Europe is in the midst of a vastly complicated, decade-long, social, political and economic restructuring that will cost trillions of euros and create significant investment opportunities. But while last year’s headlines heralded the latest “fire sale” and made us wonder if Europe herself was up for sale, the investment community has come to realize the market for distressed European assets is, in fact, far more complex and nuanced than it may have appeared on the surface.
In some quarters, the last few years felt like the start of a European gold rush. Hedge funds and investment banks bought the financial equivalent of pickaxes, mules and provisions to stake a claim on a landscape strewn with distressed assets. These earlyadopters opened new European offices, added headcount, sharpened investment ideas and developed strategies to take advantage of the turnaround. More than onehundred billion euros were raised to buy portfolios of distressed European loans and other financial assets. How to profit by buying the debt of stressed and distressed European companies has been one of the most pressing questions in the global investment community.
But most of the headlines missed the deeper story — a reckoning is taking place between the pragmatic and skeptical analysis of distressed investing and the thorny complexities of the current European financial situation. Unfortunately for this year’s headline-writers, the likely outcome will be a slow and cautious mediation between individual European jurisdictions and the investing community — and not a revolutionary overturning of the European economic order. The new investment rules for distressed Europe are country-specific, long-dated and somewhat lacking in drama. In fact, they are designed to evolve incrementally, just on the edge of mainstream political and economic events.
The creation of the Eurozone hasn’t changed the reality that the nearly 50 independent countries of Europe have unique histories, political systems, national priorities and appetites for foreign investment. To varying degrees, investing in each country requires specialized expertise in foreign capital and restructuring, and each jurisdiction presents a distinct set of opportunities and challenges. The legal, regulatory and political analysis of a plain-vanilla debt investment changes dramatically if the location of the issuer and the collateral is Nicosia, Warsaw, Reykjavik, Athens, Madrid or London. It gets more complicated if the asset is backed by local real estate or a fleet of tankers registered under a flag of convenience.
Investing in distressed Europe is not for the unwary or inexperienced — investors must pick the battleground carefully by balancing the risks and merits of each legal jurisdiction. The established markets in Poland, which are supported by the rule of law and the enforcement of security, need to be compared with the uncertain markets of Romania and increasing banking regulation and currency control issues affecting markets in Hungary.
Once one starts to explore these differences, and rank European countries by subtle investment drivers, it becomes clear that some are better suited for distressed investing than others. For any given jurisdiction, distressed investors start with the insolvency law — does it favor liquidation or encourage rehabilitation? Does it treat foreign investors hospitably, respect secured creditors’ rights and allow efficient transfer of ownership of collateral, including real estate? Are accounting standards uniform? Do invisible “old-boy networks” influence outcomes? Will withholding, capital gain or stamp taxes be incurred or imposed retroactively? Can foreign exchange risk be hedged? Will the legislature protect or promote certain industries? Will there be a liquid exit for the investment — can it be re-sold without friction?
Investors who have spent years trying to enforce a mortgage in Italy, or foraging for opportunities in Greece only to discover that the best assets have changed hands without coming to market, or confronting the problems faced by secured creditors in Spanish bankruptcies, have learned to carefully consider which countries are worth prospecting before expending significant resources.
As it turns out, the countries that we’ve all heard the most about may not be the most fertile ground for the distressed investor. Stable precedent and established rules are needed for distressed investing, as successful corporate turnarounds and restructurings rely on concrete roadmaps to move a company from insolvency to raising new capital. For countries that have faced questions about their near-term economic survival, the fear of unpredictable legislative changes affecting ownership transfers, taxes, employment and foreign currency controls may actually repel the liquidity needed for turnarounds and restructurings to succeed.
With so many differences, and so many questions to be answered, prudent distressed investors may marvel at the overly-broad brush strokes of the European investment thesis as portrayed by the financial media. Those investors realize that successful distressed investing in Europe, in this climate, requires a patient, detail-oriented, cautious and humble analytical style — one that respects (and hedges) the long-term risk.
Investors who can afford to be patient will find plenty of distressed opportunities in Europe. By definition, half of all companies perform below their peers. Investors triage that underperforming half by eliminating the companies that will fail even with additional cash and the companies that will survive without a cash infusion. That triage still leaves plenty of special situations where a selective distressed investor can find and add value.
And distressed investors have this advantage: opportunities emerge after known strategic and operational blunders occur. By cautiously and skeptically analyzing “everything else that can go wrong” with a poorly managed company, a distressed investor often obtains more reliable guidance than the average investor studying the optimistic projections of a new business led by untested management.
Navigating the ruins on this field of broken dreams is humbling and reminds distressed investors that some markets aren’t so rational after all. Buyers and sellers often expect more continuity than the world offers — they expect both good and bad times to linger longer than they actually do. Seasoned distressed investors know that most of us construct biased worldviews by over-weighting recent events, ignoring broader trends, neglecting contrary evidence and following the crowd in times of stress. Those seasoned investors know that distressed markets tend to magnify our irrational biases.
So ignore last year’s tempestuous headlines, and remember that the successful prospectors in this gold rush will be patient and calculating. Watch for modest, opportunistic debt purchases of underperforming midmarket manufacturing companies in Poland, Germany or the Netherlands. Expect to see steady increases in market volumes for distressed claims rather than massive positions in credit default swaps referencing Italian or Spanish sovereign debt. Over the long haul, humility, experience, caution and patience may well be the watchwords for successful distressed investing in Europe.
For distressed investors who have completed their diligence and priced jurisdiction-risk into their projected returns, conservative distressed investment opportunities exist across Europe. But that type of investing rarely makes big headlines.