|
Vultures of the New Economy Investors Are Buying Ailing Firms` Debt In Hopes of Cleaning Up on a Rebound By Ian Springsteel Special to The Washington Post Sunday, September 9, 2001; Page H01 http://www.washingtonpost.com/wp-dyn/articles/A60963-2001Sep… Through the spring and summer, broadband and telecommunications companies such as Teligent Inc., Rhythms Communications, PSINet Inc. and NorthPoint Communications Group Inc. filed for bankruptcy, one after the other. Worse, prices for their networks and services collapsed, leaving investors who held their bonds, let alone their stocks, with little or no value. The broadband bust was in full swing. Watching this, Chuck McMinn had his fingers crossed. The chairman of Santa Clara, Calif.-based Covad Communications Group Inc., a provider of high-speed Internet access via digital subscriber line, figured his company could weather the slowing economy and the pressure from anxious investors until the middle of next year, when the company`s approximately $530 million in cash would run out. By then, he hoped, the shakeout would be over and Covad could raise new funds to see it through to steady profits. Investors in Covad`s bonds weren`t so optimistic. The initial buyers of Covad`s $1.4 billion in junk bonds had largely sold off their holdings at steep losses. By July, the bonds traded at 10 to 15 cents per dollar of their original value. The company was still losing money, and the market for broadband Internet access had slowed dramatically. Despite Covad`s cash on hand, many expected the firm to fail. Then opportunity knocked. Several hedge funds that had bought some of Covad`s bonds met with McMinn and other executives at Covad`s offices in mid-July, urging them to cut a deal: File for bankruptcy; pay us back a fraction of what the bonds are worth, in cash and preferred stock; and Covad can walk away debt-free. All over the country, "vultures" are spotting struggling firms such as Covad and snapping up their debt. Like the bird of prey they`ve been named for, these investors clean up debris -- in this case the leavings from the latest boom-and-bust economic cycle. The vultures` hedge funds -- vulture funds, of course -- specialize in distressed debt, meaning bonds and loans that are trading at a steep discount to their original value. Vulture funds have been around for years, often formed -- by insurance companies, mutual funds, highflying tycoons, investment banks and the like -- specifically to buy distressed debt and underpriced assets during recessions with the hope of making a bundle when the economy rebounds. The current slowdown is no different. With poor returns in stocks, which continue to plunge, the distressed-debt market has blossomed this year, welcoming a host of opportunistic players, including investment banks such as Goldman Sachs Group Inc. and Credit Suisse First Boston, empire-building tycoons of the likes of Warren Buffett and Philip Anschutz, and a wide range of hedge funds, backed with money from pension funds, insurers and the super-wealthy. The allure for these investors is that they can buy the debts of telecommunications, financial and other struggling companies at a steep discount, aiming to make returns of 30 percent or better per year as the economy improves. An Appealing Deal The deal for companies -- like Covad -- can also be attractive. Far from fearing the prospect of tangling with vultures, "I was personally excited about the opportunity," McMinn said. "I felt that this was a very savvy thing to do. The bondholders had recognized the value of the company and wanted to work out an agreement that was mutually beneficial." Several rounds of negotiations with the bondholders, which sources say included distressed-debt funds Oaktree Capital Management, based in Los Angeles, and New York-based Fir Tree Partners, were "very tough," McMinn said. But eventually an agreement took shape: Covad would pay out 19 cents on the dollar for the bonds, plus about 15 percent of the company`s equity in preferred stock. At a cost of only $283 million, Covad would retire all of its $1.4 billion in debt and would still hold $250 million, enough to operate into early 2002. "At the end of the day, we knew and they knew that this was a good deal for everyone," McMinn said. After gathering the support of a majority of bondholders for the plan, Covad filed for Chapter 11 bankruptcy protection on Aug. 15. The company hopes the bankruptcy court will approve the deal, applying it to all bondholders. Cutting Losses The flood of vulture-fund money is playing a crucial role in keeping the current economic slowdown from worsening. By providing a ready market for banks, insurers, and loan and bond funds to shed troubled debts, vulture investors are helping initial investors cut their losses and recycle capital back to healthy companies. In all, approximately $40 billion is currently dedicated to buying distressed company bonds and bank loans, compared with about $25 billion just 18 months ago, according to estimates by Edward Altman, a professor at New York University`s Stern School of Business. Plus, less-specialized hedge funds hold about $40 billion to $60 billion, ready and available for distress investments; in fact, the funds have raised $4 billion in the first six months of this year for that purpose, according to hedge-fund tracker Tremont Tass Ltd. Banks and insurers are not struggling the way they did in the early 1990s, when the numerous bankruptcies from real estate and leveraged-buyout excesses weakened the banking system. Nonetheless, the distressed-debt market is helping them clean out their balance sheets and limit their loan-loss reserves. But conditions could turn less rosy. Some investors expect that additional business failures and debt defaults will cause the supply of distressed debts to overwhelm the demand. There is currently an estimated $600 billion worth of distressed and defaulted bonds and bank loans for sale at an average of 60 cents on the dollar. Yet, defaults and bankruptcies are not expected to peak until early next year, according to Moody`s Investors Service and the American Bankruptcy Institute. "Eventually, I expect the amount available for sale will overwhelm the market," said Marc Lasry, managing partner of Avenue Group, a $1 billion distressed-investment fund. When that happens, Lasry and other buyers say, investors will focus on only the best companies available, while loan prices of less promising firms will fall sharply. NYU`s Altman isn`t so sure that this is how things will go. "That view has some merit," he said, "but the counterargument is that [bankers] wake up and say `Why sell?` " "Banks may just hold debt because they can," due to their strong earnings, he said. Nonetheless, Altman and investors alike sound a note of caution: There remains a chance that some structured loan and bond funds, known as collateralized debt obligations, which currently hold $300 billion in loans and bonds, could unravel. "If things get worse," Altman said, these funds "may be triggered into liquidity mode and forced to sell their holdings." The market for distressed and bankrupt loans is a secretive world, especially compared with securities trading, where regulators demand a certain amount of transparency. Buyers and sellers trade loans and bonds among themselves directly, rather than on an exchange or through a central market. No reporting is required of specific sales. A few analysts and trading desks publicize limited information about how they handle the debts of larger companies. But most participants refuse to say how much of a loan has been bought or sold, to whom or at what price. But several do say that the pace of activity has quickened in recent months. "In the first quarter, many investors were still nervous, as many were not convinced the market had reached its nadir. Now that they are seeing some economic stability, fund flows to distressed-asset funds have increased significantly," said Nicola Meaden, chief executive of Tremont Tass, based in London. "Right now there is a lot of product to choose from, and the market is increasingly liquid. That`s good for us, and good for the banks and mutual funds that want to sell distressed assets," said Brian Schinderle, co-head of the $900 million Special Investment Group for PPM America, the U.S. division of Britain`s Prudential Portfolio Management, a division of London-based Prudential Insurance Ltd. "Interest in distressed bank loans, and pricing in the market, improved substantially in the second quarter and remains strong," said Paul Hogan, chief risk officer of Fleet Financial Group, the Boston-based bank group. Fleet sold $100 million in troubled loans between April and June, in addition to $225 million that it sold late last year. For banks, this interest has meant that they are not necessarily stuck when borrowers do not repay loans. For instance, Bank of America sold $800 million of bad loans in the first half of the year, enabling the bank to keep its percentage of problem loans down, at about 1.63 percent. `Good for the Banks` Banks sold about $2.6 billion in commercial loans in the first half of the year. That has kept the growth in nonperforming loans to about 1 percent. Without these sales, nonperforming loans would have risen by about 12 percent to 14 percent, according to a Goldman Sachs analysis. "The ability to sell problem loans is good for the banks for many reasons," said David Gibbons, deputy comptroller for credit risk at the Federal Reserve`s Office of the Comptroller of the Currency. "Not only does it help them recoup funds to put to work elsewhere, but the active trading of loans helps banks to understand what others see as the true risks and rewards of various loans." Banks and bondholders, of course, take a loss, since they never get the full amount they lent out. But they sell at a discount because they have concluded that there is little chance the borrowers will pay up or because it will take too much effort to get their money back. It is easier for them to cut their losses by selling the debt, and the risk, to others. In turn, investors in distressed debt gamble that they can get their money back. And because they paid less than full price for the loan, they have to recover only a fraction of the original loan to make money. For instance, when there were indications late last year that Finova Group, a major financing company, would default on its bank loans and bonds, numerous banks sold the Finova loans they were holding. The loans traded at a low of 63 cents on the dollar last December. Major vulture funds, including Oaktree, New York-based Angelo Gordon and Cerberus Capital and PPM`s Special Investments Group in Chicago, bought the debt, as did a variety of hedge funds that do not specialize in distressed debt. After a joint venture between Buffett`s Berkshire Hathaway Corp. and Leucadia National Corp. battled with General Electric Co. for control of Finova, the value of the bank debt and bonds rose. The winning bid by Buffett`s group gave bank debt and bondholders 70 cents cash on the dollar and 30 cents in new bonds. That means most of the distressed investors won big. Facing the Pressure In situations similar to Covad`s, companies not in default are being pressured by distressed investors to use cash on hand to buy back their bonds, instead of using it to fund their operations, or face lawsuits. Investors assert that directors and management have a fiduciary responsibility to repay bondholders with cash on hand, if they think the company is going to fail. In the case of Covad, chief executive McMinn said no legal threats were made, but he added that the Covad board was aware of the legal thinking among bondholders. Some companies would rather fight than negotiate. Mpower Communications Corp., a Pittsford, N.Y.-based telecommunications services firm, for example, ignored overtures from Fir Tree Partners to cut a deal, and last month he was named in a civil suit by Fir Tree, asking the court to declare Mpower insolvent. This would then force the company to pay bondholders back with its cash on hand. Fir Tree holds $70 million of the company`s $467 million in bonds. Almost immediately, Mpower countersued for defamation and claimed business interference. Other companies are taking matters into their own hands. Primus Telecommunications of McLean, for instance, secretly used a Wall Street investment bank to beat distress investors at their own game. Between April and July, the company spent $88 million to snap up $386 million of its $1.12 billion in outstanding bonds, or 23 cents on the dollar. "We knew we would eventually have to repay those bonds at par. By retiring them at a discount, we`ve improved our cash flow and our balance sheet," said Primus spokesman Jordan Darrow. "Our goal is to become financially self-sufficient by next year," said Darrow, who acknowledges that the company still has only enough funds to operate until the first quarter of next year. With far less debt, though, the company "is in a far better position to raise new funds next year." Jack Williams, a law professor and scholar in residence at the American Bankruptcy Institute, fears that banks are quicker than they have been to turn their backs on long-term business customers, selling their loans and leaving their customers as prey for vulture investors. And because the vultures do not have long-term relationships with the borrowers, the vultures may force bankruptcies and asset sales too quickly. "It`s likely that more people and more companies will be considerably harmed in this downturn, as many will not receive the kind of accommodation they need [from] their lenders to keep going until the economy improves," he said. But Barry Ridings, co-head of the restructuring group at investment bank Lazard Freres & Co., which handled recent restructuring negotiations for Rhythms Communications and Vlasic Foods International, among others, said: "I would rather deal with a [distressed-debt] investor who paid 50 cents on the dollar than a dozen bankers who all made the original loan. The bankers signed onto the original business plan that failed, and they want their money back." |
|
| aus der Diskussion: | Covad - Himmel oder Hölle |
| Autor (Datum des Eintrages): | Bannerman (10.09.01 00:24:12) |
| Beitrag: | 34 von 149 (ID:4386843) |
| Alle Angaben ohne Gewähr © wallstreetONLINE | |