Gyrations in the credit markets and public equity markets have roiled private dealmaking, upending agreed deals and making financing hard to find..
But with the economy struggling to avoid falling into a double-dip recession, turnaround specialists and investors in distress say conditions are in their favor.
“Our firm has never been busier. Our people have never worked harder,” Michael Psaros, managing partner of the New York buyout firm
KPS Capital anticipates two or three announcements by the end of October, where it is buying carve-outs by larger strategic sellers. Psaros said 75 percent of the firm’s pipeline is corporations selling non-core operations, with the remaining 25 percent being sales in Chapter 11.
KPS Capital also has been active on the exit front, announcing an agreement in August to sell Attends Healthcare Inc. to a strategic buyer, Domtar Corp., for $315 million. (A source said the deal would deliver KPS Capital a 15x return and 120 percent IRR.)
KPS Capital bought the money-losing PaperPak Products Inc. in 2007, rebranding it for its primary product, an adult incontinence aid, upgrading its manufacturing equipment and making other operational improvements. Such opportunities are consistently available to the turnaround specialist that is willing to invest, Psaros said. “We strongly believe our business is non-cyclical, because there is an inexhaustible supply of bad management.”
Some investors may have rushed in too quickly when markets bounced back from the financial crisis, Psaros said. “The assumption was that there would be a traditional economic recovery. All these companies needed was a return to conventional end user demand. … As we all know, that has not turned out to be true.”
But while markets may have bounced back, the broader economy has scarcely risen out of recession. As a result, in deals that were done then, in anticipation of economic improvement, companies continue to limp along, leading to “creditor fatigue” and increasing difficulty in the future, said Albert Koch, a vice chairman and managing director at restructuring consultant AlixPartners LLP. “It is going to become increasingly difficult for companies to refinance.”
Recent market volatility has exacerbated the situation, Koch said. “The high-yield market was red hot. You could refinance almost anything. Almost overnight it has become very unappealing.”
While a weak domestic economy is a factor, the larger issue looming over credit markets is the psychological effect of the sovereign debt crisis percolating in Europe, said Steven Oh, a managing director at the investment manager PineBridge Investments LLC and co-head of its PineBridge Leveraged Finance unit.
With Greece already in bailout mode and fears growing over other euro-demoninated economies from Ireland to Italy, debt investors fearing an “Armageddon scenario” are fleeing to safe havens, such as U.S. Treasury securities and gold, Oh told Buyouts. “While the market is cheap today, it could get cheaper tomorrow, and the market is looking for an entry point.”
The uncertainty makes it difficult to price deals, as well as to pick sectors that might present the best opportunities, said Franklin Harris, co-head of the financial sponsor group at the investment bank Lincoln International LLC. “Given the recent public market turmoil, it’s a particularly difficult time to focus on broad investment themes.”
The turmoil can work to the advantage of a distress investor, thanks to the inherent patience of private equity, said Andrew Miller, a senior managing director at the investment bank Houlihan Lokey. “Part of it is the model is to know when things will get cheaper. A good distressed financial investor does not invest in the equity too early. With patience, they can wait and buy the company for less than the debt.”
In a somewhat longer view, investing in distress appears to be on track to meet its historic norm for the past several years, according to Thomson Reuters data. Since 2006, this segment has been a steady source of about 100 deals a year, except in the financial crisis year of 2009, when the number of deals tumbled to 75. Through Aug. 10, Thomson Reuters had tracked 70 deals in the distress/turnaround category, close to recent norms.
At least 20 firms are in fundraising mode now, focusing on distress and turnarounds, according to data collected by Buyouts. The two largest, pools being raised by