‘Debt Raiders’ See Bull Market in Bankruptcies : Investing: Their maneuvers are reshaping the corporate landscape as a listless economy hurts indebted firms. Some call them ‘vulture capitalists.’
The fall of the Hunt brothers’ empire was a calamity as big as all Texas, but it allowed an investor named Richard Rainwater to demonstrate again how some people’s loss can be others’ gain.
Rainwater saw opportunity in Penrod Drilling Corp., the oil drilling firm built by legendary wildcatter H. L. Hunt and driven to bankruptcy court by his sons Herbert and Bunker. Others were interested in Penrod, too, but while they tried to force an auction of the company’s shares, Rainwater and allies quietly snapped up debt that gave them leverage on a key creditors committee.
By last spring, Rainwater and friends controlled their prize: a company with net assets of more than $1 billion, won for an investment of about $430 million.
Rainwater’s move illustrated what has become one of Wall Street’s hottest strategies for cashing in on the unfolding bull market in bankruptcies. Investors sometimes called “debt raiders” buy large positions in a bankrupt company’s debt in hopes that they can turn bonds or bank loans into control--and riches--in the unpredictable hurly-burly of a reorganization proceeding.
The deals often culminate with the investors forcing through their own plan of reorganization and swapping their debt for controlling shares of stock in the company.
Far from being just another arcane Wall Street game, these maneuvers are reshaping the corporate landscape as a listless economy drives more heavily indebted companies into bankruptcy court. Bond defaults have leaped 80% this year, and experts believe that more and more highly leveraged U.S. concerns will meet their destiny in bankruptcy proceedings in the months ahead.
As they do, some experts expect bankruptcy court control battles in the 1990s to become as important in deciding the future of corporations--and their billions in assets and tens of thousands of employees--as junk bond-funded hostile takeovers were in the 1980s.
“You hear more about this all the time,” said Wilbur L. Ross Jr., senior managing director of Rothschild Inc. and an adviser on a host of important bankruptcies. “Now, virtually every (bankruptcy) situation we’re in involves a change-in-control issue; five years ago, it would have been a rarity.”
This year, as Rainwater showed how the game is played with Penrod, a New York bankruptcy investor named Ronald LaBow has done the same with a resurgent Wheeling-Pittsburgh Steel. Earlier this month, in a signal example of the maneuver, an investment boutique called Japonica Partners got final court blessing for its plan to take control of Allegheny International, the maker of Sunbeam and Oster appliances.
Others are queuing up to make money on such deals. Goldman, Sachs & Co., the elite investment banking firm long known for eschewing any offensive role in hostile takeovers, announced earlier this month that it has put together a $783-million fund for such activities. It is promising investors annual returns of 25% to 35%. A Chicago investment firm called Chilmark Partners has a $1-billion kitty for a similar purpose.
Some experts believe that this strategy has also captured the fancy of Carl C. Icahn, the eagle-eyed investor and TWA chairman who gained a place in the pantheon of corporate raiders during the 1980s. Icahn has this year amassed positions in the debt of Western Union, the communications firm; Leaseway Transportation, the trucking outfit, and Gillett Holdings, a broadcast and resort business that has missed bond-interest payments while trying to choke down nearly $1 billion in debt.
Some expect to see other members of the fraternity of corporate raiders try their hand at bankruptcy court takeovers as well.
These strategies are, of course, only one of a variety of ways investors can profit from bankruptcy situations. But they’re among the most aggressive and riskiest.
Many bankruptcy specialists simply buy bonds of troubled companies, hoping to profit if the securities rise in value as a reorganization proceeds. Others, somewhat more aggressive, buy large stakes, gain membership on important bankruptcy court committees and try to use those roles to promote reorganization plans that promise handsome profits for their class of debt holders.
But shooting for control of a troubled company requires particular nerve, because it often means betting millions of dollars on situations that are inherently unstable.
Still, it’s not hard to see why so many on Wall Street are attracted to these strategies. To begin with, in the current environment of tight credit, other kinds of mergers have tailed off; the number of announced mergers is down 57% this year.
This strategy offers investors a chance to pay discount prices for control while others--shareholders, bondholders and banks--eat the company’s losses in reorganization. And the discounts can be deep: The junk bond debt that is often key to the strategy frequently sells for 10% to 20% of face value.
These distressed firms are often failed leveraged buyouts, and that suits the bankruptcy investors just fine. Often, it means the company has a sound underlying business but failed because it had been strapped to too heavy a debt load in the derring-do deal making of the 1980s.
As investors have seen money-making opportunities in bankruptcies, they’ve been called some unsavory names, such as “vulture capitalists.” Do they merit such disdain?
Most of them would be the last people in the world to argue that they come to these deals with the motives of social workers. But their investments do have the salutary effect of allowing bankers, junk bond holders and trade creditors to extricate themselves from bitter and time-consuming bankruptcies.
When these investors start bidding for debt, they often bring prices up sharply. Indeed, there has recently been such a surge of interest in distressed debt that some longtime bankruptcy investors are complaining that they can’t make any real money.
Certainly, bankruptcy investors such as Japonica that bring large amounts of equity--ownership capital--to a reorganization can argue with more justification that they have helped revitalize troubled businesses.
But if these deals can be beneficial to companies and profitable to investors, they are also tremendously complex and risky, even by the risk-tolerant standards of the bankruptcy world.
“The beaches are littered with the bodies of smart New York types who thought they knew how to handle this kind of strategy,” says Herbert P. Minkel Jr., bankruptcy attorney with Fried, Frank, Harris, Shriver & Jacobson in New York.
In any bankruptcy, an investor must start with a calculation of how much the company is worth, and how much he can reasonably expect to get when the wealth is parceled out.
“You’ve got to value the pie, determine how it’s going to be divided, and determine when the distribution (the payoff to claimants) is going to take place,” said Phillip S. Schaeffer, general partner of Amroc Investments LP, a New York firm that specializes in the securities of distressed and bankrupt companies.
Tricky, too, is knowing how to maneuver in the bankruptcy proceeding to line up support for a reorganization plan.
Bankruptcy law clearly sets out the priority of claims on a company’s assets. First claim goes to secured lenders--the banks--followed by the senior and junior unsecured debtors--the bondholders and unpaid suppliers--followed, last, by stockholders.
But the division of power in a reorganization is never quite so clear. To win approval, a reorganization plan usually needs backing from at least half of those voting in each class; supporters must hold at least two-thirds of the bonds’ total face value.
So the successful debt holder is the one who knows how to horse-trade, threaten and cajole to win support for his plan from others.
“Audacity can be just as important as strategy,” said one veteran bankruptcy investor.
The opposition can come not only from rival security holders but from the company’s management, which may see a powerful creditor as a threat. There’s a potential for conflict with the bankruptcy court judge, who may view a debt buyer as a disruptive force or unfair to other claim holders.
Just how bruising reorganizations can be was clear in the case of Allegheny, which filed for bankruptcy court protection in 1988.
Japonica moved on Allegheny by making selective purchases of its bank debt, then making public offers for most of five Allegheny junk bond issues. In this way, Japonica accumulated about 50% of the company’s debts.
The purchases gave the partnership effective veto power over any reorganization plan it didn’t like, but it angered management and some creditors. They sued, contending that Japonica shouldn’t be able to buy up claims solely to secure the power to vote on a reorganization plan.
In a 100-page opinion, U.S. Bankruptcy Judge Joseph Cosetti agreed.
Japonica skirted this obstacle by working out a plan acceptable to management and other creditors. The plan--the 12th considered by the court in 2 1/2 years--will give shareholders and debtholders $665 million in cash and securities.
Japonica’s cash and debt will be converted to a 90% stake in the firm, giving the partnership the right to name a new board and management. The old management’s cooperation was won in part by “golden parachutes” giving them a half-year’s severance pay.
But the legal issue raised in the case hasn’t been resolved and may soon flare up again for some other bankruptcy claim buyer, said Rothschild adviser Ross. “I’m sure others will soon be using the same argument to try to block such purchases,” he said.
LaBow’s campaign for Wheeling-Pittsburgh shows how things can get woefully snarled in a bankruptcy, even when they’re going right.
The steel company was America’s ninth largest and arguably least efficient when it landed in bankruptcy court in 1985. Once in the court’s supervision, it didn’t need to pay interest on earlier debt. As it cut its payroll by 20% and began modernizing, its profit turned up sharply--to $179 million last year.
That sounds great for creditors, but it set off a lengthy brawl over who would get what from the rapidly enlarging pie of Wheeling-Pittsburgh assets.
The Pension Benefit Guaranty Corp., which oversees Wheeling-Pittsburgh’s under-funded pension plan, wanted more for current and former workers. The steelworkers’ union wanted higher pay to offset sharp wage cuts they had taken.
Needless to say, shareholders and creditors wanted more too.
Meanwhile, LaBow spent 14 months in litigation with Goldman, Sachs & Co., which had paid $15 million for 34% of the firm’s stock, expecting that it could force LaBow to sell out to them. Goldman was stymied and finally agreed to back LaBow’s plan.
The steelworkers union last month approved a four-year pact that will open the way for a judge to approve Wheeling-Pittsburgh’s reorganization plan and allow it to emerge from bankruptcy.
But if Wheeling-Pittsburgh does re-emerge soon, it will be three years later than some were predicting at the outset.
LaBow’s Stonehill Investment, which paid $150 million for $300 million in face value of bank debt, will end up with 40% to 60% of Wheeling-Pittsburgh’s stock.
LaBow says he is looking for similar deals but can’t imagine handling more than one or two of them at the same time.
“If you can do two of these at once you’re very fortunate,” he says. “They’re very, very complex; they always take longer than you expect.”
The complexity and difficulty of these deals is apparent in the way some investments have turned into spectacular failures.
One much-discussed case was Balfour Investors’ costly attempt to take control of Global Marine, a big Houston offshore drilling firm that spent three years in bankruptcy between 1986 and 1989.
Global’s problem was falling oil prices. Balfour figured that prices would rise, increasing the value of the company sufficiently that even its junior junk debt holders could be substantially repaid.
Balfour spent $50 million for junk with a face value of $190 million and proposed a plan that would have allowed it to convert its debts to a controlling stake.
But oil prices were going nowhere, and after a tooth-and-nail fight with other claimants, Balfour found itself at the end of the mess line. The paper it had bought for 20 cents on the dollar was trading at around 2 cents.
The firm didn’t respond to requests for comment, but officials have acknowledged losing $13.5 million on the deal.
“The hard part is figuring out what the company’s value is,” said Joseph Kelly, a New York attorney. “If you’re off by a little, you might as well be off by a mile.”
