Chapter 4
Distressed Debt’s Value Seekers
You need to understand how a company’s going to operate in the bankruptcy process and how that’s going to affect its ongoing operations. You’ve got to mesh many different disciplines into one. That’s our edge. We have the expertise to understand those different disciplines better than others.
—Marc Lasry, February 2011 interview
By December 2008, Lehman Brothers had filed for Chapter 11, pushing the financial system to the brink of collapse. Freddie Mac and Fannie Mae had been put into conservatorship, and, despite an $85 billion loan from the Federal Reserve, AIG faced the prospect of liquidation. TARP was passed into law, giving the Department of Treasury $700 billion to attempt to avert an even worse financial crisis, and yet there was considerable doubt that this would be sufficient. With the Dow Jones Industrial Average down more than 30 percent, Marc Lasry faced one of the toughest decisions of his career. Was this the right time to commit capital to new investments? Were asset valuations close to bottom, or would macro conditions deteriorate further?
For Lasry, chairman and CEO of Avenue Capital Group, one of the pioneering investors in distressed assets, it was a pivotal moment. Avenue focuses on undervalued opportunities investing in public and private bonds, bank debt, post–reorganization equities, trade claims, and other securities of companies under financial distress, but if the financial system were to collapse, no investment would make sense, particularly entities already in trouble. And Avenue Capital, the hedge fund Lasry and his sister Sonia Gardner founded in 1995, was already having a rough year, with its funds down about 25 percent.
Lasry’s decision would be guided by extensive credit analysis conducted by his team, rather than a gut attempt on his part to time the market. The analysis indicated that Avenue’s existing investments had experienced mark-to-market hits—not permanent impairments. Moreover, the Avenue team had identified a range of new opportunities. “We did our research and we invested in specific credits where we were confident we fully understood the downside—not only the upside.” Lasry’s belief is that you can’t time the market—“we invest when we have conviction in the credit and we believe it’s cheap. If it gets cheaper, then we buy more. We were investing where we thought we were right on credit at the end of 2008 and 2009, unlike others who were somewhat paralyzed by the turmoil in the markets, or simply just didn’t have cash. In retrospect, we may not have invested at the absolute bottom of the market, but we were close.” According to one of Avenue’s investors, the U.S. hedge funds were up more than 60 percent in 2009, so Avenue’s decision to invest the cash paid off.
Perhaps the best example of Avenue’s credit analysis and investment discipline during the turbulent 2008–2009 period was the firm’s concentration on the U.S. auto industry. The auto industry was in desperate shape, with the economy slumping, unemployment soaring, and gas prices topping $4 per gallon. As vehicle sales dropped to levels last seen in the 1980s, the chief executives of the Big Three automakers faced Congress in November 2008 to plead for assistance. It was clear that the operating hurdles faced by the Big Three were insurmountable and painful restructurings were inevitable. But because of the massive amounts of capital that would be required and the close links between automakers and their suppliers, the risks were huge.
Avenue has dedicated investment teams focused on its U.S., European, and Asian distressed strategies, in addition to its Real Estate, CLO, and Fund of Funds groups. In the U.S. distressed strategy alone, Lasry has 30 investment professionals, including five portfolio managers. Unlike many hedge funds, Avenue is further organized by sector. The team following the auto industry, benefitting from more than 30 years of collective experience, quickly concluded that the U.S. government couldn’t afford to let General Motors and Chrysler fail. Moreover, their belief was the White House and Congress, would not disappoint organized labor, a major constituent. And members of both parties, the Avenue team reasoned, eventually would come to understand that allowing the automakers to liquidate would send huge shock waves through the economy, driving up unemployment, and crushing entire communities that were tied to the industry. If GM and Chrysler failed, they would take many auto parts suppliers with them, disrupting the businesses of the Japanese and European transplants and contributing further to the nation’s unemployment rate.
Once the Avenue team felt confident that an uncontrolled collapse of the auto industry was unlikely, it zeroed in on an opportunistic point of entry for its investment, and selected Ford. The nation’s No. 2 automaker, the team determined, offered the best combination of a strong balance sheet, an aggressive restructuring plan, and a good product mix. Because Ford had raised capital in 2006, it had the liquidity to navigate a weak sales environment. The company’s management, under CEO Alan Mulally, was successfully transforming its culture, focusing on core brands and selling assets like Jaguar, Land Rover, and Volvo. While most investors were fleeing financial services companies, Avenue believed that Ford’s captive finance company could be an advantage in a tough credit environment.
Lasry and his team made their move. They began aggressively accumulating Ford senior secured bank debt in December 2008–February 2009 at significant discounts to face value. According to pricing information obtained from UBS, the market at the time was in the 30s and 40s. By the peak of its investment, Avenue had acquired more than $500 million, face value, of Ford bank debt.
As Avenue’s team had predicted, both GM and Chrysler went through government-sponsored Chapter 11 filings, which allowed the industry’s suppliers to survive. The government’s “Cash for Clunkers” program helped stimulate sales. Meanwhile, Ford continued to bolster its balance sheet and managed to avoid a government bailout, giving its image a boost in the eyes of consumers. The company rolled out a steady stream of successful new products, and Ford’s credit arm allowed the company to offer buyers leasing and financing options at a time when the credit markets were frozen. By the beginning of 2010 Ford’s senior secured bank debt had recovered substantially to high 80s and low 90s (source UBS) when Avenue sold its Ford positions. As previously noted, the Avenue U.S hedge funds generated gross returns over 60 percent in 2009, one of the best annual performances in the firm’s history.
The Ford deal encapsulates Avenue’s strategy at its best: spotting an opportunity in a deeply troubled sector, conducting a thorough top-down, bottom-up analysis of both the industry and the individual company, and, before making a move, thinking through the downside. Working with Avenue’s highly experienced analysts as they dig into a potential opportunity, Lasry always looks to identify worst-case scenarios and specific risks to every investment. Lasry, who, with typical understatement, describes his style as conservative, adds that most investors don’t like to get hurt. To that end, the firm focuses on the top of distressed companies’ capital structures, buying mostly secured bank debt so they are first in line to get paid if the companies default or file for bankruptcy protection.
That conservative formula has made Avenue into one of the world’s biggest investors in distressed debt, with more than 275 employees across offices in the United States, Asia, and Europe, including New York, London, Luxembourg, Munich, Beijing, Singapore, Hong Kong, and Jakarta. As of January 31, 2012, Avenue’s assets under management stood at about $12.5 billion, below the $20 billion the firm had managed earlier. This was largely the result of the firm returning $9 billion in capital and profits to investors, following Avenue’s decision in early 2011 to exit previously distressed investments that had significantly moved up in price when the market was strong.
Brother-and-Sister Partnership
The successful formula also has distinguished the unlikely brother-and-sister founders of the firm among the distressed industry’s leading investors. Lasry and Gardner were born in Marrakech, Morocco, the family home for generations. Their parents left Morocco in 1966 and moved into a two-bedroom apartment in Hartford, Connecticut, where Marc and Sonia, then seven and four, shared a bedroom with their younger sister. Their father was a computer programmer for the state of Connecticut, while their mother taught French at a private school the Lasry children later attended. (When the siblings arrived in the United States, they spoke no English, only French.) At night, their parents worked a second job selling Moroccan clothing to boutique stores.
With the help of scholarships and loans, Marc and Sonia both attended Clark University in Worcester, Massachusetts. It was there Lasry met his future wife, Cathy, a friend of Sonia’s who lived across the hall in their freshman dorm. Lasry graduated in 1981 with a BA in history. The summer before he was to start at New York Law School, he worked as a UPS truck driver and considered ditching his academic plans. “These drivers make a lot of money. I thought I could get into management,” he told a group of students in a speech at his alma mater in 2007. “But my wife didn’t want me to be a truck driver. She wanted me to go to law school.” So he gave up his dream of driving a big brown truck, and received his JD in 1984.
Lasry’s down-to-earth style—he’s plainspoken and partial to casual sweaters and slacks—and his company’s simple-sounding philosophy cloak a profound understanding of distressed-asset investing. After law school, Lasry clerked for Edward Ryan, chief bankruptcy judge for the Southern District of New York. He spent the following year practicing law at Angel & Frankel, which also focused on bankruptcies. Going through all the filings and financials, Lasry became an expert on distressed companies and how to profit from them. He realized he was looking at a large and relatively untapped market with very little competition.
Lasry soon left Angel & Frankel for a job as the director of the private debt department at R. D. Smith (now Smith Vasilou Management). It was there he first got involved in “trade claims,” the market in purchasing and selling to investors the unsecured claims of vendors and other creditors against a debtor. A year later, in 1987, he landed a big position at Cowen & Company, managing $50 million in partners’ capital. It was right around the time that his sister Sonia had graduated from law school and Lasry’s new department at Cowen needed a lawyer. “We got into business together completely by accident,” says Gardner. “And I don’t think it’s something we ever would have planned. I had just graduated and was looking for a job, and Marc said, ‘Do this with me—I need someone I can trust.’” At the time, investing in distressed debt was a relatively esoteric business practiced by few, and Lasry wanted someone he could depend upon to help run Cowen’s trade-claims department—without hiring a competitor in training. Gardner agreed to take the job, thinking of it as a temporary gig. They’ve worked together ever since.
At first, Gardner found the switch from law school to Wall Street anything but glamorous. “Early on, we were investing in Storage Technology, a company that had filed for bankruptcy in Denver, so I used to fly to Colorado for a week at a time with bags of quarters in order to make copies of the list of creditors who had accounts receivable due from the debtor. These schedules were hundreds of pages, so it would take days to make copies; back then, it wasn’t possible to get the lists online as we do now. People thought we were crazy for flying to Denver to make copies ourselves, because our competitors would simply order the lists and receive them by mail weeks or months later when the Court got around to making the copies. But the extra effort gave us a tremendous advantage, as we ended up being the first ones in the market buying the claims. I would fly back to New York, and we would make calls to each of the creditors to buy their claims and negotiate the contracts individually. Of course, there were many days when I wondered to myself, ‘Did I go to law school so I could stand at a copy machine for 12 hours a day?’ ” Gardner recalls, laughing.
Those early experiences helped establish what would later become one of the firm’s defining characteristics: an understanding that certain markets are inefficient and a dedication to performing careful homework combined with a willingness to do whatever it takes to get the job done. “Trade claims was a great business because it was an untapped market with little competition, and we knew how to do the research, find the trade creditors quicker than others, and negotiate the contracts,” Gardner says.
Trade creditors typically have no interest in receiving stocks or bonds, and do not want to wait out the bankruptcy process to get paid on their claims. Instead, they often prefer to sell their claims for immediate cash, even at a steep discount. When Bloomingdale’s filed for bankruptcy, for example, a trade creditor may have sold merchandise to the retailer for $100,000, but its cost was perhaps only $40,000. If Lasry offered them 50 cents on the dollar in immediate cash—or $50,000—in most cases it was worth striking a deal. In bankruptcy situations, trade creditors are concerned about recovering the cost of the merchandise first and foremost. “So as long as they got back their cost and could book a profit,” Lasry explains, “it made sense for them to sell.”
Catching the Eye of Robert Bass
It was while working at Cowen that Lasry caught the eye of legendary Texas billionaire investor Robert Bass. When Cowen decided to raise money for a fund, the Robert M. Bass Group, then a client of the firm, offered to provide Cowen with virtually all of the capital. After Cowen refused to take all of the Bass capital, the siblings decided to leave the firm and go work for Bass. “Once we got to the Bass organization, we realized it was a pretty unique place. It’s difficult now to fathom, but back then the only people who really had capital were wealthy family offices,” remembers Lasry.
The Robert M. Bass Group, later called Keystone, Inc., had been known as a breeding ground for some of the world’s top private equity investors, including David Bonderman, who went on to found Texas Pacific Group (TPG), and Richard Rainwater. When Marc and Sonia joined the Bass Group, they were given a portfolio of $75 million to invest in trade claims, bank debt and senior bonds. They reported to Bonderman, then the Bass Group’s chief operating officer. Lasry was 30; Gardner was 27. From the beginning, Bonderman recalls how Lasry came onto the scene and blew the guys at Bass away. “He didn’t always speak up,” Bonderman says. “But when he did he always had a vision for the investments that no one else saw. He always brought fresh perspective to the table.”
The siblings wanted to call the entity “Maroc” after their birthplace, Morocco, but a Bass colleague advised them to pick a name starting with the letter “A” so they would be on top of all the distribution lists. They flipped the first two letters and settled on Amroc Investments. Aside from Amroc’s flagship $75 million fund, they also had the ability to draw down an additional $75 million, giving them access to $150 million in capital, which made them one of the largest distressed funds in the United States at the time.
“I met all these exceptionally smart guys at Bass,” says Lasry. “David Bonderman, Jim Coulter, Tom Barrack, and many others. It was a phenomenal period, and I quickly realized I was dealing with guys who are off-the-wall smart and really good guys—nice, smart people.”
Even though they were doing very well under the Bass umbrella, after about two years, the siblings were ready to really strike out on their own. “I think it was a little bit of hubris probably,” Lasry admits. He had learned a lot from the superstars at Bass and felt ready to invest his money on his own. What’s more, Drexel Burnham Lambert had collapsed in the wake of Michael Milken’s indictment for securities fraud, which plunged many companies with low junk bond credit ratings deeper in the red. Suddenly, there were massive opportunities for distressed investors. “You know, when you look back on it, I left what probably was one of the best jobs in America, running money for one of the world’s first billionaires,” Lasry says. “And back then there weren’t that many. But I don’t regret it.”
Lasry and Gardner opened their own boutique distressed brokerage firm in 1990 with $1 million of their own capital, keeping the name, Amroc Investments, and their affiliation with the Robert Bass Group. Gardner remembers the pride she felt in building a business. “It was just the two of us and a secretary when we started—we were both working 14-hour days, 7 days a week. We slowly built one of the largest private distressed debt brokerage firms that existed at the time, and expanded Amroc to more than 50 employees.”
Lasry was keeping up a grueling schedule, meeting with clients and bankers establishing relationships, and brokering billions of dollars of debt for their clients. “At the same time, for five years, we also ran our own money, just my sister and me,” says Lasry. They stuck to their winning formula, managing Amroc and continuing to invest their personal capital, and generated compound annual returns in excess of 50 percent.
By 1995, the Amroc distressed brokerage firm was facing new competition as big players like Goldman Sachs, Merrill Lynch, and Citibank entered the market. As a hedge against their brokerage business, Lasry and Gardner formed their first Avenue fund using capital from friends and family. They wanted another “A” name, and this time they named it after Madison Avenue, where their offices were located. They started Avenue with less than $10 million in 1995, building it into a $1 billion hedge fund firm over the next five years.
Two years later, in 1997, they formed their second Avenue fund, Avenue International, an offshore fund that attracted U.S. tax exempt and non-U.S. investors. Also in 1997, David Bonderman of TPG, their former Bass colleague, approached Lasry to run an institutional distressed fund—a partnership that heralded their new strategy of offering institutional funds with a private equity structure. TPG would be a general partner of the fund and receive a share of the profits. With TPG’s help, they quickly raised Avenue Special Situations Fund LP, a $130 million, seven-year lock-up fund.
By 2001, Avenue’s assets under management had grown substantially and they were also still running Amroc Securities, their distressed brokerage. Lasry and Gardner were at a crossroads, as they realized they could no longer operate both businesses if they wanted to continue to meet the standards they had set for themselves. So, in August of that year, they decided to close Amroc to focus all their energies on Avenue. They moved the Amroc trade-claims employees over to the Avenue side, retaining their visible presence in the market. Their database alone was worth keeping the business running. “We were viewed as the Merrill Lynch of the trade-claim world. We were the biggest and most active player in that market and everybody knew who we were,” says Gardner.
In 2004, Avenue launched a European-focused distressed business with Rich Furst as the senior portfolio manager. In addition to buying distressed debt, the firm in Europe writes loans for small companies unable to obtain financing, an important offering because that region’s high-yield bond markets are less developed than those in the United States. Today, Avenue has most of its assets in its U.S. and European strategies, including more than $3.5 billion allocated to Europe investments overseen by Furst and a team of 20 dedicated investment professionals in London and Munich. The rest of the firm’s assets are invested in Asia, where Avenue began operating in 1999, and several other businesses.
“People think we got to $20 billion overnight, but it wasn’t as easy as it seems,” Lasry says. “We had the background. We had good returns. We had the infrastructure, and we had good people. And, importantly, we had high-quality, stable, long-term investors that allowed us to raise money in a difficult fundraising environment. We were also lucky that we were in the right place at the right time.”
It was a lot more than luck, of course. The siblings’ characteristic methodical investment approach was paying off. Gardner explains, “We made the decision when we started Avenue that we were going to build the infrastructure before raising the money. Funds that do it backwards typically get into trouble. We always made sure we were well staffed, and we spent the money so that on day one of each fund, we had the back office set up, as well as the front office. And, obviously, we would add more staff and other resources over time.”
Gardner now spends most of her time overseeing all aspects of Avenue’s global business operations. “I think some funds don’t place enough importance on establishing institutional-quality infrastructure—in terms of accounting, compliance, legal, investor relations, and information technology capabilities,” says Gardner. “They just pay attention to the front office. But you can have great returns and then you have a blowup in the back office, and you’re out of business.”
She emphasizes a best-in-class compliance culture. “The ethical tone from the top is what drives your organization—it has to be engrained in the culture,” Gardner says. “That’s true whether you have one employee, hundreds, or even thousands.”
Darcy Bradbury, a D. E. Shaw & Co. managing director who met Gardner in 2007 while working with her on the President’s Working Group on Financial Markets, recalls Gardner’s sense of ethics and focus on the basics. “It was our responsibility to produce a report on sound practices for the industry for asset managers and investors,” Bradbury says. “Sonia always had a very strong sense of integrity and ethics and really brought that into the discussion. She taught us about best practices for building a business over the long term, how you can’t cut corners and you have to have a very clear focus and that, at the end of the day, your investors have to trust you.”
Lasry and Gardner complement each other by having different strengths. In fact, their killer combination has worked so well that Lasry was named one of the 50 most influential people in hedge funds by industry trade publication HFMWeek in 2010.
Detecting Diamonds in the Rough
While Wall Street concentrates largely on investing in strong, healthy companies, Lasry feels perfectly comfortable looking at companies in distress. Unlike most investors, he’s not afraid of being in the middle of an investment where credit conditions could get progressively worse before they get better. “We are constantly searching, trying to find value, typically in troubled companies,” he says. “And then we try to buy those assets at a discount. In contrast, most investors try to find companies that have no problems. And, when companies have problems, people get nervous. We look at the world very differently than most investors.”
For Lasry, with his long history of distressed investing, sifting through distressed companies is second nature. When he sees a troubled company he asks himself, “What’s the value of the company? What assets does this company have? And where do we want to be in the capital structure?” He gives a simple example of a company with $1 billion of liabilities and only $100 million of value.
Lasry continues, “If you happen to be a secured creditor and have the first $25 million, then you’re safe. If you’re at the bottom of the capital structure and there’s $900 million ahead of you before you get paid, it’s a different story. It’s fine to be an unsecured creditor if you believe the value of the company is enough to pay off all the unsecured creditors in the capital structure,” says Lasry.
Next, says Lasry, you need to take a look at the liability side. “Say you have liabilities of $1 billion, $200 million of secured debt, $300 million of senior unsecured debt, and $500 million of subordinated debt. If the company is worth only $200 million, as an unsecured creditor you’ll walk away empty-handed. It all goes to the secured investors. But if the company’s worth $500 million, then the secured will receive par and the senior unsecured may also get a full recovery. You have to analyze the value of the company, and then compare it to the liabilities to determine where you are in the stack and what your remaining values may be.”
Distressed investing is often perceived to be more risky than equity investing, but Lasry believes it actually presents less risk. He only pursues investment ideas where he’s comfortable that his downside is protected. So, when his investment professionals do their homework, he wants to know the worst-case scenario. “I don’t want to hear how great the investment is—I want to hear how we could get hurt. Once we know that our downside is protected, then we look at the upside potential.”
Avenue typically has 40 to 50 positions at any time. As a general matter, Lasry wants to be about 80 percent invested with 10 percent to 20 percent in available cash in order to opportunistically take advantage of market opportunities. The firm has never employed leverage to enhance its returns. “A leveraged portfolio forces you to act irrationally when markets are irrational, as opposed to acting rationally when markets are irrational,” Lasry says.
The private equity–like structure of many of Avenue’s funds is appealing to institutions because it limits the potential cash drag as well as providing a stable capital base that is less prone to short-term, irrational market movements. Investors also receive a preferential return before Avenue receives any incentive allocation.
“We’re conservative,” says Lasry, especially compared to other prominent managers in the distressed sector. “Sometimes we find ourselves alone in buying the debt of a certain credit.” Lasry names Oaktree, Angelo Gordon, and Centerbridge as competitors, “but what you’ll find is that there are far fewer folks in our space than there are in the equity space.”
Lasry believes Avenue’s real edge over its peers is the firm’s experienced investment team, and its deep, fundamental understanding of all the ramifications and risks of bankruptcy proceedings and restructurings. Avenue’s team is adept at recognizing the potential value of companies struggling with financial distress, at gauging the risks inherent in the bankruptcy process itself, and at evaluating the opportunities that will emerge after restructuring. The Avenue team prides itself on its comprehensive approach and broad experience across a large number of distressed opportunities as well as cycles over the past 20-plus years. Understanding the fundamental value of companies in distress as well as the unique risks and opportunities of bankruptcy is a particular strength of Lasry’s investment team. As a result, the firm has captured outsized risk-adjusted returns in the distressed investing space.
“You need to understand how a company’s going to operate in the bankruptcy process and how that’s going to affect its ongoing operations,” says Lasry. “You’ve got to mesh many different disciplines into one. That’s our edge. We have the expertise to understand those different disciplines better than others.”
“What has made Buffett successful, what has made other people very, very good, is their ability to see things in the available data that others don’t see,” Lasry continues. “It’s the same thing in the distressed world. The information is all public, but I think we do a better job of analyzing the intricacies and assessing the risks. We have exceptional investment professionals with many years of experience in the business, and ultimately, that’s the reason we’ve done well.”
Avenue did so well, in fact, that in October 2006, Morgan Stanley Investment Management bought a 15 percent stake in the firm for approximately $250 million. Before the financial crisis, having a major investment bank as a stakeholder in the firm seemed like a dream come true. Gardner, who negotiated the deal, recalls that they were approached by many investment banks that wanted to buy a much higher percentage of the firm, but signed with Morgan Stanley because the deal allowed them to retain control of their business. They invested 100 percent of the proceeds they received from Morgan Stanley back into the Avenue funds. Stuart Bohart, co-head of the alternatives division of Morgan Stanley Investment Management at the time, had hoped to expand Morgan Stanley’s capabilities.
“We had a strong presence across private equity, real estate and Fund of Funds, but not hedge funds,” says Bohart. “We wanted to create that with a hedge fund partnership.” But the credit crisis ended up hitting financial institutions like Morgan Stanley the hardest, forcing them to focus on their own survival above all else.
For Lasry, it’s about a lot more than the next hot investment—he thinks independently. “I look at myself as a value investor. I’m trying to constantly find mispriced investments and add value in a situation. For Avenue, investing means having conviction in your work and companies where you invest, even when the Street has written them off.”
Many times, as a distressed investor, an industry outlook or thesis is critical to having a full understanding of a specific company’s management and balance sheet. That was the case with Avenue’s successful investment in Six Flags, the largest regional theme park operator in the world. Similar to Avenue’s investment in Ford, the firm’s analysts and restructuring experts covering the leisure industry dove into Six Flags and did their work. The team thought Avenue could invest in the bonds and secured bank debt at a big discount to where the public comparables were trading. “It’s very company specific,” says Lasry. “You have to look at the entire capital structure and value all the assets and figure out the real values, and then put on your restructuring hat and figure out how you think distributions will be made, and in what form. Will it be cash or post-reorganization equity? Will the debt get reinstated? With respect to the theme park industry, we knew where competitors were trading and we had researched historical sales in the industry, and we thought we would be able to invest as low as a 50 percent discount to the public comparables. So we thought we were getting paid for the risk/reward of this investment.”
In 2007, Avenue aggressively started buying Six Flags’ bonds due in 2010 at very significant discounts to par. In order to help the company manage the refinancing of this early maturity, Avenue offered to backstop a debt for debt exchange of their 2010 bonds into a longer dated senior note with a significantly higher coupon. The new senior notes’ priority status allowed Avenue to leapfrog approximately $1 billion of now structurally junior notes that had not participated in the exchange. This vastly improved Avenue’s asset coverage and associated risk profile. It also squarely positioned Avenue with a blocking position in the new fulcrum security. As the financial crisis gained momentum in 2008, Avenue began to aggressively purchase secured bank debt at also at very distressed prices. This provided a complimentary barbell strategy to the existing senior note investment.
Facing an imminent restructuring, in April 2009, Six Flags announced a debt exchange offering that gave approximately 85 percent of the equity to the junior bonds with the remainder split amongst existing preferred and common stock holders. Six Flags’ senior notes and bank debt would remain unimpaired and would stay in place. But this proposal did not adequately address the company’s rapidly mounting liquidity problem, and was dead on arrival. The exchange was extended several times; during this period, Lasry and his team negotiated with management to try to formulate an alternative and more feasible plan. Avenue would backstop a cash infusion of $100 million of new capital. The Avenue-led senior bondholder group would receive 97 percent of the equity, while the junior note holders would receive only 3 percent, and with zero recovery to the preferred or common. Early in June 2009, Six Flags told Lasry and his team that it wanted Avenue to increase the backstop commitment to more than $200 million, and the negotiations reached an impasse.
During this same period, Six Flags entered into negotiations with its banks and hastily filed for Chapter 11 after entering into an agreement with its bank lenders. Once in Chapter 11, management abandoned the bank plan and adopted the Avenue-led senior note plan that would refinance the banks at par and give 95 percent of the equity to the senior bonds.
It wasn’t that Avenue sought out a company headed toward bankruptcy in order to gain control of it. “The real win for distressed investors is finding opportunities where you’re buying bonds at 30, 40, 50, 60 cents on the dollar, at a price where you believe that your investment is covered by the asset values with respect to where you sit in the capital structure, and you’re going to ultimately get par,” says Lasry. In the case of Six Flags, Avenue thought its downside was par and the value of the equity could be worth quite a bit more than par if it could do a rights offering, receive equity and make some changes to business operations to improve profitability.
“We determined that if the capital was easy to raise, then other investors would take us on and we would get par plus accrued. But if it wasn’t easy to raise capital, then we’d end up getting control of the company and create significant equity at a pretty low multiple,” Lasry says. “At the time, Six Flags really didn’t have a choice in filing for bankruptcy. They were massively overleveraged, as there was approximately $2.5 billion of debt for a company that was only generating about $200 million in EBITDA.”
After Avenue had committed to make its investment, the junior bondholders wanted to take control of the equity. “To give them control, we told them they’d have to pay us par plus accrued interest, which they ultimately did,” Lasry says. In the end, the junior bondholder group got control of the company and handed over $480 million cash to the group of bondholders led by Avenue, even though they were only owed $400 million. The extra $80 million was interest that had accrued before and during the bankruptcy and a break-up fee for the Avenue backstop. “So, for an investment we made at significantly distressed prices, we ended up receiving in excess of par, which worked out pretty well.”
In 2008 and 2009, the firm saw dozens of large cap opportunities, whereas today the focus is more on middle market credits (i.e., companies with $100 million to $5 billion in balance sheet debt). “Back in 2008, everyone was so nervous that they were focused more on liquidity, rather than value,” Lasry says. “And that’s what always ends up occurring. The more your focus is on liquidity, the more you’re willing to sell because liquidity is paramount. Whereas, if your focus is on the quality of the investment and not solely liquidity, then you’ll do very well, as long as you’re right on credit and have stable capital.”
Investors appreciate that level of focus on the portfolio, which is part of the reason Avenue has been able to continue to raise new funds over the years. The firm’s investor base has undergone a dramatic evolution from its start in 1995, when its capital came from friends and family. At the end of 2011, public and corporate pension fund capital comprised over 50 percent of the firm’s assets. Foundations, endowments, family offices, and insurance companies made up much of the remainder, with less than one percent drawn from high-net-worth individuals.
Charles Spiller, Director of the Pennsylvania Public School Employees Retirement System, started investing with Avenue after an introduction from New York Life in late 2000 and has seen a 10-year track record in their private equity portfolio of between 15 percent and 17 percent. “Beyond being impressed with their track record, I was attracted to their very conservative utilization of debt—they really didn’t lever their portfolio,” Spiller says. “I also liked their due diligence and credit analysis but, of course, nothing is without risk. Marc makes you feel comfortable that you’re invested with him because, [as an investor], you never feel like you’re panicking. He doesn’t seem to let anything bother him.”
But even larger funds like Avenue, postcrisis, have to worry about liquidity and have a plan of action in place. “I think everybody worries about liquidity,” says Lasry, “but we have a structure where we have more long-term money than short-term money. And, even in a tough market, there is a lot to do in distressed. We have been through challenging cycles in the past and we always figure it out. That’s the beauty of being in this business for more than 25 years. You come to understand the movements in the markets. There’s never a dull moment and that’s why I love it.”