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Vulture Investing: Best Before or After The Bankruptcy?

Absent a stalking horse bidder, control over a bankrupt company is given to its debtholders. That’s always seemed counter intuitive to me, since the debtholder population usually consists of varied species of hedge funds, lenders, and investors, none of which have a specific mandate or know-how to run a company.

It’s a curious situation which often results in a rapid sell-off. Sometimes buyout firms are hesitant to invest in a bankruptcy-bound company’s debt, or as a stalking horse bidder, but wait till this moment to bid. I spoke with Jennifer Feldsher, partner in the restructuring group at Bracewell Giuliani, about advantages of waiting versus diving in early.

When will the LBO-backed busts which have fallen into the arms of their lenders come to market?

In my experience so far, the traditional lenders aren’t interested in holding equity after restructuring and want a very quick exit. Those companies end up with hedge funds or private equity funds that take control. That will continue, as the volatility in the market makes that more attractive to even non traditional hedge or PE funds.

One example is WCI Communities (a Florida homebuilder which recently emerged from bankruptcy). They are issuing equity in a trust that is going to hold land that will be sold off over time. First lien lenders and creditors are receiving equity in the trust, and I would not expect lenders would hold onto that equity over time. Some entities can’t hold equity because they’re not structured for it.

For buyout firms wanting to invest in a bankrupt company, it is better to get involved in debt before the company files for Chapter 11, or is it better to wait and invest on the other side of the bankruptcy process?

That’s very tough to tell and every situation is different, and it depends on what you’re trying to get out of it. (Mattress company) Foamex presents a good example. In that case, (Bracewell Giuliani client) Matlinpatterson Advisors was a substantial debt holder prior to the filing. That enabled them to go to the company and provide the DIP (debtor-in-possession) loan. They knew the company and knew its assets and could move quickly to put together a stalking horse bid.

There is some merit to having a significant position prior to the filing or towards the outset of the case, because you can control, or at least have a significant influence on how the case gets restructured, through a plan or through an asset sale. It’s not a perfect sciences, but sometime you’re the only people standing up bidding. In the case of Nortel, MatlinPatterson was the only one standing up, saying the company shouldn’t be sold in pieces. You don’t always win as they didn’t in that case. But if they didn’t have the debt, they wouldn’t have even had a say.

If you’re looking to make a play in a particular industry and not focused on a particular entity, there are a lot of opportunities where you can get involved in the back end. You can wait and see how the case works out and see the market value on the back end. Typically, after the reorganization, the securities trade up. That happened with WCI’s trust. The idea of creating a trust that’s going to liquidate the debtors’ assets over a five year period is that people believe a firesale today is not going to be most value. But over 5 years you will get greater value. So the securities will cost you more.

I don’t want to say always stay away from back end, because sometimes there are lenders who just want to get out and will sell at very cheap.