[Video] What Is Distressed Debt Investing?

Finance | Provided by Katie Robinette

Katie Robinette and Mark Wilkerson of Cornerstone Advisors explore the modern private equity landscape by looking back on the third and fourth of four market cycles that shaped the industry. Covering the period from 2001 – 2008, this episode opens with many tech firms and investors suffering from the consequences of the Dot Com collapse, terrorist attacks and corporate malfeasance. From the ashes, a firm founded in the 80’s makes news by generating the largest leverage buyout deal of all time, only to be surpassed by a familiar name. Spanning from 2009 to present, the fourth of four market cycles includes the emergence from the worst downturn since the Great Depression, unprecedented monetary policy and the rise of the Unicorn.

As we discussed in the last episode, the dot.com crash in 2000 was catastrophic for tech companies and their investors. But they weren’t the only casualties during this period. The subsequent terrorist attacks and corporate scandals, left lots of businesses in trouble and with risk aversion high and with financing once again impossible to obtain, the leveraged buyout business was in limbo too.

But here’s the thing. Those same buyout firms who were sitting on the sidelines during the tech mania were now sitting on the piles of cash they didn’t deploy (well the smart ones were anyway). They are in the enviable position of being able to supply capital at a time when capital was scarce – and they begin buying up the debt of financially distressed companies at bargain prices. The goal was to amass a large enough position in the debt to force a restructuring of the company, at the end of which their debt would be converted into equity. This type of private equity strategy is called distressed debt investing, and its emergence reflects the opportunistic nature of these firms. When the world is fearful, those brave, smart enough and nimble enough to invest can reap great rewards.

And they did. In 2004/2005 (after the stock market begins to soar once again) firms begin cashing out huge gains on those investments.  And as the cycle goes, this gets the attention of investors who are becoming more and more risk tolerant and hungry for high returns. Add this to the return of credit on an unparalleled scale and you get something called “The Golden Age of Private Equity” and the return of the leveraged buyout on a scale not seen since the 1980’s.

This time it’s the VCs who are taking a back seat while buyout investment reaches historic highs in 2005, 2006 and 2007 and becomes a powerful force in the economy in a way it never had before. Hundreds of billions are being raised by the new Kings of Capital, with Blackstone setting the all-time record at $22B for the fund it raised in 2007.

But Steve doesn’t stop there, he does something else unprecedented. He takes Blackstone public – the first private equity firm ever to be taken public, and at the end of the first trading day he’s worth $10 billion (if this isn’t a sign of the times I don’t know what is).  

But poor Steve does not get the award for largest leveraged buyout deal ever, that once again goes to KKR when they buy energy giant TXU for $45 billion, which finally surpasses their RJR Nabisco deal from the 80s. But actually close behind is Hilton Hotels which Blackstone does close… just before the credit markets freeze and the GFC ensues. The GFC was affected the entire global economy. No sector was spared. It was the worst downturn since the Great Depression. Pundits claimed that private equity is doomed because of the massive prices paid and the massive amounts of debt on their companies acquired during the Golden Age.

However, a hero emerges! Ben Bernanke and the Federal Reserve launch unprecedented monetary policy to save the U.S. economy and financial system.

Once again Private Equity has massive amounts of capital to invest from record-breaking fundraising in 2006/2007. Private Equity becomes a source of much needed capital during that time. Distressed debt investments become common again and the best Managers capitalized on the situation.

And gradually the credit markets open up, which allows PE to refinance the massive amounts of debt on their portfolio companies acquired during the Golden Age.  And the bull market in stocks leads to record M&A and a flood of exits for private equity. By the way that Hilton deal we mentioned…. With record distributions, investors redeploy that capital back into private equity. 2015 saw the best environment for fundraising.

That brings us to today: 7 years from the GFC asset prices are near record highs, leverage is at record highs and venture capital is back with… Unicorns. A unicorn is a venture capital backed company valued in excess of $1billion – once rare today >80 in 2015. So if we are at a potential the peak of cycle #4, why would you invest in PE now? Tune in to the next episode to find out!

What Is Private Equity Investing: A Five-Part Video Series From Cornerstone Advisors

Living and working in the Pacific Northwest, ‘investing in private equity’ is an oft heard phrase. But what exactly is meant by private equity and how does this investment differ from other investments? How can an investor access private equity investments and does private equity have a place in the traditional portfolio?

In this easy-to-understand five-part series, Katie Robinette and Mark Wilkerson of Cornerstone Advisors introduce you to the world of private equity investing. They’ll explain private equity investing, discuss the structure of these investments and also the different types of returns generated. The series goes on to explore the four market cycles that have occurred since 1980 and what each one means to today’s investor interested in private equity.

Check out the other videos in this series: