There is one reason for the lack of debt finance available for new private equity deals that may have been overlooked – building a portfolio of debt positions via the secondary market is cheaper. “The primary market can't compete with the secondary market on a relative value basis,” says Maurice Benisty, Chief investment officer at GE Corporate Bank. “The gap is closing in the US, but not as quickly in Europe.”
Pricing of secondary debt is not uniform, however. Benisty notes that some businesses in sectors such as telecom, healthcare and food have seen the price of their debt climb around 15 percent from the trough. “Everything else,” however, “is trading down”. He says some debt positions that were being sold at 80 cents on the dollar a year ago are now being sold at par – while others changing hands for around 70 cents a year ago are now for sale at 30 cents. He believes that approximately 30 percent of the total market may now be categorised as distressed.
It's the type of scenario that grabs the attention of turnaround gurus like Howard Marks, chairman of Los Angeles-based private equity firm Oaktree Capital Management. “Most of the opportunity stems from the excesses of the buyout industry. Between 2003 and 2007 you had private equity firms buying the best companies they have ever bought but they paid ultra high prices. As a result, the quality of the debt is in many cases lower quality than on the poorer companies they backed before.”
Marks believes there will be plenty of willing buyers of credit in the period ahead – but also that the scale of the opportunity means the space won't get too crowded. “You can't achieve high returns and not have people try to emulate you. Some hedge funds went in but now they have withdrawals to cope with and others spent their money too soon. But this is an environment where the amount of supply could trump the demand.”