Saturday, May 15, 2010
The Critical Role of Private Equity

Last month the Gordian Group’s Peter S. Kaufman and Henry Owsley sat down with the American Bankruptcy Institute for a podcast on the role of PE in distressed companies during this economic cycle.

For PE that’s looking to buy into underwater situations, there are plenty of opportunities, but someone’s going to take a haircut: either new PE’s got to be willing to “link arms” with the old PE and give creditors less than 100%, or new PE can try to do a deal with the creditors and impose a deal on the old PE.

PE firms who currently own distressed companies need to create a portfolio of options and see which ones take root.  For example, together old and new PE can wait it out and try to grow the business.  This requires that the company’s long-suffering creditors are willing to wait it out with you.  Readers of this blog know that before embarking on this strategy, viability tests must be run to ensure that the probability of a successful turnaround is high and you’re not throwing good money after bad.

Another possible play for distressed firms is to engineer a financial restructuring.  If the entity is already underwater, this restructuring may include an involuntary bankruptcy and/or asset sale.  This can be thought of as a loan-to-own strategy.  The holders of the PE will reap the most benefit, leaving a lot of angry creditors.

What is the landscape for credit today?  With short term rates near 0%, there is a lot of available credit.  Kaufman and Owsley opine that we may be in another speculative bubble with results that are no different than they are any time that excess capital chases yield:  poor investment decisions that ultimately need to be unwound.

What are some of the considerations necessary to achieve a positive result in today’s environment?  First, is PE willing to put in more capital?  Are all of the players willing to get creative and/or “ruffle some feathers”?  Are the varying views of valuation even in the same ball park?  What kind of documentation is underlying the debt?  What does PE bring besides cash?

How quickly are you able to determine viability?  It doesn’t take Gordian Group too long to understand the valuation, capital structure and the documentation, but they find that people don’t want to “’fess up” about make-or-break issues such as liquidity.  They concur with our point of view that it’s never too early to face the reality of your liquidity position and taking steps to improve it.