributions from Kodak alaris over a long time, it just so happens we own it. In the same way as any other scheme, we have a covenant with Kodak alaris.”

    In some respects, he argues, ownership gives the scheme an advantage in the event of insolvency as under a more conventional arrangement the trustees would have to take their place behind other creditors.

    “We have a lot of control in terms of running the business,” he says. This means, Bradshaw argues, that the scheme can make a more informed decision about the balance between its own income needs and the company’s longer-term investment require­ments. The alternative, he says, would have been mass lay-offs and the risks of costly court action lasting several years.

    “The other alternative was the PPF and possibly an implosion of Eastman Kodak.

    We don’t know what’s going to happen in three to four years

    “We don’t know what’s going to happen in three to four years, but a lot of schemes don’t know that either – at least this gives our members a fighting chance.”

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