In this session, Felicia Perlman, Partner & Head of McDermott’s Business Restructuring Practice Group, and Fred Levenson, Partner & Co-Head of McDermott’s Private Equity Practice Group, moderated a discussion that explored lessons from several real-life scenarios during which fund managers and advisors discussed how to protect investments while also maximizing returns. These industry leaders also shared their insights on evaluating investments and determining the strategies to best manage changing circumstances and financial challenges. Session panelists included:
Peter Chadwick, Managing Director, Berkeley Research Group
Jeffrey Finger, Co-Head of US Debt Advisory & Restructuring, Managing Director, Jefferies
Suzanne Gibbons, Managing Member – Distressed Investments, Davidson Kempner Capital Management
Randy Raisman, Managing Director, Marathon Asset Management
Below are key takeaways from the discussion:
The discussion kicked off by providing a survey of the current state of the market. They highlighted that the leveraged credit market today is more than double what it was in 2008, with leverage levels back to historical highs as companies have benefited from strong capital markets. It was also noted that the significant amount of leveraged debt outstanding indicates that even a modest uptick in default rates should yield a meaningful increase in restructuring and distressed investment opportunities. Furthermore, they pointed out that private debt markets have grown significantly over the past few years and that there is still a good amount of dry powder looking for opportunities to put it to work. It was concluded with the observation that opportunities for distressed investing are increasing.
It was then discussed where they saw the most opportunity in healthcare. Panelists said 30% of transactions last year were in the areas of physician specialists, behavioral health, services and technology, oral health and post-acute care. They emphasized three new trends that were observed in 2021: (1) maximizing revenue (e.g., building value-based care into one’s business plan); (2) being strategic vs. just focusing on scaling for its own sake; and (3) not just identifying, but also defining responses to future risks.
The discussion then shifted to a hypothetical case study involving two companies: one that has public, syndicated debt and another with private debt. They underscored the difficulty of being part of a public deal compared with the relative ease of a private, club deal. It was also noted that while the pricing of private deals is strong, owners of private debt typically own it for a relatively long period (e.g., five-to-six years), which is not usually the case with syndicated debt. Thus, credit investors must be aware of the relative value of their potential investments. Upon being asked by Felicia how to decide whether to double down to protect an already-existing investment or seek out and look for something new, it was noted that it is extremely difficult to find someone new to step into a broken capital structure, so using one’s balance sheet to protect oneself should be an option that is taken into consideration in such a scenario. A recent out-of-court deal was also discussed in which private debt involving five lenders was converted to equity; this illustrated the importance of investors believing in a company’s business plan. It was concluded by explaining that in order to decide if something is worthwhile, their team typically aims to be on the steering committee and hold a significant portion of the debt.
Next, Fred asked about what decision trees look like when an investor is part of a company’s capital stack. Panelists responded that as most of their clients are involved with private equity-style capital, they tend to take a multiyear view. It was also discussed that one strategy is buying debt when one believes a sector or company is undervalued but one has a positive opinion of the company’s management. Under such circumstances, it was noted, one might buy debt at well below par and exit at par. They explained, however, that one must also be aware that they may end up owning the company if things don’t go as planned.
The conversation then turned toward covenants. Felicia pointed out that the trend 15 years ago was toward covenant-lite deals, yet it seems the canary in the coal mine simply and suddenly disappeared, as covenants had already vanished by the time people got to the table to have a discussion. She asked the panelists to discuss how to evaluate an investment under such circumstances. Panelists agreed covenants truly do not exist anymore, and one added that there is not usually a default because of covenants. It was then discussed the various ways that one’s position in the capital stack impacts one’s decision-making process.
Finally, the panelists responded to a question from Felicia as to what red flags to look out for in 2022. A panelist reiterated that the primary consideration in making any investment should be one’s belief in the business and whether one can see the other side of whatever issue is causing distress; they added that if one is not involved in a situation and it is looking like a dumpster fire, they will not get involved. One panelist responded that one should exercise caution if one is “not big enough to be in the room,” and another panelist discussed keeping an eye out for fraudulent transfer liability, especially if it is possible a company might file for bankruptcy in less than two years.