If tenure length and retention rate are any indicator of a firm’s success, Guggenheim Partners certainly achieves positive marks. Many people within the firm were scooped up right out of college and have never left. Jeff Abrams, Kevin Gundersen and Zachary Warren, three portfolio managers who sit on the investment committee, have been with Guggenheim for over a decade. Gundersen and Abrams joined in 2002 as research analysts, while Warren joined the team two years later in the same role. This was when private debt was a nascent asset class.
This is not uncommon, Gundersen explains, with those selected having undergone a rigorous process involving recruiting potential hires out of undergraduate programmes through campus interviews and follow-up phone interviews.
If the applicants get through those rounds, next up is “Super Saturday”, where the top 30 candidates are flown in and participate in a full day of interviews. They are then given one week to prep a case study and eventually present it to the firm’s investment committee.
“Some of the most senior members of the team we hired eight to 10 years ago right out of college,” he says. “The firm has attracted and retained great talent by allowing our investment professionals to look at a broad spectrum of investment opportunities.”
The private credit arm of Guggenheim grew out of an idea that maybe giving up some liquidity could provide an attractive investment proposition.
“So the way we approached private debt initially,” Warren says, “the basic question was, if we are willing to sacrifice liquidity and go direct to corporate borrowers, could we create better packages of risk and reward than we could readily buy in our liquid credit alternatives? The thesis led us into the market in 2002.”
Jeff Abrams: “When the group first started, and all three of us were involved at the beginning, it was really flexible capital base.”
Abrams notes that Guggenheim benefitted from a degree of latitude when it came to private credit in the firm’s early years.
“When the group first started, and all three of us were involved at the beginning, it was a really flexible capital base,” Abrams says. “Technically, we might have been investing out of a separate account, but that account gave us real flexibility to do anything we found of value in credit.
“That allowed us to play in the syndicated market in loans and bonds [and] go into direct lending, where we found relative value. And opportunistic, higher-yielding opportunities when they arose. So, it allowed us to get our feet wet in a lot of different areas. Then a CLO business grew out of the syndicated activities.”
In the years after the financial crisis and the ensuing regulatory crackdown on banks, the private debt market mushroomed. Private equity sponsors turned to alternative lenders for deals and limited partners found an appetite for the asset class. A number of firms joined Guggenheim and other lending practices that were around before alternative lending became fashionable.
It is a trend that continues. This year alone, Adams Street Partners and The Riverside Company both established debt investment arms. Hancock Capital Management, which previously had a junior debt-lending business, made a key hire to establish a senior debt-lending business, Private Debt Investor reported in June.
More and more investment vehicles are popping up, as well. According to PDI data, the total number of funds closed from 2008 to 2011 was 216. The number so far in 2016 is at least 128, meaning that, year-to-date, more than half the number of funds have closed in a quarter of the time. The average fund size was a whopping $1.12 billion in 2008 and plummeted to $444.3 million following the global financial crisis in 2009. That figure worked its way back up to $709.5 million in 2016.
To unpick that further, pre-crisis, there were fewer funds with larger targets being raised. Now, more vehicles are seeking smaller commitments. In 2008, 99 funds closed, while a total of $109.9 billion was raised. In 2016 so far, with 128 debt funds closed, there has been $90.8 billion raised.
Guggenheim is currently in the market for capital, though its vehicles’ targets are larger than the 2016 average. It is raising at least two corporate credit funds. One fund recently passed its $1.5 billion fundraising goal, a source tells PDI. It has a $2 billion hard-cap and will likely hold a final close by year-end, according to the source. The initial Private Debt Fund raised $1.35 billion in 2012, passing its $1 billion goal, PDI data show. Guggenheim is also out raising a mid-market distressed debt fund with a target of between $750 million and $1 billion, which would have a five-year investment period, sources tell PDI. With that investment period, the capital could be committed to distressed companies even if the next credit crunch is years away.
Guggenheim declined to comment on the fundraising.
Kevin Gundersen: “We have data on thousands of middle-market companies that we have looked at over the last 15 years.”
The Merge Healthcare deal presents a case study in how Guggenheim approaches its deals by utilising resources beyond just the firm’s private debt arm.
Gundersen says the company looked at Merge in 2012 as part of a transaction that would have taken the Chicago-based company private. That deal didn’t come to fruition, though, and in 2013 Merge refinanced $252 million in senior secured notes, priced at 11.75 percent. A $255 million facility and a $20 million revolving credit facility from Jefferies took the notes’ place, according to a quarterly report filed with the US Securities and Exchange Commission. Guggenheim participated in the syndicated deal.
A year later, Merge needed to refinance, partially because of concerns about the firm’s leverage. The facility’s terms limited the initial consolidated leverage ratio to 5.5:1, which would later decrease to 4:1 over a period of two years, according to the SEC report. It garnered a mention in the company’s 2013 annual report as a risk factor. Then, Guggenheim came knocking.
“A year later they ran into covenant issues and we were able to step in and provide a solution,” Gundersen says. “We had followed the business for several years, had a relationship with management. In the end, they didn’t choose us because we were the cheapest option. They chose us because we understood their business and were able to move quickly.” Then-CEO Justin Dearborn said on the first-quarter 2014 earnings call that Guggenheim showed up “proactively” with a six-year $235 million term loan, which did not have financial covenants for one year.
A little over a year later, Merge wanted to buy DR Systems, a medical imaging and information company.
“When the company wanted to go do an acquisition,” Gundersen says, “we pointed out, you’re a public company, you don’t want to look over-levered. That was your issue a year ago when we refinanced the syndicated deal.”
Merge and Guggenheim cut a deal that let the healthcare company purchase DR Systems for almost $70 million including preferred shares. Then, in August 2015, IBM announced it would buy Merge for $1 billion.
“The breadth and scale of the Guggenheim platform creates a differentiated sourcing engine,” Gundersen says. “We have data on thousands of middle-market companies that we have looked at over the last 15 years.
“We wouldn’t have had that history [with Merge Healthcare] had we not had the syndicated part of our business. It’s really important, both from a sourcing and underwriting perspective.”
Warren adds: “So we’re sharing resources, particularly in the research area that is looking at liquid credit, high yield and loans as well as private debt.”
By using Guggenheim’s size and scale, the private debt arm can flex the institution’s muscle, generating dealflow from some of the most well-known firms on Wall Street. Warren called them a “very valuable sourcing channel … over the past couple of years”.
The firm gets tips from the big banks, such as Morgan Stanley. Gogo, the in-flight WiFi provider, had filed the papers for an initial public offering with the SEC in November 2011. The company delayed its IPO, and in June 2012 the New York-based financial behemoth stepped in and served as lead arranger on the facility, a $135 million loan that later increased its principal. In June 2016, Gogo repaid the $287.7 million outstanding on the facility in full.
“Morgan Stanley brought that deal to us and a handful of others,” Gundersen says. “We want to be one of the first five people that gets that call. That was not a syndicated process, it wasn’t widely shown. Had we not got the call from Morgan Stanley, we wouldn’t have been involved in that deal.”
These types of deals set Guggenheim apart, whereas deals that run an auction process are pretty straightforward. Multiple private equity firms might make a bid for a company and each have several credit firms lined up as potential lenders, Gundersen says.
He explains if a business in an auction scenario is easy to understand, “that’s right down the middle of the plate. It’s an easy deal to get done. There’s nothing we bring to the table other than capital, and we just don’t like deals where our capital gets treated like a commodity”.
Zachary Warren: “If we are willing to sacrifice liquidity and go direct to corporate borrowers, could we create better packages of risk and reward?”
Guggenheim’s private debt arm could be on target to beat its $3.8 billion in direct lending investments completed in 2015. Through the third quarter of this year, the firm completed $3.7 billion in deals. Some of those investments came from the firm’s Private Debt Fund 2.0, which pursues direct lending investments in the US and Europe.
Among deals made in the third quarter was a $250 million unitranche loan in September to a commercial mortgage services company where Guggenheim served as the agent and sole lender in a transaction that backed an acquisition. In another investment, the firm participated in a $139 million first lien loan to support a refinancing done by the private equity sponsor of a fitness and hospitality resort operator.
Across corporate credit as a whole, Guggenheim’s total corporate credit buys topped $12 billion last year, which included bank loans, high-yield and bridge financings.
When it comes to due diligence, Guggenheim also uses the resources of its other departments. Gundersen returns to the Gogo example to explain that along with sourcing, the private debt department works with all its sister businesses.
Guggenheim has an aviation team outside the corporate credit group. So when the firm did due diligence on the internet provider, it used the aviation team’s connections to get introductions to United Airlines and American Airlines, companies that could give the firm insight on Gogo.
“I think it starts with … enterprise value and what the asset is worth,” Abrams says. “Because we’re involved in all these different strategies – liquid, illiquid – we really have good context for where those markets are at any given time.”
The firm focuses on capital preservation as well, Warren says. Even when a Guggenheim deal goes sideways, the firm can still recover most of its money. He points to one involving financing for Evergreen Oil, a re-refiner of motor oil, and explains that Guggenheim had financed another company in the industry.
“We thought we had good asset protection,” Warren says. Since the firm financed a similar company, they knew that the borrower could be a potential buyer of Evergreen and were also aware of another potential purchaser.
Guggenheim supported Evergreen with a bankruptcy financing facility, which allowed the company to make its way through the Chapter 11 case. Evergreen owed Guggenheim $66.2 million at the time and received a $60 million bid for its stock from Clean Harbors, a successful pitch that handed control of the debtor to Clean Harbors.
The buyer announced the purchase on 16 September 2013, three days after a federal judge in a Santa Ana, California, bankruptcy court confirmed the reorganisation plan, setting what was left of Evergreen on a path to exit Chapter 11.
“You’re not going to get a full-value bid in bankruptcy, which we didn’t,” Warren says, “but, nevertheless, it still covered most of our debt. And we thought about the way out before we went in. So those were the things that enabled us to get a good recovery.”
Looks like that intensive hiring process pays dividends for Guggenheim: Warren and his colleagues appear to have learnt a few things since their college days.
Direct lending investments completed by Guggenheim’s private debt arm in 2015
Deals completed by end of Q3 2016
Guggenheim’s total corporate credit buys in 2015, including bank loans, high-yield and bridge financings