Value Investing Forum 2022 Scaling Up: Stressed and Distressed Investment Trends - McDermott Will & Emery

Value Investing Forum 2022 Scaling Up: Stressed and Distressed Investment Trends

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During this session, Aymen Mahmoud, partner and co-head of the London Finance, Restructuring and Special Situations Group, led a discussion that explored the metrics that can be used to differentiate between short- and long-term impact, the effect of covenant lite, high-yield financings and where the greatest need will exist for special situations capital in the coming years. Session panelists included:

  • Sean Britain, Managing Director, H.I.G. Capital/Bayside Capital
  • David Groban, Managing Director, Searchlight Capital Partners
  • Vikas Keswani, Managing Director, HPS Investment Partners
  • Michael O’Hara, Co-Head of US Debt Advisory & Restructuring, Managing Director, Jefferies

In Depth

Below are key takeaways from the discussion:

  1. The session commenced by asking the panelists about current valuation trends. Mergers and acquisitions (M&A) are looking very different in 2022 because of a large amount of excess capital, the private equity fundraising environment has changed significantly and investors are able to explore opportunities in new sectors such as shipping, food and agriculture. Additionally, investors have recognized the increased interest in special purpose acquisition companies (SPACs) and calls for rescue funding. Notwithstanding such volatility, investors are optimistic about the future and have found that to proceed in this environment, investors cannot solely rely on valuation. There is a large focus on due diligence as investors are less reliant on contracts and more focused on the life span of a company because they want to understand the entire target company to determine whether it is viable.
  2. There was a discussion noting that the current, benign investing environment (which was not the case in years past) has provided investors with the chance to explore new opportunities because of a large amount of excess capital. The importance of due diligence in a volatile market, going beyond just the contracts that result from the volatility of valuations was also emphasized. Furthermore, it was noted that diligence can be extremely helpful in assessing the life span of a target company and whether it is possible for said target company to create cash flow or a solution that provides additional capital. This discussion was wrapped up by stating that there is a focus on finding “hustlers” that private equity firms can give liquidity to so they can successfully maintain their business and explore different niche areas like the food industry and shipping. Ultimately, there is optimism about the next 18 months to the extent due diligence is conducted on distressed businesses (aka businesses that, if provided with liquidity to reach the other side, would generate cash flow and operate successfully).
  3. It was discussed how a combination of the current global political climate, energy, inflation and supply chain concern have caused tremendous volatility in valuation, requiring greater due diligence. It was noted that there is a host of industries and volatility in sectors that had never existed before. When asked what metrics are used when assessing a target company, it was shared that their firm focuses on filtering the “front end,” which includes equity screens and cash flow structures. There were also discussions about the challenges companies may face since SPACs exploded in 2022—and will continue to grow. It was concluded by stating that 2023 may be the year for the food sector and planting.
  4. It was highlighted that 2022 looks quite different from an M&A standpoint than years prior and most deals were achieved through thoughtful and creative refinancing and noted that these deals typically involved converting debt to equity and out-of-court workouts. Additionally, it was mentioned that wages, inflation, cash flow and supply concern all cause tremendous volatility in valuations, however, such conditions may also bring new opportunities. Panelists explained that default statistics carry very little weight (some focus is on liquidity) and further noted that because of such volatility, new metrics should be based on fundamental analysis. This is especially true in the tech sector, as investors were focused on revenue and other aspects of a deal and leaving other areas unaddressed or missed could be an issue in the future.
  5. Panelists talked about the current investing environment, pointing out that from an investing standpoint, they remain optimistic as there is so much excess capital. This excess capital has given investors the opportunity to make creative deals, playing with debt and equity. It was also noted that they have received a greater number of calls concerning SPACs and rescue financing than in years prior. It was further remarked that in the current climate, there are not as many special business plans being funded. Rather, plans that are marginal are getting funded. They believe there may be an uptick in the distressed market, however, not in the near future. It was shared that while the current geopolitical landscape, including supply chain issues, the Russia/Ukraine war and the volatility of the energy sector, have created issues, they also provide opportunities in new markets.