Debt for control has always been an attractive strategy to some degree, but private equity firms that traditionally have not been in the loan-to-own space are increasingly adding the strategy.
This will not be a passing phase, and is not the result of some fad where everyone else is doing it. This will be a permanent strategy of firms that previously have been equity-only buyers. But expanding into debt investing requires clearing a number of hurdles.
First, not every firm’s fund documents allow them to purchase debt. The second hurdle is having the expertise to buy at the right price. Truth be told, when it comes to distressed debt, it’s all in the buy. I’ve seen some not so successful deals be very successful because the buy was incredibly perfect. This is why experienced distressed debt professionals are being recruited at private equity firms.
Further complicating the issue is the fact that with debt, you’re working with public information. It’s different than the traditional private equity model where you’re able to perform a large amount of diligence before you commit the money, so the risk appetite is different.
When a company can’t afford your debt and a default is just around the corner, they may work with you to come up with a resolution, or they may reject your advances. Then you might need to be aggressive and exercise the rights you have under the credit agreement, but that’s really up to the private equity firms.
When it comes to the secondary market in debt trading, there are so many really good players that demand tends to outweigh supply, and that’s why you’ll see some quoted prices for certain deals be higher than what one would expect.
Throughout the distressed debt space, the competition is getting brutal, and that can lead to overpaying. In an uncertain market, the disciplined buyer will probably be the one to end up with the best returns.
Perry Mandarino is head of PwC's Business Recovery Services practice.