In search of distress

With Asia’s economies still booming, restructuring opportunities are thin on the ground. That’s just how some distressed specialists like it, writes Brett Cole

For private equity funds, Asia and growth are synonymous.  The global financial crises didn't derail but merely confirmed the resilience of the Asian economies. Moody’s Investors Service estimates that speculative grade default rates in Asia ex-Japan for non-financial companies will fall to 1.1 percent year end compared with 3.4 percent at the end of 2010.

 “There was some anticipation that after September 2008 there would be a flood of distressed deals in Asia,” says Cameron Duncan, partner at restructuring advisory firm KordaMenthaNeo’s Singapore office. “Whilst there has been a number of high profile corporate restructuring cases in Asia over the last couple of years, the volume of deals has been much lower when compared to the US or Europe. Recently the number of new restructuring cases in Asia has been minimal.”

Proprietary desks at investments banks and hedge funds stopped their Asian distressed investments in the wake of the global financial crises, often because of their exposure to US mortgage-related securities, whose value had cratered and threatened to imperil the firms themselves.

But that is music to the ears of people such as Robert Petty, managing partner and co-founder of Clearwater Capital Partners, which has invested more than $3 billion in Asia ex Japan in the decade since it was founded.

“There are not a whole lot of people doing this in Asia,” notes Petty.

Clearwater is currently raising its fourth fund that is expected to garner about $900 million with a side-car fund of $100 million. The firm has 75 people in six offices. “Asia’s growth provides strong exit opportunities for investors in turnaround situations,” is how Petty describes the appeal of his strategy.

There is $20 trillion in outstanding corporate debt in Asia including a $11.9 trillion loan market and a $5.6 trillion bond market. Asian companies have issued $315 billion worth of bonds in international debt markets.

Short-term debt to overall debt is at 69 percent and debt to equity is 49 percent in Asia, higher than other regions. 


Not ‘one giant fed cycle’

Asian economies are not part of “one giant Fed cycle”, as an Asian-focused distressed investor argues. There are different economies that are often counter-cyclical to the economies of Western Europe or the US.  Likewise within Asian economies different areas of a country often have different growth rates, for example the eastern seaboard of China compared with the western provinces. Different industries also grow at different rates, for example consumer good demand in China remains strong while shipbuilding remains mired in a global slump.

In the past 10 years there have been different cycles in Asia that have ranged from the wash-up of the widespread bankruptcies as a result of the Asian financial crises to the effect of severe acute respiratory syndrome and the supply chain crises caused by the March 11 earthquake and tidal wave that struck Japan.

Today distressed Asian investors are looking at investments as diverse as offshore oil and gas rigs in Indonesia, wind power plants in western China and air filtration companies in South Korea’s steel town, Pohang. In Australia the majority of distressed debt opportunities are in real estate, says KordaMenthaNeo’s Duncan.

Large-scale infrastructure investments in Asia also present opportunities for distressed investors. These long-term projects sometimes run into short–term financing problems that can be attractive opportunities.

Clearwater’s Petty sees great opportunities for investments in small and medium sized Indian companies, $50 million to $250 million market value.

Stock prices for these companies have fallen as much as 50 percent since November. Some have run into liquidity problems through using some working capital for longer-term investments.

China bankruptcies

Alix Partners Asia forecasts that 2011 bankruptcies in China will increase from their very low levels in 2010. The firm, chosen to be the global adviser on the restructuring of General Motors Corp., sees opportunities to advise on restructuring in the auto supply and construction materials industries, the latter caught up in a government-driven slow down of the real estate sector.

China’s auto supply industry grew 50 percent in 2009, 35 percent in 2010 and is expected to grow about 10 percent in 2011, according to Alix. Many companies are highly leveraged and competition has depressed margins significantly while over-capacity looms.

“There is less liquidity in the market as there are lending restrictions; for example there are increased reserve requirements for banks,” says Ivo Naumann, a managing director at Alix Partners Asia based in Shanghai. “For many capital-intensive companies that are also dealing with their high debt levels there is a need for capital to carry out restructuring.”

In 2008 China enacted a new bankruptcy code that is not much different from respective codes in the US and Western Europe. But there is a question of implementation. A judge would need to be able to assess and rule whether restructuring is better than liquidation.

Traditionally, there was a bias in China to try and muddle through rather than to restructure the company. Chinese judges, bankers and company executives are not familiar with the restructuring process and many thought restructuring was a process that ends in liquidation or solely favours creditors.



In China offshore creditors are subordinate to onshore creditors. Onshore creditors may favour foreclosure as they are fully secured. Offshore creditors would be much more interested in a comprehensive restructuring allowing them a higher recovery. Managing the various stakeholders in a restructuring in China is crucial and challenging for advisers, says Alix Partners’ Naumann.

Distressed debt investors and their advisers in Asia all agree that success in the region is dependent on local knowledge and contacts. In some jurisdictions contracts are dealt with flexibly.

 In many Asian markets corporate governance is weak. Fraud is widespread. Due diligence must thus be extremely careful and thorough. “It is not a market for the faint hearted,” says Neil McDonald, partner at law firm Hogan Lovells in Hong Kong. 





Deal in focus: Griffin Coal

In 2008 Clearwater Capital sensed an opportunity to invest in a viable but floundering business in Western Australia: Griffin Coal, the state’s oldest coal mining company. Griffin was mining on four separate sites and building/commissioning two mine mouth coal-fired power plants. By the end of 2008 its debt, which had been trading over par the year before, was trading at historic lows, below US$.50. Griffin’s revenue in the six months to June 30, 2007 was A$141 million and total debt was A$522 million.

Clearwater visited Griffin’s mines, power plants and port operations. In meetings with Griffin management and owners there were discussions on restructuring and rescue finance options for the company. Griffin defaulted on its December 2009 note coupon payment after export coal sales slid and productivity and liquidity issues arose. Within days of the default Clearwater formed and then lead an ad hoc noteholder committee. The five largest Griffin noteholders decided to work closely with Griffin management and advisers during an interest payment “grace period”. On January 3, 2010 Griffin’s directors decided to put Griffin and certain other related companies into voluntary administration.


The road to 2x

KordaMenthaNeo was appointed administrator. At KordaMenthaNeo’s request Clearwater lead a small working group of noteholders to maximise stakeholder returns from the administration. Clearwater also served on various Griffin creditor committees. In 2010 Clearwater co-underwrote and provided a A$95 million DIP financing package. This allowed Griffin to continue business while avoiding liquidation and a possible “fire sale” of Griffin assets. In the second half of 2010 India’s Lanco began talks to buy Griffin’s coal operations for A$750 million. Lanco closed the purchase in February this year, enabling Griffin’s DIP financing to be fully repaid.

The US notes were then trading at about 95 cents on the dollar. In April, KordaMenthaNeo sold Griffin’s two power stations to Japan’s Kansai Electric Power Co. and Sumitomo Corp. The notes are trading at about par. “With more than $100 million of capital invested in Griffin this was a significant deal for us,” said Clearwater’s managing partner Robert Petty. “We were able to buy into Griffin at an attractive valuation and with the benefit of the rescue package and our close working relationship with the administrators the business survived despite an overleveraged balance sheet and operational issues.”

Clearwater doubled its return from the Griffin investment.