Retailers in trouble, margin of safety, bad balance sheets - distressed investing

Opportunities are everywhere.

It’s Awful, Except for Distressed Investors Readying to Pounce

(Bloomberg) – Distressed-debt investors may be getting closer to the moment they’ve been waiting for: an old-fashioned market meltdown.

Coronavirus concerns have sent bonds of the lowest-rated issuers plunging over the past week, amid the kind of panic selling that creates opportunities for investors who focus on troubled companies. They’ve been raising new funds and stockpiling record amounts of cash for years – even as the supply of distressed debt bumped along at skimpy levels – to pursue opportunities that have yet to emerge.

Energy companies, already the biggest source of distressed bonds, were among the hardest this week, with new lows on issuers ranging from Chesapeake Energy Corp. to Whiting Petroleum Corp. Oil fell to its lowest level since December 2018 and energy bonds have continued to under-perform most high-yield sectors.

Other industries weren’t spared, with yields driven past 20% on some bonds from retailer J.C. Penney Co., container-maker Tupperware Brands Corp. and mall operator CBL & Associates Properties Inc.

​“Markets had been ripe for a correction for some time,” said Ben Briggs, a high-yield and distressed credit analyst with INTL FCStone Inc. “Once the dust settles, there will likely be buying opportunities to be had.”

The supply of distressed debt has been mostly stuck around $100 billion since early 2017, leaving investors, bankers and lawyers who specialize in the field scrounging for what little business was available. The day of reckoning has been put off because central banks around the world have made cheap money so widespread, which enabled financially weak companies to put off defaults.

U.S. corporate high-yield bond funds reported outflows of $4.2 billion during the week ended Feb. 26, the largest outflow since October 2018, according to Refinitiv Lipper data. Risk premiums on derivatives insuring against high-yield defaults widened the most this week since September 2011, after S&P Global Ratings cut the U.S. AAA credit rating.

GSO’s Hunt

Managers at GSO Capital Partners are looking at their existing investments and companies they like that are already in their portfolio, to see what opportunities may exist, according to Dan Oneglia, co-head of distressed investing at the credit arm of Blackstone Group Inc. The energy sector is already distressed, and certain companies that were already weak are getting weaker, Oneglia said.

The volatility in the markets this week “does make people stand up and pay attention,” he said in an interview. “It’s too early and hard to say if this is short-term or if there’s something more going on.”

Distressed opportunities will be limited to sectors that are directly affected, like the airline and cruise industries, said Kenneth Buckfire, co-founder of investment bank Miller Buckfire, which is now owned by Stifel Financial. It will be four or five years before the “vast majority” of potentially troubled debt comes due, he said. That means any impact from coronavirus will be limited, he said.

Leveraged Losses

“We’re probably entering a market period with increased volatility, so risk premiums should go up,” he said. “It doesn’t mean the market is going to close.”

But market losses, especially if fueled by leverage, could create forced sellers, and deter new buyers from stepping in given the unknown impact of a potential economic slowdown, said Phil Brendel, the distressed-debt analyst at Bloomberg Intelligence.

“Distressed spikes usually occur due to sharp selling in a vacuum of bids, prompted by great uncertainty,” he said. “We have those elements now, so an acceleration of distressed supply seems likely.”


Some value investing wisdom from Oaktree Capital - from the recent memo:

“…no one can tell you this is the time to buy. Nobody knows.” - Howard Marks

“We’re certainly buying,” Marks said in a Bloomberg Television interview on Friday. “If you’re a distressed investor, you must turn more aggressive when you’re given good chances. I’m not saying this is the bottom, but this is certainly a time to do some buying.”

(Source - Marks Says Oaktree Is Starting to Find Bargains in Credit - Bloomberg)

“Oaktree’s Marks Says the Market Sell-Off Is Creating Bargains” - VIDEO

(Source - Watch Oaktree's Marks Says the Market Sell-Off Is Creating Bargains (Video) - Bloomberg)

“Oaktree’s Marks Says Economy, Markets Will Have ‘Bad Showings’ for a While” - VIDEO

(Source - Bloomberg - Are you a robot?)

Who is Howard Marks?

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BERLIN (Reuters) - Major private equity firms, which have built up big distressed debt funds in recent years, are ready to snap up assets on the cheap if the coronavirus outbreak causes deeper market disruptions, executives told an industry meeting this week.

Distressed asset investment took center stage at the SuperReturn conference in Berlin as financial markets reeled from investor panic over the coronavirus outbreak which has so far wiped $5 trillion off equities. [MKTS/GLOB]

Industry officials debated when a global recession might kick in and whether the coronavirus would be the trigger.

Billionaire private-equity chief Leon Black said his firm, Apollo Global Management, which built its reputation on investments made in the aftermath of the 2008 financial crisis, was ready to deploy funds in the event of a global recession.

“A downturn would not be a bad thing for Apollo,” he said during a panel discussion.

Apollo, which manages over $300 billion in assets, invested almost $50 billion in four months around the time of the 2008 financial crisis, and was prepared for a similar splurge should there be another downturn, he said.

“At this point in the cycle, you do have to keep an eye out for potential disruptions and we may already be seeing some of that coming to pass,” said Jason Thomas, global head of research at The Carlyle Group, a $225 billion private equity fund.

Funds could invest in company credit, loans in particular, which tend to decline proportionally to equity in a downturn even though it’s more senior in the capital structure, he said.

The more the senior the debt the higher the priority for repayment in the event of a bankruptcy.

“Credit becomes relatively undervalued, creating a buying opportunity irrespective of your views on the broader economy,” Carlyle’s Thomas said.


Many private equity firms have been building up distressed debt funds for several years, keeping a chunk of them on hold for a downturn. Such “dry powder” among distressed debt funds hit a record $77 billion globally in 2019, according to data from Preqin.

Some distressed debt specialists told Reuters in January that 2020 could be their year, with default rates tipped to rise and an expected increase in the number of companies that will struggle to service their debt.

The difficulty for these funds is predicting the end of what has been a long economic growth cycle. Many have been focusing on challenged sectors such as automobiles and energy instead of looking for a particular flashpoint in the economy.

“The automotive sector is facing a massive cyclical issue even before taking into account the coronavirus,” said Chris Boehringer, co-head of distressed debt for Europe at Oaktree Capital, a fund with $122 billion of assets under management.

“It is a sector that is used to 20-25% of growth but was actually down 20% last year. That, along with energy, are two sectors where we see a lot of dislocations potentially coming up and opportunities for us.”

One private equity executive at the conference, who is focused on distressed assets, told Reuters: “I signed up and expected to have meeting requests from six or seven others with a similar profile - instead, I had more than 50”.

“Everyone here is trying to figure out when the cycle ends, if this time is different. Maybe coronavirus is the first trigger”.

Oaktree Planning New Distressed Fund to Catch Bad Debt Surge

(Bloomberg) – Oaktree Capital Management LLC is planning a new distressed debt fund as recent credit market turmoil throws up investment opportunities.

“High-yield bonds, loans and CLO tranches, for example, offer markedly better opportunities than they did in the very recent past,” co-founder Howard Marks said in a March 16 client note titled ‘A Different World’.

“In recent years, the opportunities in U.S. distressed debt have been few, far between and highly concentrated in energy and retail,” Marks said. “Now it’s clear that companies of all kinds are likely to find that revenues decline faster than costs, run into cash flow problems and be denied access to the capital markets.”

As a result, Marks said Oaktree, one of the world’s biggest buyers of debt in companies that are struggling or already in bankruptcy, is making preparations for “organizing our next distressed debt fund.” “We feel it’s important to start that process now,” he said.

A representative from Oaktree declined to comment.

The escalating coronavirus pandemic has caused the worst sell-off since the global financial crisis and deepened stress in credit markets. U.S. investment-grade bond spreads are at their highest since 2009, while high-yield spreads are at the widest since 2011.

“Yield spreads have widened substantially, and people who were thinking about investing when opportunities improved (or who contracted to do so) understand that there’s been great progress in that direction,” Marks said. “We fully intend to take advantage of the improved investment opportunities.”

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“Margin of safety” - Seth Klarman (Baupost Group)

What is it?

Financial Times:

DE Shaw is raising $2bn in the first fundraising for its flagship vehicle in seven years, joining rivals Baupost Group and TCI Fund Management in a bid to capitalise on opportunities thrown up by market turmoil.

When markets sold off this month the New York-based quantitative group started approaching investors about raising $1bn for its $13bn Composite fund, which has been closed to new investments since 2013.

A person familiar with the situation said the fundraising cap when it reopens on April 1 had been increased to $2bn because of investor demand and the number of opportunities thrown up by moves in the market. DE Shaw declined to comment.

Blue-chip managers such as DE Shaw, Seth Klarman’s Baupost and Christopher Hohn’s TCI can be closed to new money for many years, making them very difficult for investors to access. The selective reopening illustrates how the large drop in asset prices driven by the coronavirus pandemic has left fund managers preparing to replenish their firepower and capitalise on what many see as a historic buying opportunity not seen since the aftermath of the 2008 financial crisis.

“We’re hearing from a lot of managers that they’re setting up new vehicles to take advantage of the dislocation,” said Patrick Ghali, co-founder of Sussex Partners, which advises institutions on investing in hedge funds.

Baupost has started approaching its existing investors about raising more money for the first time since 2011, said people familiar with the matter. Accepting new investors — which it has not done since 2008 — is also under consideration by the $29bn Boston-based manager, the people said.

Its founder Mr Klarman, a value investor who is sometimes compared to Warren Buffett, is known for his willingness to return capital to investors when he thinks opportunities are sparse. In January he warned in an investor letter that stock market prices were stretched and said that “full exposure in this environment seems dangerous, given prevailing lofty valuations”.

However, Baupost recently told investors it had deployed about $1.5bn in the three weeks from the end of February to mid-March, lowering its cash holding from about 31 per cent of its assets at the start of the year to 27 per cent. Bloomberg first reported Baupost’s investments and plans to raise more capital.

Meanwhile, TCI is also looking to reopen, said a person familiar with its plans. The London-based fund invests in a concentrated portfolio of stocks and gained about 40 per cent last year. This year it has suffered large falls in performance but has still been approached by investors wanting to increase their allocations.

Also opening up to new money is Bob Treue’s $640m Barnegat fund, which arbitrages tiny mispricings in the bond market. The 20-year-old fund has a long-term annualised return of about 14 per cent, and is down nearly 10 per cent this year. It has been closed to new investors for two years, and is opening up next month.

Meanwhile, Ken Griffin’s Chicago-based Citadel is launching a new “relative value” fixed-income fund to take advantage of the recent bond market volatility.

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Long live traditional retail.

“In the summer, it [retail] will be where we thought the industry would be in five years”

Retailers, though, are facing a cash-flow problem, not a just structural challenge. They’re not bringing in money because they can’t operate. Any retailer weighing filing for bankruptcy has no idea when stores may reopen again, and what the world will look like when they do.

“Filing for bankruptcy doesn’t create a sudden cure for the virus, it doesn’t create a cure to open stores — so why incur the expenses of Chapter 11 when you’re not going be able to do anything while business is closed?” said Michael Sirota, co-chair of the bankruptcy and corporate restructuring department at Cole Schotz

“There is disruption in the real estate market and a lot of unknown in retail: is the mall going to be there or not? Will I have cash or not?” said Christa Hart, senior managing director at FTI Consulting.

Debt-holders that have the ability to help force a company into bankruptcy if it is late on interest payments or violates its covenants are aware of this reality, say bankruptcy bankers and lawyers. It makes it difficult for them to negotiate the terms of emerging from bankruptcy, because there is no clear view of what retail looks like in one month or three months. There is limited upside forcing a retailer to liquidate because it is nearly impossible to hold a liquidation sale with retailers forced close.

Modell’s recently had to pause its liquidation efforts, because its liquidation sales ran right up against government guidance to stay home.

“It’s not as if we were using the space or premises and selling inventory and not paying them,” said Sirota who advised Modell’s on the bankruptcy “We were deprived of that access.”

The landlords agreed in that case to delay rent payments.

With liquidation sales seemingly untenable in the short term, there is also little desire to finance bankruptcies. Financing bankers who spoke to CNBC on the condition of anonymity said while it may be possible to get financing for bankruptcy from existing lenders, the bar has been raised significantly for new lenders. That stands in contrast to bankruptcies like Toys R Us and even Sears, when banks lined up to offer assistance.

That’s not to say there won’t be retail bankruptcies, particularly for companies with impatient investors or with already significantly broken businesses. Once the cloud of uncertainty lifts, there will likely be many more.

But until then, though, for most retailers, the only option is to cut costs. Macy’s and Kohl’s have furloughed most of their employees. Retailers are slashing investment, putting projects on hold, and culling through other expenses like outside consultants. They’re also delaying their payments to the brands that have already shipped product to help conserve their cash, say sources familiar with the situation.

The separation of winners and losers that was already happening in retail will continue, but at an expedited pace. Department stores will suffer, weighed down by large real estate footprints that make little sense to today’s shoppers. Those that have been strapped with debt and unable to invest in their business will fall further behind. Many apparel brands will struggle to compete. And Walmart will be a survivor.

“In the summer, it will be where we thought the industry would be in five years,” said FTI’s Hart.