alternative assets, Argo Group, asset managers, bankruptcy, BDCs, business development companies, Colony Financial, de-leveraging, distressed assets, distressed consumers, distressed investing, Fortress Investment Group, income/dividend bubble, JZ Capital Partners, litigation funding, private equity funds
In my last post, I briefly highlighted some difficulties a private investor might face with classic distressed debt investing. Recognizing these limitations, I usually prefer to stick with distressed debt asset managers & investment vehicles. However, there’s many other firms in orbit around this opportunity. Even better, my definition of distressed investing stretches to include what I call the distressed consumer. Consider it exploitation of the poor, if you wish – but the real bonanza is actually much more equal opportunity. To be blunt, it’s really about the exploitation of the (financially) stupid… And stupidity’s an enduring human frailty to bet on, despite the frequent & pointless efforts of politicians to legislate it away.
Let’s begin with the business end of things:
Picture you’re an ailing company whose business & finances are beginning to seize up. You’ve executed on most of the usual cost-control & cashflow measures already, but you still need more juice… Your book of receivables might yield some quick cash – Intrum Justitia (IJ:SS) can help. PRGX Global (PRGX:US) may unearth new and unexpected savings, waste & fraud for you. [PRGX is now expanding into US healthcare. Considering the unconscionable levels of fraud, waste & over-billing in that industry, this could offer them a huge new growth opportunity]. You might have been pinning your hopes on launching/winning a crucial lawsuit, but now you can’t afford the legal expense & uncertainty – Burford Capital (BUR:LN), Juridica Investments (JIL:LN) & IMF Australia (IMF:AU) can lower your risk & provide the necessary funding. Maybe you should also start selling anything that isn’t nailed down – call Ritchie Bros Auctioneers (RBA:CN).
At this point, you’re getting desperate – you need additional financing, not to mention the fact your existing lenders want out…! More flexible (i.e. expensive) forms of funding are required, which you won’t find in the banking world. There are less palatable alternatives, but the most obvious source of ‘friendly‘ funding might come from the likes of the (US) business development companies, for example. These were originally envisaged to be PE/VC firms which invested in small/medium enterprises. But over the years, management & investors’ obsession with dividends at all costs has corrupted many of the BDCs, in my opinion – now, equity interests & warrants are just kickers, the real focus is on providing high interest debt & mezzanine funding.
With insatiable demand from investors, and the continuing collapse in yields & spreads, they’re constantly pushing the envelope in terms of risk. Which means they unfortunately gravitate towards loans which can be barely serviced today, let alone tomorrow…and may soon be the next write-down they attempt to avoid. I wouldn’t be at all surprised to see the entire sector end up in another final edition of David Einhorn’s ‘Fooling Some of the People All of the Time’. So God forbid I’d actually highlight some BDC tickers..!?
But if that’s what really tickles your fancy, here’s a twist: Consider JZ Capital Partners (JZCP:LN). It’s London listed, but the equivalent of a US BDC – it primarily invests in small-medium US companies & is run by a well-respected US team (Jordan/Zalaznick Advisers). Versus most BDCs, I believe it’s got a better quality portfolio, a better investment record, and (best of all) it’s far cheaper – despite a recent run-up, it still trades on a 15% discount to NAV. I’ve tracked and/or invested in JZCP for well over a dozen years now – kelpiecapital did a detailed write-up a little over a year ago. [Incidentally, this fits right in with a recent/popular theme for me – buying cheap US assets in the UK/Europe (for example, see here & here). So much for efficient markets..!]
Eventually, of course, you’ll end up begging for help restructuring your finances & business from companies like Lazard (LAZ:US), FTI Consulting (FCN:US) & Begbies Traynor Group (BEG:LN). [You’ll be encouraged to know if they don’t get it right the first time (i.e. pre-bankruptcy), you can always ask them back to finish the job off in bankruptcy! At that point, they might also call in the following: Counsel RB Capital (CRBN:US) or Great American Group (GAMR:US)]. But before that fateful day, there’s a few listed turn-around firms which might take pity on you & invest. Volvere (VLE:LN) & EPE Special Opportunities (ESO:LN) are two such small, cheap & interesting UK firms, while there’s a veritable rash of them in Germany (Bavaria Industriekapital (B8A:GR) is just one example).
Once bankruptcy hits, of course, we’re into classic distressed debt territory. The most obvious pure-play funds are listed in London – note most are funds of funds which are now in wind-down mode (as a consequence of wide-spread credit crisis gating in their underlying fund investments): Global Fixed Income Realisation (GFIR:LN), FRM Credit Alpha (FCAP:LN), Acencia Debt Strategies (ACD:LN) & NB Distressed Debt Investment Fund (NBDD:LN). CQS Diversified Fund (CQSU:LN) & BH Credit Catalysts (BHCU:LN) are in-house fund(s) from the immensely successful CQS & Brevan Howard – they also offer investors exposure to distressed debt (along with relative value & long/short strategies).
The US has an unexpectedly disappointing offering of distressed debt funds. This is certainly a disservice to investors…but the blame may actually lie partly with investors too. The US obsession with dividends (particularly in the fixed income & real estate sectors), and the over-valuation it encourages, makes it nigh impossible for (listed) funds to buy true distressed debt. Because it doesn’t pay a coupon, and prospective gains on principal are sure to be lumpy & uncertain – both of which are incompatible with a consistent/excessive dividend strategy. About a year ago, I did investigate further & there were really only 4 funds that jumped out at me – I wrote about them here (inc. Colony Financial (CLNY:US) which I sold recently in light of other highly correlated holdings & to realize some gains).
Fortunately, the US does offer something better: The cow, rather than the milk, i.e. distressed debt asset managers. These were included in a series I wrote last year, covering alternative asset managers – here, here & here. That series actually culminated in a write-up on Fortress Investment Group (FIG:US) – which is a significant (5.9%) holding for me, with substantial gains to date & plenty more upside potential still. Oaktree Capital Group (OAK:US) & Apollo Global Management (APO:US) are two other US firms with a primary focus on distressed debt asset management. However, let’s not forget Argo Group (ARGO:LN) (a 5.2% holding) has similar expertise, and the unique distinction of investing primarily in emerging markets – here’s my latest letter to them.
I did come across two other rather fascinating companies recently. The first is Firstcity Financial (FCFC:US), which buys portfolios of non-performing loans. I wish I’d found this company years ago – now it’s been taken over at $10.00. [I’ve a faint suspicion the bid might still be raised, or maybe even trumped – DYOR, of course]. Its website, reports & recent filings are worth a read, regardless. The second company emerged from bankruptcy with large net operating losses (NOL) intact. It’s run with a dual mandate: i) Distressed debt investing, and ii) private equity investment to take advantage of its NOL. This is a great reminder there’s probably many other similar NOL companies out there, post-bankruptcy or otherwise. However, this company may have a unique distinction – it’s run from a financial perspective, and its NOL amount to many multiples of its current market cap! I’ll save this one for a possible future investment/write-up…
Finally, how can we wrap up this section without referring at least once to what I like to call ‘the investment opportunity of a life-time‘: European distressed assets. Unfortunately, there’s not that much to say, yet… It’s obvious there’s $10s of billions of non-performing/distressed assets scattered across the continent, mostly located on bank balance sheets which are urgently in need of further de-leveraging. However, a significant percentage of banks & countries don’t seem quite ready yet to bite the bullet & recognize (let alone realize) their losses. But this process will follow an inevitable & inescapable path…
To date, we’ve seen a limited number of deals, with US alternative asset managers & funds actually doing most of the running – I expect those same large US PE/distressed fund managers will become even bigger European-focused buyers & fund-raisers over time (a key reason for buying FIG, for example). However, there’s still an appalling dearth of pure-play European distressed investing opportunities at this point. Some of the UK listed property companies/funds & real estate debt funds may ultimately focus on distressed property/loans, but that remains to be seen. Otherwise, the only company that’s really caught my attention is NBNK Investments (NBNK:LN), now effectively controlled by Wilbur Ross – this looks like it’s shaping up to be a European bank/banking assets acquisition vehicle. However, it will require some major debt & share issuance to complete acquisitions of any significant scale.
OK, in my next Century post I’ll turn to the distressed consumer…