The credit markets saw a rocky start to 2016 and big moves immediately after Brexit. Any observations?
We’ve been negative on credit for a while now. Oil and gas are a big problem as well as metals and mining. That will not go away. When these capital structures were constructed two or three years ago, they were assuming oil at $100 a barrel. Historically, leveraged-loan recoveries are 80 cents on the dollar. Oil and gas recoveries will be much lower. That is a fact.
The other fact is that there’s less liquidity for debt markets, yet we have the largest credit markets in history. There’s a real imbalance between market-making capital and capabilities and the size of the market. One scary statistic is: In 2008, the high-yield market was $1 trillion. Today it’s roughly $2 trillion. Since the crisis it’s doubled. Leveraged loans amounted to $500 billion to $600 billion in 2008. Today we’re at $1 trillion. The average investor doesn’t realize how much levered credit markets have grown.
So how will Z Capital position itself for this?
You’ll see higher defaults across many industries. It’s somewhat cyclical — but we argue it’s not all cyclical. There will be a lot of opportunities in the debt market and we’re seeing a fair amount of interest in it. … [W]hen things are moving around, it means it’s a good time for guys like us who are willing to find opportunities.
Z Capital focuses on value-oriented, opportunistic deals. Any recent examples?
We bought Twin-Star International from Trivest Partners in April. It was the last company in an old fund. We got it at a very good price and we liked the business a lot. They make a range of home-interior-heating products — electric fireplaces in various forms — some of which are quite sophisticated. They’re targeted toward small homeowners who don’t want install a fireplace. It’s an interesting business with a lot of cash flow. We have two letters of intent for add-on deals, one of which may close in the next 60 days. Their customers include Costco, Home Depot and Rent-A-Center, which is a rent-to-own store. We’re pretty excited.
Your deal to buy Pink Taco seems like a very different business from Twin-Star. How does that fit your model?
We try to buy assets or companies that have great fundamental economics and strong growth prospects. Pink Taco is a business started by Harry Morton — grandson of the Morton’s Steakhouse founder. We bought the location on Sunset Boulevard in Los Angeles. It’s edgy and popular with the beautiful people. We plan on expanding it pretty quickly. We also own a controlling stake in Real Mex Restaurants, which owns Chevys and El Torito and others. The team there will manage Pink Taco with Harry Morton. They’re very relevant today, especially for millennials. Pink Taco is fun, loud. It’s a different environment and transportable to different markets. The unit economics are terrific, with high-volume food and high-volume alcohol sales. It’s a great, fun atmosphere that’s relevant today, and Mexican cuisine is one that’s growing across all price points. We’ll expand into other iconic locations, including Chicago, Miami and maybe Las Vegas.
Z Capital also focuses on distressed assets, right?
In May, we bought a hotel out of bankruptcy called Waldhaus Flims Mountain Resort & Spa, an enormous asset in the Swiss Alps, an irreplaceable asset, at a great price. People look at us as value investors with a pipeline of opportunities, as we see value that others don’t. We have a knack of doing that.
Edited for clarity by Steve Gelsi
Photo of Jim Zenni courtesy of Z Capital