Waiting on troubled times
Most investors probably are hoping that the market turmoil of the last few months is blowing over.
But if it’s just a prelude to a much more serious financial shakeout, Howard Marks and Bruce Karsh are ready to pick up the pieces.
Marks, Karsh and their team at Los Angeles-based Oaktree Capital Management have built a $47-billion investment portfolio in large part by stepping into situations other investors are fleeing.
Mostly out of the public eye, 12-year-old Oaktree has become one of the world’s biggest players in “distressed” securities -- primarily bonds of companies that find themselves in financial trouble or are perceived that way by Wall Street.
In the distressed-investing field, Oaktree is “the standard,” says Jon Hirtle, chief of financial advisory firm Hirtle, Callaghan & Co., which oversees $15 billion for clients and has invested with Marks and Karsh.
Oaktree, which a few months ago sold stock in itself to outsiders for the first time, also is a growing force in a number of other markets around the globe, including commercial real estate and private equity. It opened an office in Beijing in March, its tenth location worldwide.
Pension funds and other institutional clients know Oaktree as a skilled -- and very patient -- opportunist. Like other so-called alternative-investment managers, it hunts for potential investment gems away from the money-management herd.
The basic idea: Buy an asset for less than its true value and sell it later, when others finally recognize what you saw.
“Most of our transactions are tinged with distress,” says Marks, 61, the firm’s chairman and co-founder.
In 2000, when the movie theater business was crashing because of a glut of screens, Oaktree bought in. Ditto in 2005, when the owner of a huge Berlin apartment complex needed to sell the property.
But in the corporate bond market, Oaktree’s principal turf, distressed pickings have been slim in the last few years. The easy-money era on Wall Street meant that few companies faced a struggle to stay afloat. Capital was there for the taking.
With the global credit crunch that struck in midsummer, however, the picture has changed markedly. If more companies begin to sink under the weight of their debt, opportunities will blossom for distressed-bond buyers.
In the first half of this year, when markets still were giddy with confidence, Oaktree amassed a war chest. The firm is believed to have lined up about $11 billion in cash or cash commitments from its clients, the largest such sum of any distressed-investing firm.
It also is said to be raising more than $4 billion for a fund that would invest in some of the corporate buyout loans that investment banks now find they have trouble offloading, as many investors and lenders have turned skittish.
“We’re so excited about this environment,” Marks says, without getting into details about the new funds.
The money Oaktree has raised is a testament to its reputation as one of the sharpest players in the field. It also may reflect that many corporate and public pension funds missed out the last time distressed opportunities mushroomed.
That was in 2002, when bonds of companies including Lucent Technologies, Nortel Networks Corp. and Tyco International Ltd. plummeted in value amid a rash of corporate accounting scandals and extreme pessimism about the telecom business.
“They were ‘money-good’ bonds at bankruptcy prices,” Marks recalls. “It was the greatest buying opportunity we’ve ever seen.”
Oaktree scrambled to round up capital from its investors that summer. “We said, ‘We’ll take every dollar we can get,’ ” Marks said. The firm wound up putting more than $2 billion to work in depressed bonds in mid-2002, but it could have handled more.
The reward for investors who answered Oaktree’s call: a 73% return on their money in 2003 as the bonds surged in value.
Like many distressed-securities investors, Oaktree may take an active role in restructuring companies whose debt it buys. With billionaire partner Philip Anschutz, the firm remade the failed Regal, Edwards and United Artists theater chains in 2000 and 2001 after buying the companies’ debt for as little as pennies on the dollar.
“We loved it,” Karsh says of the theater chain business. “What better situation in bankruptcy?” The business was sound, he said -- there simply were too many screens nationwide. Anschutz and Oaktree closed a chunk of the theaters, worked out deals with the remaining landlords and brought the theaters public again as Regal Entertainment Group in 2002.
The theaters epitomize what Marks says is Oaktree’s preferred investment opportunity: “Good company, bad balance sheet.”
They believe there are a lot of those companies on the horizon.
Marks, whose periodic letters to clients over the last decade have chronicled the highs and lows of corporate finance and market swings, was aghast at the global debt buildup of the last few years and the easy terms lenders gave borrowers.
The extension of credit was the equivalent of “stacking logs in the fireplace,” Marks says. The bigger the woodpile, the bigger the blaze once it’s lit.
In February, just before Wall Street began to realize the extent of the debacle in the sub-prime mortgage market, Marks warned clients of “a race to the bottom going on, reflecting a widespread reduction in the level of prudence on the part of investors and capital providers.”
Now what?
Marks and Karsh believe the market tumult of July and August was just the first warning shot. They say they have put little money to work in distressed corporate securities because, in their view, there still isn’t much from which to choose -- particularly given how quickly stock and bond markets have snapped back since mid-August.
“It’s early right now,” says Karsh, 51, Oaktree’s president. He expects the U.S. economy to tumble into recession in 2008 and eventually expose a host of companies, and investors, desperate to work their way out of crushing debt.
“Leverage is the dominant theme of this era,” Karsh says. “And I’ve spent my entire career seeing the bad side of leverage.”
Even so, Oaktree isn’t suggesting to clients that it will repeat the huge returns of 2003. The firm is setting its sights on annualized gains of 15% to 20% on distressed debt, according to investment consultants. That still would handily beat what most big investors expect to earn in the stock market.
One change for Oaktree: In the next distressed-investing boom, its success or failure will matter to more than just the firm’s nine principal partners and their clients. In May, Oaktree and its principals took in nearly $900 million by selling a stake of less than 20% of the firm to outside investors.
But Oaktree took a different route from some rivals in the alternative-investment realm, such as Blackstone Group and Fortress Investment Group, which chose to sell their shares to the general public on the New York Stock Exchange.
Oaktree opted to raise money from a limited group of big investors via a new securities market created by brokerage Goldman Sachs & Co.
Goldman’s market offers private companies a way to raise capital without the laborious process of going public. It also keeps all but the most sophisticated investors from getting their hands on the shares.
That suited Oaktree, because Marks believes most investors wouldn’t have the patience to put up with the peaks and valleys of the alternative-investment business.
“This is not a steady business,” he says. “How can I produce a steady profit?”
Then why sell stock at all? Marks says it is critical for Oaktree’s long-term growth to have a tradable stock that can be used to lure talent and keep current fund managers aboard.
A tradable stock allows the company’s 420 employees to know what their stakes are worth at any moment, and provides an easy way to turn those stakes into cash.
For the firm’s principals, the sale of stock meant a big payday. So far the buyers haven’t made out that well: The stock has fallen from $44 a share at the offering price to about $38 lately, reflecting the general slide in financial shares.
Marks hopes his investors are focused on the long run. Despite his expectation that the debt boom of this decade must be unraveled, he insists that he has a positive long-term outlook on the global economy.
“I don’t want the world to end,” he says. “I tell my wife, ‘I’m not a pessimist, I’m a realist.’ ”
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The Oaktree file
Background
Oaktree Capital was founded in April 1995 by Howard Marks, Bruce Karsh, Richard Masson, Sheldon Stone, Stephen Kaplan and Larry Keele, when they decided to bolt from L.A.-based Trust Co. of the West. They had been with TCW since the late 1980s directing portfolios of junk bonds, distressed debt and other assets.
Top officers
Chairman Howard Marks was a pioneer in junk bond investing, starting at Citicorp in 1978. He received his undergraduate degree from the Wharton School at the University of Pennsylvania and an MBA from the University of Chicago. President Bruce Karsh got his start investing in distressed debt with billionaire Eli Broad in the mid-1980s. He has an undergraduate degree from Duke University and a law degree from the University of Virginia.
Main investment areas
Junk bonds, distressed debt, private-equity buyouts, convertible bonds, real estate development
Assets under management
$47 billion
Clients
Public and corporate pension funds, endowments, insurance companies, wealthy individual investors
Recent investments
Took a 0.5% stake in Bank of China, that country’s second-largest bank; bought Fu Sheng Industrial Co. of Taiwan, the world’s biggest maker of golf-club heads; bought Stock Plzen, the Czech Republic’s largest maker of alcoholic beverages.
Real estate developments
Master developer of Vellano, a 600-acre community in Chino Hills; partnering with other investors in Macao Studio City, a resort property that will combine theater, television and film production facilities in the Chinese gaming center; owns a large chunk of land on the Hawaiian island of Oahu.
-- Tom Petruno
