Firms Continue To See Opportunities In Distress

Regardless of the improving economy, buyout firms large and small continue to see opportunities to invest in distress. Investing pros at the Buyouts New York conference last month aired a variety of strategies, from conventional operational turnarounds to distressed-debt investing and deleveraging plays.

This even as distress, by conventional measures, seems to be at an historic low. Standard & Poor’s Leveraged Commentary and Data reported in May that leveraged loan defaults hit a 38-month low in April, falling below 1 percent. Edward I. Altman, a noted expert in credit risk at New York University, predicted in February that the corporate debt default rate would be just 2.8 percent for all of 2011.

No matter.

“There is no cyclicality to stupidity,” declared Richard Maybaum, managing director at Littlejohn & Co., speaking on a distress-investing panel. The Greenwich, Conn., firm, a distress specialist, is currently raising a $500 million side fund targeting distressed-debt opportunities, on top of a $1.34 billion pool that held its final close in November that is 20 percent dedicated to such distressed-debt transactions.

And while economic conditions look bright for large-cap companies that have access to publicly traded credit markets, it is a different story with smaller firms, where Littlejohn does extensive scouting to ferret out opportunities. “The lower middle market is still broken,” Maybaum said. “The capital markets are not there for them, so they can’t kick the can down the road. And there are a lot of cans.”

Rick Schifter, a partner at TPG Capital, said the firm invests in distressed debt as a way to ride the debt up as the company’s prospects improve, buying discounted paper when it may be 50 or 60 cents on the dollar and selling at 90. “It also sometimes put us in a position to become an equity investor in a restructuring,” he said. That is a challenging strategy in an improving market, Schifter acknowledged. TPG targets “companies that are better than the public markets give them credit for. Those are few and far between.”

Josh Harris, a managing partner at the mega-firm Apollo Management, said during a keynote interview that his firm is putting more emphasis on distress for control. “Half our capital has gone into that strategy.” In what he called “regular way private equity,” a firm buys a company and takes on debt. In distress investing, by contrast, the firm buys the debt with an eye for taking control after a default. The firm can actually reduce debt on the portfolio company that way, he said.

Others take an operational approach. David Shapiro, co-founder and managing partner of KPS Capital Partners, said its 2009 purchase of High Falls Brewing Co. was opportunistic rather than thematic. The company had a run-down brewery in Rochester, N.Y., and falling sales, but it also had the well-regarded Genesee beer brand.

Later that year the firm added the Labatt USA brand in a carveout from Anheuser-Busch InBev and has followed on with deals for brands such as Magic Hat, Pyramid and other craft beers. In the process, the firm added 300 jobs to the company, modernized the plant in Rochester and built a brewing community, Shapiro said. “We thought it was an interesting opportunity. And once we did something interesting, there was going to be a real opportunity to add on.”