For certain there’s no shortage of investment opportunities. As of July 14, ratings agency Standard & Poor’s counted 145 companies globally (118 in the United States) as being at high risk of defaulting on their debt. Another 42 companies (40 in the United States) have already defaulted on their debt so far this year, compared to only 22 defaults for all of 2007. Looking ahead, S&P expects the U.S. speculative-grade default rate of 1.4 percent to jump to 4.7 percent by May 2009. For that to happen, 73 issuers would have to default within the next year, or an average of 6.3 defaults per month. And none of those figures includes the vast number of troubled companies whose debt S&P doesn’t track.
Maria Boyazny, a managing director who oversees $3 billion in distressed-oriented funds-of-funds at
Meantime, U.S.-based turnaround specialists are flush with cash. They’ve raised north of $25 billion from limited partners in the past 18 months, according to information compiled by Buyouts.
But the gloom-and-doom troops seem to be patiently biding their time as opportunities parade past. Several have actually slowed their investment pace over the last few months, according to data compiled by Thomson Reuters, publisher of Buyouts.
Indeed, across the board turnaround shops seem intent to avoid being on the receiving end of one of their favorite metaphors—the falling knife. “Right now we are selling a couple of businesses that are generating competitive interest from buy-side [turnaround] firms,” said Lorie Beers, a managing director at
Unfortunately, that could mean more companies winding up in total liquidation, never to be seen again, rather than ending up back on their feet thanks to the operational prowess turnaround shops can bring to bear. The slow deployment of capital by turnaround shops could also contribute to the depressed outlook for buyout-shop deal flow. More and more, turnaround firms have been turning fixer-uppers into cash flow-positive companies that can sustain leveraged buyouts. Recent examples include KPS Capital’s sale last October of manufacturing concern Genesis Worldwide II Inc. to
, co-founder and managing partner of KPS Capital, said that his firm could easily have invested half of its $1.2 billion third fund, which closed last November, in opportunities that have been presented to his firm thus far in 2008. To date, however, the fund has become steward to only one platform during that time, Global Brass and Copper Inc., an East Alton, Ill., manufacturer and distributor of copper and copper-alloy components. In its inaugural deal,l the company acquired certain assets of Bolton Metal Products Co. for an undisclosed amount this past February.
“The investment opportunities that one sees at the beginning of a down cycle tend to be very low quality, because the worst companies in their respective industries are the first to get sick while the strongest companies are the last to capitulate,” Psaros said. He and other investors in distressed assets believe that we are just at the beginning stages of a cyclical downturn that could last beyond the end of this decade. “These cycles, generally speaking, last for three years, and we have no reason to think that this one’s any different because we haven’t seen anything quite this bad in our respective careers,” Psaros said of himself and his fellow partners. “Patience, for an experienced turnaround investor, is a virtue.”
Patience, of course, helps turnaround firms like KPS avoid paying up for a company whose value still has plenty of room to fall. In fact, turnaround professionals say that many owners have held on to yesteryear’s pricing expectations, thus creating a disconnect that can preclude a deal from being struck.
“We’re certainly seeing the lagging expectations of stakeholders preventing transactions, which to me has been an underlying theme over the last 12 months,” said Paul Halpern, a partner and general counsel at Philadelphia-based turnaround firm
Michael Donohoe, principal and general counsel of Dallas-based turnaround shop
Indeed, if default rates perform as expected, there’s a chance that sell-side confidence will come down, and valuations with it.
KPMG’s Beers said that the correction in valuations may have already begun. “Reality has begun to set in and people are adjusting their expectations,” Beers said. “Those that don’t have to sell right now realize that in this environment they are not going to get a full value for their companies and they’re sitting on the sidelines. But those that do have some sort of adverse issue, be it balance sheet or operational, are taking a more realistic approach” to what they’re willing to sell for.
Once buyers and sellers do start seeing eye to eye, deal pros say that consumer products and services be ripe for the picking. Rising costs for raw materials such as oil and gas, resins, and food are placing higher burdens on companies that cannot pass the cost on to their customers. Of the 32 buyout-backed bankruptcies thus far estimated in 2008, 11 are consumer products and services businesses, including retailers and restaurants.
“The working class has lost its expendable income,” said Tim Pruban, founder of crisis advisory firm
Added KPS’ Psaros: “While from a purely self-interested standpoint I am very happy for my investors and for KPS because this is a great time for us, as an American and as a father and as a husband this is a scary time.”