Early success drives demand for Centerbridge III

The global financial crisis froze out credit markets and clobbered portfolio company valuations. Those are two reasons why the 2006-vintage domestic buyout and turnaround funds have generated a median internal rate of return of just 8.1 percent, according to Buyouts data. But the timing could not have been better for distressed debt and buyout specialist Centerbridge Partners.

The investment mandate for Centerbridge’s $3 billion debut allowed the firm to pivot between traditional buyouts, distressed debt and tradable credit strategies, depending on market conditions. That flexible strategy, spearheaded by founders Jeffrey Aronson and Mark Gallogly, ultimately yielded a net internal rate of return of 22.5 percent, good enough to qualify as top quartile.

That early success no doubt help explains why the firm was expected to close its third flagship fund at a $6 billion hard cap in late October after less than six months on the market, according to Pennsylvania Public School Employees’ Retirment System documents. (Pennsylvania PSERS ultimately declined to commit to Fund III following negotiations with the firm. The retirement system declined to comment on why.) The close would rank Fund III among the largest private equity fundraises of the year.

Possible investors in Centerbridge Capital Partners III, expected to be oversubscribed, include San Francisco Employees’ Retirement System, Pennsylvania State Employees’ Retirement System and Los Angeles County Employees Retirement Association, all of which have approved commitments over the last several months. Portfolio Advisors, Pathway Capital Management, The World Bank and UTIMCO are also said to be considering investments, according to San Francisco documents. 

“Centerbridge has developed a deep bench of senior professionals skilled in sourcing and negotiating investments and structures, analyzing companies and sectors, and assisting in operations,” consulting firm Cambridge Associates wrote in a Sept. 23 memo presented to San Francisco Employees’.

Still, Centerbridge’s track record contains its share of hiccups and adjustments, according to limited partners. While the New York and London-based firm scored big with Fund I, questions remain about how its $4.5 billion follow-up, a 2010 vintage, will ultimately perform. A Centerbridge spokesman did not respond to several requests for comment.

Centerbridge I & II

Centerbridge was founded in 2005 by Aronson, the former head of Angelo, Gordon & Co.’s distressed securities and leveraged loan business, and Gallogly, who previously led The Blackstone Group’s private equity business. Since then the firm has grown its team to include 42 investment professionals and more than 140 operations, tax, legal, compliance and investor relations staff, according to San Francisco Employees’ documents.

Centerbridge invests with a hybrid, “all weather” approach that draws from the strengths of both founders’ backgrounds. Although the firm is often described as a distressed debt specialist, its strategy allows for investments in both distressed debt-for-control deals and traditional leveraged buyouts, giving it the ability to put capital to work across different market cycles.

The distressed debt component of the strategy also allows Centerbridge to trade out of its toehold positions in a company’s securities if they grow too expensive to obtain control.

That flexibility drove capital deployment and returns in Fund I, which made 31 investments. Roughly 40 percent of Fund I’s capital went to non-control distressed investments and delivered a 1.9x multiple on invested capital, according to a separate San Francisco Employees’ memo prepared by its staff. Another roughly 20 percent of fund capital went to distressed-for-control deals, leaving a little less than 40 percent for conventional private equity investments.

Centerbridge’s investment approach shifted as the market began to improve during the early part of the following decade. The firm closed its second fund on approximately $4.5 billion in 2011 and invested the largest share of its capital, or about 45 percent, in conventional  buyouts. 

The firm had invested 87 percent of Fund II’s committed capital across 19 deals as of March 31, according to documents made available by the San Francisco Employees’. It has exited wholly or partially at least two and both generated strong multiples (an IPO of Santander Consumer USA generated a 2.9x and a partial sale Aquilex Holdings notched 2.2x). Centerbridge also holds at least two investments, accounting for $500 million of invested capital, below cost.

The fund, still in its investment phase, has netted a 9.2 percent internal rate of return as of the same date, according to San Francisco Employees’ documents. Many LPs do not consider returns meaningful until at least year five of a private equity fund, in part due to the j-curve effect in which management fees disproportionately hurt returns in the early years.

Geographic shift 

In addition to its heavier allocation to buyouts within Fund II, Centerbridge also ramped up its exposure to European distressed debt as the domestic market waned. The firm opened a London office in 2011 and soon put capital to work in loan-to-own deals, acquiring German auto repair company ATU Auto-Teile-Unger from Kohlberg Kravis Roberts and French plastic pipes distributor Frans Bonhomme from Cinven in 2013.

The same year, Centerbridge joined with Corsair Capital and others to acquire a £600 million ($968.72 million) stake in a network of Royal Bank of Scotland branches.

The difference in geographic exposure between Fund I and Fund II is striking. Approximately 37 percent of Fund II’s capital went to European deals, compared to just 6 percent of Fund I. The exposure to Europe in Fund III may trend even higher, according to San Francisco Employees documents. Unlike its prior funds, Fund III will not have a limit on the amount of capital that can be earmarked for European investments.

The shift takes place at the same time the recent retirement of Centerbridge Europe Chairman Simon Palley presents questions as to how the London team will adjust under its new chief, Lance West.

“While it has shown its aptitude for structuring and sourcing European investments, particularly in distressed debt, the firm has not yet proven its ability to add post-investment value or exit DFC (distressed debt for control) deals in Europe,” according to the Cambridge Associates memo.

Indeed, Centerbridge’s European track record has yet to bear meaningful returns, and San Francisco Employees’s investment staff noted that the firm marked its holdings in a European auto service company at 0.5x cost. That business is going through a major restructuring, according to the San Francisco Employees’ memo.

It is unclear if the investment being held at 0.5x cost is ATU, which is also going through a restructuring. A spokesman for ATU had not responded to a request for comment as of press time.

Despite these questions, Centerbridge’s track record, flexible investment strategy and ability to execute across different market cycles has clearly resonated with investors. Fund II’s performance may well improve as its investment portfolio matures, and the firm is confident that its operations team can improve the value of the companies that it currently holds below cost, according to the San Francisco Employees’ memo. 

“Centerbridge Capital Partners III presents a compelling opportunity to gain exposure to a control-oriented distressed and traditional private equity strategy through one fund invested in both equity and debt,” according to Cambridge Associates. “The team’s credit acumen is prodigious, and the firm’s private equity investments have performed well to date.”