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:
- Jeffrey kicked off the discussion by providing a survey of the current state of the market. He 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. Jeffrey 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, he 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. He concluded with the observation that opportunities for distressed investing are increasing.
- Peter then discussed where he saw the most opportunity in healthcare. He said 30% of transactions last year were in the areas of physician specialists, behavioral health, services and technology, oral health and post-acute care. He emphasized three new trends that he 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. Suzanne underscored the difficulty of being part of a public deal compared with the relative ease of a private, club deal. Randy 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, Randy noted, 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, Randy 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. Randy then discussed an out-of-court deal he recently did in which private debt involving five lenders was converted to equity; this illustrated the importance of investors believing in a company’s business plan. He concluded by explaining that in order to decide if something is worthwhile, his 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. Randy responded that as most of his clients are involved with private equity-style capital, they tend to take a multiyear view. Suzanne 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, she noted, one might buy debt at well below par and exit at par. Suzanne 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. Suzanne agreed covenants truly do not exist anymore, and Randy added that there is not usually a default because of covenants. Fred, Suzanne and Jeffrey 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. Randy 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; he added that if one is not involved in a situation and it is looking like a dumpster fire, he will not get involved. Jeffrey responded that one should exercise caution if one is “not big enough to be in the room,” and Suzanne 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.