With the economy slowly recovering from recession and scores of bankrupt companies being hung out to dry, distressed investing seems to be drawing greater interest from traditional buyout shops.
Anecdotally at least, buyout firms are on the cusp of moving into the area as they see experienced distressed funds doing deals left and right, industry pundits say. At the same time, they’re being cautious before diving in. Therein lies the rub: while the practice of investing in distressed companies does seem to be creating a buzz, buyout firms have not started doing it in large numbers just yet. At least not in the eyes of Edward Altman, a professor of finance at New York University’s Stern School of Business.
“The firms that focus on this type of investing are ahead of the game,” he says. “I haven’t seen any traditional firms jump into distressed investing, but I do get a least one phone call a day from a firm that is thinking of raising a fund devoted to the distressed markets. There’s not much going on in traditional buyouts but there is a lot happening with distressed companies.”
Rodger Krouse, a managing director at Sun Capital Partners, which only invests in distressed companies, says that while he also hears of a lot of firms pondering the idea, Sun has not seen any traditional buyout firms come into the distressed area. However, he added that he wouldn’t be surprised if some do emerge in the near future, as many seem to be in the preparation stages.
H.I.G. Capital, which just launched into fund raising mode for H.I.G. Capital Partners III, is looking to invest a larger percentage of its new fund into distressed companies. While the Miami-based firm only invested 15% of its last fund into distressed companies, Tony Tamer, H.I.G.’s co-founder and managing partner, says that more than 20% of H.I.G. Capital Partners III will be put into distressed companies.
Tamer is not the least bit worried about H.I.G. getting deeper into the distressed arena. “We feel comfortable, because we have professional operating expertise in the area,” he says, adding that the challenges facing distressed investors are very different than what traditional buyout firms face.
“You have to navigate though the bankruptcy process, which can be confusing, because of the various classes of bankruptcy. Distressed investing takes work. You can’t just get into distressed investing. It takes certain operating skills and some very heavy lifting,” explains Tamer.
Sun’s Krouse agrees that traditional buyout firms are not going to waltz into the distressed space and become heroes overnight. “You really need a certain mind set and investing style to feel comfortable doing it. You’re going into industries that you often do not know, and dealing with companies that are not performing well. You have to turn them around. That is a great challenge and there is a skill set the goes with the challenge.
No matter how a buyout firm gets into distressed investing, says Russell Pennoyer, a partner at Benedetto Gartland & Co., it will no doubt get addicted. “There are always companies that run into difficulty. Even in good times, companies go bankrupt. There will always be pockets of value in distressed companies that will always make this type of investing worthwhile,” he says.
Pennoyer predicts that firms will continue to play in the distressed arena and become very successful, even after the economy improves markedly. Then there are others who “will move out of it because the risk is too much for them.”
Altman uses the example of law firms to explain what will happen. “There is less M&A activity now so M&A lawyers are becoming restructuring specialists,” he said. “There is less regular activity, so everyone becomes a specialist but they are just bridging the gap. It’s the same thing in the buyout space. When traditional investing gets back to normal, they will head back to what they were doing before.”
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