Vultures Raising Billions for Buying Spree (Dead Cat Bounce?)

Reuters
Vultures Raising Billions for Buying Spree
Saturday February 22, 2:58 pm ET
By Dane Hamilton

NEW YORK (Reuters) - With nearly a trillion dollars worth of distressed and defaulted corporate debt flooding the market and the economy eventually headed for a rebound, now is the time to start buying corporate paper, right?

These days, dozens of private equity firms are banging on investor doors, looking to raise billions of dollars to buy distressed debt and undervalued assets in the hopes the underlying companies can be turned around.

But few of these "vulture" funds, it seems, have mastered the art of buying at the bottom, particularly when it came to investing in "falling knives" like WorldCom (Other OTC:WCOEQ.PK - News), experts say.

"When blood is running in the streets, that's the time to buy," said James Manley, founder of Atlantic Pacific Capital, a "placement" firm that raises money for private equity funds. "A lot of these people just don't know how to pick the bottom."

Manley, whose Greenwich, Connecticut-based firm is raising money for distressed funds like MatlinPatterson, Wellspring Capital Partners and others, said returns for distressed funds have on average have been "flat" over the past year, well below the double-digit returns investors demand. Still, those returns haven't stopped dozens more from raising money.

Distress investors fall into two categories: those who trade in corporate paper in the hopes it will rise, and those who buy to gain control of an enterprise, hoping to turn it around.

The basic theory is that good companies with bad balance sheets can be turned around, making that debt more valuable. If the company goes bankrupt, control investors will be able to swap that debt for equity and push for business improvements.

Unfortunately, experts say, many vultures failed to predict the extent of mismanagement or fraud at WorldCom, Enron, Adelphia and other major issuers of debt, disclosures of which drove that debt to unprecedented lows.

And with an economy that shows few signs of improving anytime soon, many such investors are facing tough times generating the double-digit returns that their pension fund investors demand for tying up their money in an illiquid asset.

Zurich Capital Markets, which compiles an index of 10 "representative" distressed securities funds, says returns for such funds were 2.64 percent in 2002, compared with 14.7 percent in 2001 and 19.8 percent in 1999.

"Academically, you can say the market is right for distressed investing," said Erik Hirsch, chief investment officer of Hamilton Lane, which advises pension funds on private equity investment. "But a number of groups have lost hundreds of millions of dollars in the last few months."

Firms that got slammed typically bought companies like WorldCom when their bonds were trading at 50 cents to 70 cents on the dollar, only to see the bonds collapse to the mid-teens as news of corporate mismanagement came out, experts say.

While bonds in the 50- to 70-cent range are still viewed as distressed but likely to improve, bonds below 20 cents on the dollar reflect a company with a high likelihood of liquidation, traders say. That leaves only the most courageous to buy those bonds.

Still, experts argue that bottom-feeding has fewer risks with funds that engage in a buy-and-hold strategy. Annual performance numbers can be misleading for a fund that aims to hold the paper for years and help a company restructure.

"This is the first wave of distress, and the verdict hasn't been written yet," said Bill Farrell, founder of Greenwich, Connecticut-based Farrell Marsh, which raises money for private equity funds. "We're waiting for the market to return."

Some fund managers seem positively sanguine over the prospects for investing in distressed securities, despite recent losses.

"Some funds have proved hugely successful," said Brian Murphy, managing director of Portfolio Advisors, a Darien, Connecticut-based fund manager that oversees $2.5 billion in private equity. "We are seeing more distressed players than ever and there are plenty of good quality funds to invest in."

MatlinPatterson, for instance, is raising more than $2 billion for its second distressed debt fund. And Pegasus Capital Advisors intends to raise $750 million to add to its $800 million under management for "control" investing. Others in the market include Wellspring Capital, which is going for $500 million and Black Diamond Capital, which is raising $500 million, market sources say.

The latest round of fund raisings come on top of last year's crop, when veteran "vulture" funds that won big after the recession of the early 1990s -- Apollo Group, Cerberus Capital, Angelo Gordon and Oaktree Capital among them -- each raised over $1 billion.

Experts say there is still a huge disparity between supply and demand for such paper, and that many more funds could be raised and still compete successfully for deals.

New York University Professor Edward Altman recently put the amount of defaulted or distressed debt on the market at a whopping $942 billion. But funds dedicated to control investing have only raised some $20 billion for that strategy, experts estimate.

Farrell Marsh's Farrell says investors may have to wait years in some cases for a big return. For control investing, a fund first must accumulate a large position in the debt, swap it for equity and then push for a business turnaround.

"The survivors of the early 1990s did very well or they wouldn't be around today," Farrell said.

"Dead Cat Bounce?"

Doesn't that expression more often refer to equity markets? These vultures are snapping up distressed BOND debt, not equities. Bonds are generally still in "bubba bubble" status, except for these distressed by scandal one's they're talking about, right?

P.S. You'll always be famous for your shuttle thread!!!

Neither traders nor investors can buy at the very bottom any more than they can sell at the very top. BUT, guessing the bottom is easier than guessing the top. (Nobody wants to sell when their greed tells them to hang on just a little longer. . .)

Neither traders nor investors can buy at the very bottom

These are the ones who set the bottom. Granted their whole position will not be at the low.

You have gone way beyond my knowledge and expertise in asking that question. When I saw the article I was just fascinated with the idea that there is this much pent up demand, ready and willing to bust out at the right time.

Thank you for your comment about the Columbia. You know what they say about all fame. BTW, I think the thread, Observation on TPS damage on Orbiter, that is running with over 2500 replies is where the action is. I have to wonder how many NASA engineers and others are taking notice. FR's reach is far and wide.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.