Only Fools Rush In? In today’s Wall Street Journal, Peter Lattman spelled out a fear I’ve been hearing on the tips of buyout pro tongues for a week or two now: All those leveraged loans gobbled up by buyout firms are looking pretty ugly. “Everyone who thought they were being very smart buying these loans in April is starting to feel the pain on those deals today,” one source told me.
Firms like Apollo Management, Blackstone, Carlyle Group, Cerberus, and TPG have purchased at least $12 billion in discounted LBO debt. And in buying the debt of some of their own bad deals, they bought themselves double exposure to a potential blow-up. I have to say that I was immediately suspicious when I heard about the massive chunks of discounted debt the firms started buying in the spring. I understood the idea behind it: “We have money, but cannot execute our plan to spend it (mega-buyouts). You have product, and you can’t execute your plan to sell it. Let’s get together and reduce the backlog. Maybe then you can lend me new money.” Leon Black was even quoted saying in April, “We’re well on our way to a credit market recovery.”
But it hasn’t been that easy. Yes, the backlog has been reduced from around $200 billion at one point to closer to $50 billion or maybe even less. But the PE firms bought the loans at between 80 and 90 cents on the dollar. Leveraged loans are trading at around 65 cents on the dollar now. “It’s clear they are all sitting on paper losses,” the WSJ story reported. Those bottom feeding prices probably aren’t sustainable, but they’re certainly not pretty, and they likely won’t be turning upward anytime soon.
It goes to show that two wrongs don’t make a right. To me, the moves seemed like distractions, not to mention, the success hinges on the premise that these highly levered companies will whether the recession completely unscathed. And maybe they will, but they’re going to get a lot uglier first. Their only option, really, is it wait it out and hope things bounce back sooner rather than later.
And I should note that I was ok with Apollo’s argument that the firm had its roots in distressed debt investing and would merely shift its focus that way as the market demanded it. I did not, however, think it made any sense to buy, with leverage, the loans of its own companies, which are often already distressed and in troublesome industries.
“We are doing exactly what you would expect of us in this market — using our distressed expertise and appetite for complexity to find investments in good companies that are available at significantly discounted levels,” Apollo founder Leon Black wrote in a Feb. 29 letter to clients of the firm, Dealscape reported.