The large market appears to be in a relatively healthy state, at least when judged by the low default rates in the high-yield market. What’s happening in the middle-market, where Getzler Henrich is the most active as a crisis management consultant?
I think that’s consistent in the middle market as well, but perhaps for different reasons. The principal reason is the very healthy liquidity in the market. In today’s world, with liquidity there tends to be a solution. With all the new entrants in the lending market, there’s always somebody willing to finance or refinance a company that’s having some difficulty. And equity sponsors, because they have excess capital they need to put to work, will even put an incremental [equity] infusion into their portfolio companies to fix a problem.
But one thing we like to say in our business is, “Thank God companies are run by people.” Management still creates issues, and there will never be a lack of companies that run into difficulty merely because [management’s] ability to run the company is hindered for one reason or another. Ultimately, it’s the management team that either makes or breaks the company.
What particular industries are keeping you busier than others these days, and why?
The one industry we’re seeing a lot of activity in right now is homebuilding. Because of the precipitous drop in home sales, and as mortgages and credit markets continue to tighten, the homebuilders are getting into significant problems because, all of a sudden, their flow of cash dried up. They have major commitments for costs incurred for development-to-date, and what they’re doing is dropping their drawers on the prices of their existing inventory of homes just to create some cash. But that’s not going to be enough to get more cash to meet their debt service obligations.
Are you finding that buyout firms are having more interest in acquiring troubled companies, and if so, what sort of issues do these investments raise?
A lot of firms today are focusing on distressed investments in a search for higher returns, or for returns period—and even in the distressed market the multiples are getting bid up and companies are taking on more leverage. So some of those companies don’t have sufficient cushioning, and should there be a tweak, that’s when the fun will begin. Deals are no longer structured with just an equity sponsor and a senior secured lender. Now you’ve got second-lien holders, mezz holders, etc., and these people have different experience sets and different motivations. Certainly the second-lien holders and mezzanine holders have loan-to-own strategies, and so the dynamic of the workout is going to be different from what it has traditionally been.
How fast do private equity firms come to you guys for help once a problem is noticed? Are there ever instances when they try to fix a company themselves out of pride (or to save money) and end up making it worse?
The answer is a general yes. What happens is that in the private equity world, firms fall into different categories. There are those that know they know everything and are unwilling to acknowledge that they might not know something. Whether you call that pride, ego or arrogance, what it does is prevents a solution from coming to the table sooner rather than later.
Then there are those that recognize that they need help and look to permanent management change as the solution instead of bringing in someone such as ourselves. The question there is sometimes it takes three to six months to find the right person to run the company, during which things could get a lot worse. Also there’s the risk of getting rid of the right person to run the healthy company in order to find an interim manager to run it while it’s in distress.
Then there’s a bucket of firms that have their own operating partners. The question there is, since they’re overseeing an entire portfolio, do they have the time and the resources to deal with the problem?
Lastly, there’s the firms that recognize the usefulness of having folks such as ourselves, who have operating backgrounds and are experienced in dealing with troubled entities in a short time-frame.
What are some of the common, early signs that a company is in trouble that might be too subtle for some general partners to notice until it’s too late?
Sometimes the external environment changes in subtle ways—the completive landscape, some of the fundamentals of an industry or the advent of a new technology—which should be noticed by the company’s management and brought to the equity sponsor’s attention. Things like that can get away from the equity sponsor and are very dependent on the sophistication of the management team.
There’s also ineffective operating strategies. One of the critical things we look at is, does a company understand where it makes money and where it doesn’t? Does it understand its customer profitability? Does it understand its product profitability? What’s its overhead structure, or its manufacturing strategy? All these issues, depending upon the reporting and the approach of the analytics, could be well hidden and could creep up on a firm after it’s too late.