THE ANNUAL REVIEW 2010 - PEI Media

private equity annual review 2010 pa g e 87
Slim pickings
d i s t re s s e d i n v e s t i n g
What happened to the feast of distressed investment opportunities expected to flood
the US and UK markets? Amanda Janis reports
Take a trip through the PEI archives back
to autumn 2006 and you’ll be reminded
that private equity distressed investors were
beginning to rub their hands in anticipatory
glee, noting that the boom cycle’s high valuations,
excess liquidity and low interest rates
couldn’t continue in perpetuity.
Indeed, one year on, the term “credit
crunch” was beginning to appear regularly
in our pages – but no one was prepared
for the severity of the global economic
crisis that was to unfold over the next two
years, causing large financial institutions to
collapse, stock markets to plummet and the
entire global financial system to be called
into question.
The severity of the crisis – and the
subsequent responses by banks and central
governments –dampened a lot of the
anticipatory glee.
Josh Wolf Powers, founding partner
of New York-based turnaround and
restructuring firm Blue Wolf Capital
Management, has been predicting an
avalanche of opportunities related to distress
for nearly five years. He’s still waiting
for the wave of conventional distressed
opportunities, he says.
“There just has not been the avalanche of
companies in the US filing for Chapter 11
bankruptcy protection,” Wolf Powers says.
“And when they have filed for Chapter 11,
they’ve typically been far further gone, so
the Chapter 11 has resulted in a liquidating
[Chapter] 7 or has been a reorganisation
opportunity available primarily to the
lenders, to the senior creditors or secured
lenders.”
That resulted in a number of
distressed debt specialists like Oaktree
Capital Management, Anchorage Capital
Partners, Towerbrook Capital Partners and
Wayzata Investment Partners taking over
companies (often from private equity firm
sponsors), but Wolf Powers says “even those
opportunities haven’t been as numerous as
anyone imagined”.
banks and bailouts
“Things that are good for most investors,
and most citizens” aren’t so wonderful for
those hoping to find distressed investment
bargains, Howard Marks, chairman of Oaktree,
wrote in PEI’s recent book, The Definitive
Guide to Distressed Debt and Turnaround
Investing.
Thus various government bailouts and
stimulus packages over the past two years
– which one veteran distressed investor
dubbed “the socialist bailout game where
the consequence of taking absurd risk was
forgiven” – have helped restore confidence
and revive credit markets, but suppressed
the supply of distressed investment
opportunities.
However, it’s the actions – or rather
lack thereof – of lenders that industry
insiders most frequently pointed to as a
principal reason why the expected plethora
of distressed investment deals didn’t quite
come to fruition.
“Lenders – in particular banks, but
also hedge funds and other non traditional
lenders – chose rather than to exit their
uneconomic holdings, to essentially ‘live
to fight another day’ by neither admitting
defeat nor funding continued investment,”
says Wolf Powers.
Reeling from mortgage-related losses
and caught out by the suddenness of the
downturn, many banks hadn’t taken
reserves against corporate loans that
should have been marked down and become
distressed investment candidates, says David
Blechman, who in August 2009 left Sun
Capital to join distress- and turnaroundfocused
Tower Three Partners. “If it’s on
your books at par, you’re not going to
transact on it. You have to mark it down
first,” he says.
“So in late ‘08 and the first part of ‘09,
a lot of those lenders just weren’t willing
to do anything yet. And meanwhile, to
the extent that it was [private equity and
hedge] funds holding the bank debt, more
and more of those funds were willing to
own the company,” Blechman says. “So there
were far, far fewer actual distressed private
equity control buyouts of these companies
as a result of those two things.”
The situation has been the same on
both sides of the Atlantic. And while many
lenders in Europe increasingly started to
divest some of these assets in the latter
part of 2010, industry participants say
they weren’t likely to attract many true
distressed investors now, either because
the assets were no longer “distressed” given
the market rally seen in the first part of
2010, or because they’ve essentially become
“zombie companies” while sitting on the
banks’ balance sheets.
timing it right
Before the subprime crisis fully hit, distress
hadn’t really begun to manifest itself save
for in certain sectors like those related to
housing. “So there were some opportunities
there, before fall 2008, but it was all
complicated by the fact that you had no
visibility as to what the future was likely
to hold with respect to that sector,” Wolf
Powers recalls. “You saw that you were on
the edge of a cliff but you didn’t know how
high the cliff was or how fast you were
going to fall. So that made it very hard to
invest in that situation.”