PE targets deep distress

Where it is too late to reach a compromise and the asset plunges into bankruptcy, private equity firms may turn to recovery specialists. These players tend to pursue one of three avenues: purchase the claim from the creditor; co-invest alongside the creditor; or litigate, negotiate and settle. It is a business suited those with unusual skill sets, wide experience and a decidedly stubborn streak.

According to Michael Shone, president of distressed debt investor Commercial Intelligence (CI), in Malaysia alone, an "enormous" cash flow squeeze has left foreign investors in capital projects with $2-3 billion in unresolved credit.

Beyond the brink

A recent case saw CI called in to act for the shareholders in an insolvent Malaysian construction company. Encouraged by the government, the firm had entered Africa and the Middle East, where it was engaged to build an oil pipeline and terminal in Sudan, plus several commercial construction projects and hotels in Dubai. Outstanding claims and legal disputes with clients saw the firm's cash flow dry up and it entered liquidation.

CI offered a financing and management package to the liquidator, backed up by several debt recovery investment funds.

"We take over the management of the documents, the organization of the claims, and the payments to lawyers, and arbitration and court fees right up until there is a recovery," Shone explains. "When that happens, we split the proceeds with the liquidator through any number of variations. We try to get 75% of what we recover, which is what we've been getting in our most recent fund."

Also in Malaysia, CI has worked recently on an interior fit-out and furniture-building business with $212 million in outstanding claims and a textile company going through liquidation that was $288 million underwater.

CI generally looks to negotiate settlements but these take 2.8 years on average. This is because the counterparties are often multinationals or state-owned enterprises. Multi-jurisdictional contracts can work in CI's favor as they contain an international arbitration clause which says that disputes must be resolved through an independent tribunal of three arbitrators: CI appoints one to act for the insolvent Malaysian company; the project owner said to owe the Malaysians money appoints another; and the third is independent.

Arbitration takes place in London, Geneva or Paris and decisions are enforceable worldwide. Any country that is a signatory to the New York Convention on the Enforcement of Arbiter Awards must enforce a ruling without further hearing. "That's the endgame," Shone says. "You look down the tunnel to some light at the end, but it can be a very long tunnel, with very expensive tolls."

It is not uncommon for an insolvent company to jettison staff and equipment, and put documents into storage. Distressed debt investors must find the physical records, review them, and then trace former employees to retrieve data from lap-tops from which email accounts and records can be re-created.

The process is expensive but it can be lucrative. CI has recovered $167 million since it was founded in 1987. A further $113 million has been awarded in judgments that are currently being enforced, and there is $330 million or more in outstanding claims that have originated since 2007. Debt collection breaks down geographically as 40% Africa, 30% Asia, 10% Middle East, and 20% for the rest of the world.

The company is in the process of raising its $100 million Global Distressed Alpha Fund 3, which is larger than any of its five predecessors.

Niche market

In essence, these distressed debt specialists follow a similar route to the wider distressed asset industry - tracking Asian businesses as they go beyond national borders in search of new opportunities throughout the region, setting up operations in multiple locations.

However, they target assets in a different way.

Clearwater Capital Partners, like CI, has made multiple investments in the oil and gas services sector, but it spent 36 months conducting due diligence before putting any money on the table.

"Our investment strategy focuses on downside protection," says Rob Petty, Clearwater's managing partner and co-founder. "As credit investors, we favor asset-heavy businesses over, say, consumer businesses which are mostly about cash flow."

CI, meanwhile, is further down the scale, investing in assets where there may not be any cash flow at all. A traditional distressed investor looks for a company on the cusp of insolvency, which has bonds that could be traded at $0.20-30 on the dollar. CI comes in once all the bonds have been defaulted and its objective to see what could be clawed back.

"We are asked by people, can you finance this to recover? They're not asking us if we can buy something to trade it later, such as a bond" says Shone. "What we invest in, we never sell. We have only one way forward."

Many regional businesses, driven to find new growth, don't have the luxury of this sophistication or choice - as illustrated by the plight of Malaysian companies. In this respect, Shone sees future prospects getting brighter, noting that receiverships and defaults are growing in construction and manufacturing as well as oil and gas.

"It's a target-rich environment," he enthuses.

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• Topics
• Restructuring
• Restructuring
• Clearwater Capital Partners