Fulcrum security distressed investing

Historically, distressed debt strategies have performed best in the late-expansion through contraction stages, when financial distress generates an expanded opportunity set. With that control, the distressed for control private equity manager then operates the company with the aim to make improvements before a strategic sale or initial public offering. Unlike traditional private equity managers who look for strong businesses with strong management teams and apply leverage to grow, distressed for control private equity managers look for strong assets or businesses with poor management teams or strategies, and often seek to quickly de-lever.

A distressed for control investor needs the analytical and bankruptcy acumen of a distressed investor, the medium-term business planning and oversight skills of a leveraged buyout investor, and the ability to drive a restructuring process either in or out of court while a company is going through a crisis.

Thus, the strategy requires not only deep specialist knowledge, but also the ability of the fund manager to invest significant time, energy and resources into the restructuring process. Event-driven and opportunistic distressed strategies focus on uncovering and exploiting unique catalysts. Event-driven strategies are opportunistic in nature. Managers seek out stressed but performing assets—often obligations of healthy companies—that are under-priced as a result of illiquidity, market disruption or particular nuances related to the issues or issuer.

It is also important that a catalyst to unlock value, such as a refinancing, is planned or can be negotiated with the borrower. Positions in these often illiquid assets are built strategically over time. Event-driven strategies seek to identify and creatively exploit these unique opportunities at all stages in the economic cycle. For special situation and distressed investors, bad news is good news. Opportunistic distressed debt investments are made in situations in which companies are undergoing, or likely to undergo bankruptcies, or other extraordinary situations such as debt restructurings, reorganisations, spinoffs and liquidations.

Funds investing in distressed debt often become a major creditor of the underlying company through the purchase of deeply discounted bonds. Similarly, in many circumstances, they are able to exercise a certain degree of control in an underlying company through the acquisition of significantly discounted securities in order to enhance the value of the underlying company.

However, as in all situations of distress, risk is elevated. Turnaround private equity managers acquire controlling equity stakes in failing companies, often before or during formal bankruptcy proceedings. Turnaround specialists start with identifying what they believe are good companies with bad balance sheets. Given the often precarious state of the acquisition target, leverage is rarely employed by turnaround private equity managers.

Successful turnarounds require extensive expertise to distinguish situations which can merely be salvaged from those which can eventually thrive. Specialists believe traditional due diligence focused on legal and financial analysis of distressed targets is insufficient to identify winners and losers in the turnaround space. As the most subordinate type of capital, equity investments are by definition riskier than debt investments, and decidedly so in failing companies.

Thus, unlike other types of special situation investments, turnaround strategies are rarely attempted for fundamentally flawed businesses. For target companies expected to go through bankruptcy, mapping out event scenarios or scenario trees where there are interdependencies becomes critical, as there are important distinctions between different bankruptcy chapters when it comes to supervision, operations and outcomes.

Building a solid understanding of existing counterparties, with marked interest in existing debtholders, is arguably of increased importance in distressed scenarios. Beyond differences in the opportunity set, distressed private equity presents distinct challenges and opportunities compared with traditional private equity. As such, their risk-return profiles tend to vary considerably. Returns scenarios are often described as stepwise in special situations investing, as distressed prices rarely fluctuate in a gently sloping line.

Instead, outcomes are frequently more binary. With companies exhibiting signs of stress if not serious duress , risks are elevated in distressed investments. It can be a great company with a bad balance sheet, primarily due to things that are completely out of its control. It does not necessarily mean that the company needs to file for bankruptcy protection; it may just need to identify liquidity solutions, or perhaps an equity infusion, to get through this difficult period.

Bob Del Genio, senior managing director and co-leader of the corporate finance and restructuring segment for the New York metro region of FTI Consulting , says that parts of the energy sector are running into trouble even as demand has bounced back. Even if the U. If companies have difficulty accessing capital, it becomes harder to avoid restructuring or some other type of turnaround effort.

Value Preservation There are a lot more financing options, whether those are bridge arrangements, rescue financing or other workouts that are happening outside of court. Bob Del Genio FTI Consulting For fund managers and investors looking at the opportunity set among businesses in distress, there are a number of ways to get involved. Much of the money raised during the pandemic is still sitting on the sidelines, and many of those funds are designed to be liquidity providers—either through loan-to-own arrangements or simply as a financing provider.

Agile investors trade and play the spreads in high yield, they can buy the fulcrum security, provide rescue financing, or if there is a bankruptcy filing, they can fund a DIP [debtor-in-possession] or purchase claims. There are many more entrants into distressed, who have added more liquidity into the market in the form of alternative financing. The market for special situations and distressed assets has matured over the years, and much more of the activity is happening out of court through improvement plans or other solutions.

Distressed investing encompasses much more than just bankruptcies. The selloff in high yield bonds has been deep, and investors have been hesitant to return, given recent volatility. But both KKR and OakTree have published research notes in recent weeks highlighting attractive entry points reminiscent of what happened in the first half of In that instance, investors sold in response to the pandemic, only for the market to rebound significantly.

While those factors may lead to some distress, default risk remains low, in part because of the preference for work-outs. As a result, high-yield spreads are widening and fund managers that are willing to invest could be well positioned to reap higher returns for taking on the risk.

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