Not one to mince words, KPS Capital's Michael Psaros offers a ...

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36-43_CoverStory.qxd 4/6/09 5:41 PM Page 41BRASS TACKSwould be nice to get few layups that don’t necessarilyinvolve the typical turnaround process.Mergers & Acquisitions: Could you flesh out the balancesheetopportunities you’re seeing?Psaros: Companies that were over-leveraged duringthe last cycle, who are now seeing their earnings plummet,are obviously that much more over-levered. Ithink, according to [Standard & Poor’s] data, that theaverage leverage multiple in the last cycle peaked at asmuch as eight times trailing Ebitda. That’s“trailing” Ebitda in what was a boomingeconomy. If your Ebitda is off by 20% or30% today, you’re essentially leveragedthat much more. And if you don’t haveaccess to capital and maturities are comingdue, then you have a major problem.This is why there is going to be carnagein private equity portfolios. Nobody likesto talk about it, but we’re seeing it already.What’s going on in the macroeconomyis obviously going to hurt earnings,so folks are not going to have the cashflow to even service their interest payments.We’re going to see a lot more paymentdefaults.Mergers & Acquisitions: Switching gears a bit, it seemslike so many different industries are facing true transformationaldistress, including the automakers, retail, printmedia, energy, financial services; I’m sure I’m missing afew. What are your thoughts about the expansive natureof this radical disruption in what are core sectors to the USeconomy?Psaros: The list of industries is actually longer. Generallyspeaking, the only area that appears to be weatheringthe storm is healthcare, although nobody reallyknows how the new presidential regime will affect profitsthere. We’re also seeing a severe downturn in industriesthat are involved in or dependent upon manufacturing.We just had the worst quarter in manufacturingsince 1980. Aerospace companies are hurting, capitalequipment manufacturers are hurting, chemical companiesare hurting. The list could go on.In the almost 20 years that we’ve been together asa firm, we have never been in a period in which thereis no visibility into the next year on the top line. Companyafter company is trying to look into the future,but basically cannot put together a forecast or evenguess on a range in terms of what their actual revenueswill be in 2009.If you look at the industries today that are in extremesituations — autos for one; building productcompanies would be another — I can’t tell you howmany businesses have just seen the top line evaporate;literally. We just looked at a company in the recreationalvehicle space, and their order book went from havinghundreds of units in their backlog to having just twoor three units in the fourth quarter [of 2008] and nothinglined up for 2009. Building product companies inparticular and companies directed toward the consumerare effectively seeing their demand fall off of acliff.Mergers & Acquisitions: KPS has always been active inthe industrials and manufacturing arena. Will you lookto be opportunistic in some of these other areas as companiesbecome available?Psaros: There’s no style drift with us. We invest incompanies that make things. Even our investment inAttends Healthcare; outwardly, it’s a healthcare company,but we saw it as a manufacturing business witha gold plated brand name. We will continue to investin companies that either make or distribute products,so that means no high tech, telecom, entertainmentor real estate. We also made the decision as investors tostay away from restaurants and retail.Mergers & Acquisitions: As it relates to a particularbusiness, what might be considered too distressed for KPS?Psaros: We’ve already discussed the top line at length.If we can’t have complete confidence in a company’s rev-“ For the first12 to 18months of adownturn ourjob is to duck.”February 2009 MERGERS & ACQUISITIONS 41
36-43_CoverStory.qxd 4/6/09 5:41 PM Page 42BRASS TACKSenues we will walk. The second red flag is insignificant market share.If a company only controls three to ten percent of its respective marketthen the industry is telling you that the company doesn’t matter.A third thing we try to avoid is the necessity to invest a largeamount of capital in order to generate cash flow and profits. We’ll seea lot of companies that generate minimal Ebitda. You can get thesebusinesses up to $40 million or $50 million in Ebitda, but you haveto invest $150 million, so the economics don’t make sense.Ultimately, though, you have to ask if the company has a reasonto exist. If you’re the fourth or fifthbiggest competitor in a sector, this is aquestion that should apply.Mergers & Acquisitions: This downturn,perhaps unlike any other, is truly globalin scale. What are your thoughts on whatmight happen to the globalization themethat has been so important during the pastfew years?Psaros: I could talk on this subject forhours. The first point I’d make is thatthe reason a US company goes to Chinaor India today is to service those particularmarkets. The whole transfer ofNorth American manufacturing capacityhappened 10 years ago and it’s done; we’re not going back.For our second fund, which was made up of North Americanindustrial companies, China was the greatest thing that ever happened.The giant boom in consumption there raised the prices for manufacturedgoods and the intermediate goods that feed into thoseproducts.Mergers & Acquisitions: KPS has invested a few times overseas: Ebroand Ashcroft come to mind. Do you like the opportunity set for globaldeals or is it more difficult to get your arms around foreign investments?Psaros: We’re seeing an incredible amount of dealflow emanatingfrom Europe. We have had successes there, so we’re excited aboutthe opportunity, and a significant portion of Fund III will be investedin companies that are domiciled in Western Europe. But you willnot see us making a platform investment in Asia or Japan.In terms of restructuring, I think Europe is where the US wasbetween 1985 and 1990. We’re seeing a lot of companies that arerun in the same manner of a US company about 15 or 20 years ago,so that presents an opportunity.There are three primary obstacles, though. With the exception ofthe UK, very little asset-based financing is available in Europe. That’susually how we finance our deals. In the US, all of our capital structureshave a plain-vanilla revolver with a term loan against the assets.The law in various jurisdictions over there blocks asset-based financing,so you have to get creative, whether it’s through factoringor just adding more equity.Also, it’s very difficult to pursue a bankruptcy transaction in Europe,given all of the different jurisdictions; there’s no commonalityto the law. So, to date, we have yet to buy anything out of bankruptcyin Europe.The third obstacle is that it’s difficult to do the same things that wecan do here. It’s a fallacy that you can’t reduce headcount in Franceor Germany. The difference is that you just have to pay to do it, soyou have to factor those costs into the purchase price.Mergers & Acquisitions: What does thedomestic distressed market look like thesedays? It seems like many of the same faceswho were the players in 2002 — such asKPS, WL Ross & Co., and MatlinPattersonto name a few — are the same firmswho will be active in 2009. And consideringthe travails of Cerberus, Sun Capitaland Apollo Management, who haveall been burned recently, not to mention thecontraction among the hedge funds, it’s almostas if there will be fewer firms activein the distressed space?Psaros: There are probably fewer control-orientedturnaround funds out theretoday than any other time that my partner Dave [Shapiro] and I havebeen doing this. That’s because what we do is really hard, and it is evenmore difficult to demonstrate success over an extended period oftime.I think we’re privileged to be in the company of those groupsthat you mentioned. We have seen a few new entrants; basically smallerfirms whose marketing shtick is that they’ll do micro-cap or smallcapturnarounds. Generally speaking, though, we wouldn’t go afterany of those deals.The hedge funds are nowhere to be found. In our space, 2005 wasreally the year of the hedge fund. Billions of dollars effectively movedfrom bond trading into control private equity, and for the most partthey went on to lose an astonishing amount of capital doing really sillyand stupid things. It’s been a long time since we’ve run into a hedgefund, though. A lot of these fund managers, on an IQ basis, are verysmart people, and they have probably made their investors very attractivereturns around their core trading strategies. But companiesare not securities or mere pieces of paper. They’re living, breathing entities.You can’t sit behind a Bloomberg terminal and try to turnarounda brass mill. It just doesn’t work like that.Mergers & Acquisitions: Do you anticipate that the traditional privateequity funds will make a run into distress?Psaros: It’s bound to happen. It has happened in the last three cycles,where we’ve seen firms that historically pursued true leveraged42 MERGERS & ACQUISITIONS January 2009
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Not one to mince words, KPS Capital's Michael Psaros offers a ...

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