Distressed/Special Situations

RACA · Post by **RACA** » Thu Jan 31, 2008 4:54 am

Any advice for somebody looking to move of a HY flow desk into a group focused on distressed?

Bachelier · Post by **Bachelier** » Thu Jan 31, 2008 9:05 am

the customers are still on the sidelines, so make sure the MD and above that approves it knows that 2008 will probably be net negative on cash flows.

rowdyroddypiper · Post by **rowdyroddypiper** » Thu Jan 31, 2008 5:02 pm

Read Security Analysis. Also learn to read financial reports, understand what they represent and do not represent. Learn how to use a financial report as a start to your analysis versus the sole basis for your analysis. If you already know how to do these things and do them well, start thinking about potential investments. It also never hurts to get all your housekeeping done up front when it's slow. Stuff like thinking about your investment process, analsysis and deliverables. I'm not saying you have to come up with these out of whole cloth or that your ideas will even be considered, but thinking about these things will make it easier for you to talk to the group that you want to move to.

doctorwes · Post by **doctorwes** » Thu Jan 31, 2008 6:17 pm

If you are going to get involved with creditors' committees, be prepared to spend the rest of your life participating in frustrating conference calls, half drifting off and reminiscing about the genial banter on the flow desk.

RACA · Post by **RACA** » Fri Feb 01, 2008 2:56 am

Thanks for your advice.

Was wondering if you could clarify one point..."Learn how to use a financial report as a start to your analysis versus the sole basis for your analysis."...I'm assuming you mean normal due diligence, right?

rowdyroddypiper · Post by **rowdyroddypiper** » Fri Feb 01, 2008 4:49 am

What passes for normal DD is different for different people. What I mean by this statement is that you can't consider GAAP reported numbers to be the most reflective of the actual operating results for the company or the best prognosticator of future earnings. So you start with what you have which are going to be the audited financial statements, start stripping out the bullshit items and making some educated adjustments to what remains. I'm not a corporate finance wonk by any stretch but I've had some pretty deep experience in purchasing a couple of companies that if they didn't invent some sanctioned accounting shell games certainly refined the practice to high art. You'd be shocked how many people confuse "GAAP Compliant" with "Reflects Reality".

Bachelier · Post by **Bachelier** » Fri Feb 01, 2008 9:59 am

"I'm assuming you mean normal due diligence, right?"

No.

You work with bankers. Bankers, and the due diligence and then "independent" sell-side credit analysts still have a moral hazard bias. Their goal is to raise capital.

The due diligence bias is to "get the deal done."

If you run a prop hy/distressed shop, you have to think like the cynical bastard I am, and smash the balance sheets and income statements and margins with all the bad news you can pile on to it...and then see if there is still value.

You want proof that “normal due diligence” is *not* adequate?

Ok.

Here is the proof:

Distressed bonds exist.

But once, they had “normal due diligence” applied to them, n’est pas?

Also, kr and I have had skin in this game for over a decade each. It ain’t easy, and there isn’t just alpha lying around to be sucked without any work.

kr · Post by kr » Sat Feb 02, 2008 11:16 am

my 2% recovery:

bachelier's point about 'goal is to raise capital' is very important - there is an amazing amount of noneconomic activity in this business. 'Group focused on distressed' is maybe a bit too vague, and if you can be more precise then I think maybe there's more to talk about when it comes to the bridge from 'hy flow'.

Imho the toughest credits to analyse are the ex- mega-hy flow deals. Credit was granted on the back of huge momentum and story, i.e. bankers are throwing money at companies because they've been told to, and the business seems credible enough, so don't bother looking at the financials. In the pre-BK theory, it is a growth story so good that leverage ratios are hugely above any justifiable level. What the BK will achieve is completely a function of whether any of that aura will remain after reorg. How the f you can predict that, I don't know. Anyhow my point is that I would find those to be the hardest deals to 'prop'.

The better deals have quantifiable tangibles and a whole lot of intangibles that can still be used as the basis for an investment argument. They are not the headline deals, and if it takes longer for the lending crisis to turn around, so be it. What you don't want to do is be dependent on a refi in too short a timeframe.

Ok there are good 'flipper' deals but I think that is currently a 'falling knife' strategy. Actually an overall theme these days is that the 'leverage arb' for almost everything is now gone for an indefinite period of time. So the game has really changed and yet there are tons of people with equity standing around. If you can destroy their portfolio returns then you have succeeded.

RACA · Post by **RACA** » Sat Feb 02, 2008 4:12 pm

Bachelier/Rowdy Roddy - Agree with your comments about "normal due diligence." In fact, way back when there used to be something called new issue in high yield, I was surprised by the cursory levels of DD I saw from our bankers (and actually continue to see on some of my colleagues prop trades).

Indeed, your comments do echo some conversations I've had with other (seemingly) successful practitioners about the amount of research that goes into their ideas...value is an elusive thing, no?

RACA · Post by **RACA** » Sat Feb 02, 2008 4:49 pm

I guess I would change 'group focused on distressed' to 'group actively investing in distressed' or even 'group that has a history of investing in distressed.' By 'HY Flow' I mean 'secondary trading desk with a little bit of punting for our prop book.' Right now our distressed expertise is me, which is like telling a group of college freshman they have a calculus teacher who just finished taking the class last semester. My motivation for wanting to get more active in the space is that distressed investing seems like a game with a lot of nuance and opportunity.

Also, one thing that I'm curious about is how some of these deep pocketed LBO sponsors will react if their bets go bad. In your experience, how often have you seen good money chase a bad LBO in order to preserve an equity stake?