For ‘Vulture’ Firms, It’s the Best of Times
Unlike so many dot-com companies that have died painful deaths, Patrick Byrne’s Internet start-up is thriving.
Sales have jumped 140,000% in the company’s 16 months in business, and Byrne expects the Salt Lake City firm to turn profitable this quarter. His formula for success? Byrne liquidates the assets of dot-coms and other companies that have gone belly-up.
Byrne rushes in to gobble up computers, office equipment and anything else being unloaded at fire-sale prices by desperate companies. He resells the goods at below-retail prices on his Overstock.com Web site. With dot-coms dropping almost daily, Byrne is finding deals galore.
“It’s a great business,” Byrne, 38, said. “It’s really the greatest business I’ve ever seen.”
With the economy’s dramatic slowdown and the stiff losses suffered by many investors in the stock market since last spring, these are dour days for a slew of American companies, employees and investors.
But for a small number of businesses and investors, times couldn’t be better: Their success is based on others’ failure.
Known as “vultures,” they feed on the carcasses of weak or fallen companies. And right now, they have a lot to pick at.
The dollar amount of corporate bonds and bank loans that are either in default or trading as though they’ll tumble into default has surged more than eightfold in just two years. The companies behind that debt range from little-known telecommunications start-ups to giants such as Owens Corning, Rite Aid Corp. and Southern California Edison.
Meanwhile, at least 210 Internet companies went belly up last year, with more than four in 10 of those closings coming in November and December alone, according to Webmergers.com.
The goal of most vulture investors is to wait until a company’s condition looks its absolute bleakest and then pounce--that is, if their research suggests there is hidden value in the business.
At its most basic, being a vulture simply means following the adage of buying low and, hopefully, selling high.
In fact, though they would probably recoil at the label, some elite investors have lately scooped up battered securities in vulture-like fashion.
Famed investor Warren Buffett, for example, recently bought “junk” bonds issued by troubled finance companies Finova Group and Conseco Inc. Los Angeles billionaire Ronald Burkle acquired a chunk of beleaguered Kmart stock in recent months and said he is looking for more deals because prices are low. And semiconductor giant Intel Corp. agreed this month to buy Thousand Oaks-based wireless technology firm Xircom after the smaller company’s stock lost three-fourths of its value last year.
Though others may see them in a different light, vultures say they don’t hope for firms to go bankrupt or for employees to lose their jobs. But as in the natural world, vultures say they fill a critical role: By removing the diseased and dying, they lay the groundwork for the economy to revitalize itself.
“When I go into some [company] where everyone’s been fired, and I know that I’m making money off their failure, I don’t feel any guilt, but I do feel commiseration,” said Byrne, who has a doctorate from Stanford in ethics and moral philosophy. “I’m not a predator. The things were dead when I got there.”
‘Vultures’ Say They Assist Economy
Vulture investors also say they fill another important role: They take high-risk securities off the hands of investors who don’t want to take the chance of more losses.
For their trouble, vulture investors expect to--and often do--score big gains. After snapping up the bonds of troubled companies in the 1990 recession, many vultures made huge profits in 1991.
An index of defaulted bonds maintained by Edward Altman, a New York University finance professor, soared 43% in value in 1991.
But it’s a game that is, not surprisingly, fraught with danger and that can saddle vultures with heavy losses.
In fact, that’s just what some vultures have suffered in recent years. Some bought securities that were down dramatically, only to see the values continue to skid further than anyone expected.
Altman’s bond index plunged 33% last year, the worst showing since the 38% tumble in 1987, the year of the stock market crash.
“Everything that you bought on Tuesday was at a loss on Wednesday,” said Edwin Morgens, a New York vulture investor.
Though the demise of dot-coms and the sudden weakness in the economy are the most visible forces driving the current vulture feeding frenzy, the root cause lies in the good times of the mid- to late 1990s.
Bull market euphoria was in full swing and hordes of untested companies with dubious business prospects sold huge quantities of stocks and bonds to ravenous investors from 1995 to early 2000. Confident that they could return to the markets for cash whenever they pleased, many companies spent lavishly on plush offices and expensive technology.
But investors’ appetite for junk bonds waned beginning in late 1998, making it all but impossible for many new telecommunications firms and other speculative businesses to raise fresh cash.
Dot-coms and other young tech companies had the same problem last year after tech stocks began to collapse in March, drying up the market for new share offerings.
What’s more, banks began to cut back on lending to higher-risk businesses amid a slackening economy last summer.
Sturdy companies could still raise cash, but weaker ones couldn’t. Many suddenly found themselves unable to finance their operations. That in turn caused investors to flee the companies’ securities, driving down sharply the value of their stocks and bonds.
“It’s past abuses coming home to roost,” said Martin Whitman, a veteran Wall Street vulture investor who heads M.J. Whitman in New York.
In a sign of how severe some companies’ problems have become, the $650-billion face value of “distressed” bonds and bank loans today dwarfs the previous peak of $300 billion hit during the depths of the 1990 recession, according to NYU’s Altman.
Of course, the dollar amount of outstanding bonds is far larger today. But the speed with which troubled bonds have mushroomed over the last year has stunned many on Wall Street--and brought vultures flocking.
An elite group of speculators has been snapping up the securities of tottering companies at depressed prices--often from dispirited long-time holders who can’t stand the pain any longer.
Vulture firms, including Whitman’s company, Apollo Management and Oaktree Capital Management, generally aren’t well known to the public, but they are to Wall Street. They do extensive research and are expert at poring over companies’ balance sheets in search of the businesses’ true worth.
Vultures traditionally have bought the debt of companies--primarily bonds and bank loans-- rather than common stock. Sometimes jockeying among themselves, many vulture firms get involved in guiding the companies through restructuring to maximize the payoff on the stake they’ve taken.
Whitman and other vultures, for example, have piled into the bonds of California’s two destitute utilities, Southern California Edison and Pacific Gas & Electric, in recent months as other investors have fled. They’re betting that the state won’t let the companies fail and that the bonds will be repaid.
By last week, some Edison and PG&E; bonds that had been trading at about 70 cents on the dollar rocketed in value after the state attracted a horde of bidders to supply power under long-term contracts.
Scavengers’ Activity Heavy a Decade Ago
Vulture investing has existed since the Depression, when speculators traded in the debts of bankrupt railroads. The modern-day incarnation came in 1970 as vultures circled around the spectacular collapse of New York’s Penn Central railroad.
The scavengers’ heyday occurred in the late 1980s and early 1990s when such behemoths as Bloomingdale’s and 7-Eleven Inc. collapsed under the weight of ill-conceived leveraged buyouts financed with junk bonds.
One odd twist is that some vulture firms that began to boom with the junk bond collapse, such as Apollo, were headed by proteges of Michael Milken--the financier who underwrote many of the junk bond deals that later landed companies in such dire straits.
In the last decade, however, opportunities for vultures have been limited. A strong economy through much of the 1990s meant fewer companies faced financial woes.
The makeup of companies that did fall into trouble also changed drastically.
In 1990, many companies were crippled by excessive debt and by the recession. But the firms’ underlying businesses often were solid, and their brand names were recognizable.
By contrast, today’s crop of distressed businesses generally are young tech or telecom companies with unproven products and uncertain futures. One spectacular recent collapse was Iridium, a planned global satellite communications network that soaked up $7 billion in capital--then filed for bankruptcy in 1999.
“These are much riskier times than the early ‘90s,” said Bruce Spector, a principal at Apollo Management in Beverly Hills, a premier vulture firm. “This is not like shooting fish in a barrel.”
Still, one important trend is favorable to vulture investors: Though there is a mountain of troubled securities in the market, the Federal Reserve has begun to cut interest rates in an attempt to keep the economy from recession. That may put a floor under junk bond values and pave the way for many companies to recover.
“The feeling is that we’re seeing the beginnings of a 1990-type opportunity for distressed investors,” said Hubert Stiles, who runs an institutional vulture fund at T. Rowe Price in Baltimore. “There’s lots and lots of distressed product and it seems to be priced cheaply.”
Professional investors--pension funds, endowments and well-heeled individuals--are again steering money toward vultures. “We’re getting an awful lot of interest . . . that we couldn’t begin to muster in 1999 and 2000,” Morgens said. “They’re saying, ‘The time is right.’ ”
For the last few years, Morgens has focused on buying troubled bank loans secured by companies’ collateral. That’s considered much safer than buying unsecured junk bonds, for example.
Investment Banks Also Reaping Benefits
The increase in the number of distressed, debt-burdened firms also has boosted the fortunes of Wall Street investment banks that specialize in restructuring troubled companies. The role of these “workout” firms is to negotiate with lenders and--often--to find buyers for struggling firms.
Business at Los Angeles-based workout specialist Houlihan Lokey Howard & Zukin, for example, has been so busy that Andrew Miller had to cancel a Christmas vacation to Mexico.
“We’re all busy and I expect to be busy for the next two or three years,” said Miller, who heads the firm’s distressed-company mergers practice. “You make hay while the sun is shining.”
Meanwhile, as dot-coms have collapsed, a new type of vulture investor has emerged: A handful of professionals have begun buying up dot-com stocks trading in pennies, hoping they can resuscitate them by slashing costs and refocusing their businesses.
Eco Associates, an Austin, Texas-based partnership, has raised $100 million to invest in the stocks of failed dot-com companies. It has plowed $30 million into six firms, including beleaguered Drkoop.com.
“There will certainly be companies that are survivors,” said Joe Allen, an Eco spokesman.
For vulture investors such as Patrick Byrne, however, the biggest opportunity is in picking through the dot-coms’ physical wreckage--the stuff left behind from their huge spending spree financed by investors’ capital.
Before dot-coms started imploding late last year, Byrne bought about 20% of his merchandise from failed companies and the rest from manufacturers with excess inventories. But thanks to 10 failed dot-coms he has handled since Sept. 1, half of Byrne’s supplies now come from bankruptcies.
He has liquidated firms such as Toytime.com and Jewelry.com. One of his current jobs: liquidating another Internet-based liquidator.
“I view us as a machine, a meat grinder,” Byrne said. “We’re shoving through the carcasses of these companies and on the other side comes savings for the public.
“I’m not dancing with joy on other peoples’ graves,” he said.
“I feel like I’m cleaning up a car wreck. . . . It’s like I’m getting called to these wrecks and I’m going out and using the jaws of life to try to extract something living inside.”
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Boom in Bond Defaults
Fourteen companies already have defaulted on their bonds this year, meaning they have been unable to make interest payments owed to investors. That follows last year’s record of 167 defaults on bonds with a face value of nearly $50 billion. The combination of a weakened economy and high debt loads is expected to bring more defaults this year.
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Default Value of bonds Company date (millions) Southern California Edison Jan. 16 $4,620 Globalstar Ltd. Partnership Jan. 16 1,450 Chiquita Brands Intl. Jan. 16 887 Northpoint Communications Jan. 16 400 Ainsworth Lumber Jan. 15 225 Trans World Airlines Jan. 10 206 Vlasic Foods Intl. Jan. 2 200 FRD Acquisition Jan. 16 160 Renco Metals Jan. 1 150 Holt Group Jan. 15 140 WEC Co. Jan. 12 130 Fujian Intl. Trust Jan. 24 120 CFP Holdings Jan. 16 115 Waste Systems Intl. Jan. 4 84
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Source: Moody’s Investors Service
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Vulture Bait
The dollar amount of corporate bonds and bank loans in default or considered “distressed”--meaning their values reflect strong fears of a default--rocketed to $652 billion last year from just $78 billion in 1998, according to a survey by New York University professor Edward Altman.
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Source: Edward Altman
