The coast is clear

Judging from the headlines, the story of Asia, ex-Japan, has a single plotline – that of runaway growth, specifically in China, complete with all the risks and expectations that entails.

But an unheralded subplot of the Asian economic story is underway, involving distressed debt, workouts and special situation. Many of the players in this market are capitalising on their experience during the “Asian contagion” that befell the market in the late 1990s.

Among these distressed pros are the founding partners of Clearwater Capital Partners. In 2001, the firm's partners parlayed their experience with distressed debt and special situations garnered during the crisis into their own unique strategy. Clearwater's broad mandate includes a full spectrum of special-situation investments in public and private debt or equity of local issuers across Asia, with a focus on small to medium enterprises (SMEs). Since then, Clearwater has grown geographically with consistent criteria for how and when that expansion happens. Namely, there has to be a legal framework for their transactions, concrete evidence of the scale of the market, and access to local talent to execute the strategy.With landmark deals in Korea and India in particular, as well as major pan-Asian investments, Clearwater's strategy for building a track record and recruiting talent has lessons for their alternative asset brethren exploring opportunities across the region.

Clearwater's roots reach back to 1998, when managing partner Rob Petty was working at Amroc Investments LLC, a New York-based distressed debt and special situations investor.“We were well aware that in the wake of the crisis there'd be a huge opportunity in the region for workouts, but we just weren't sure what they would look like exactly,” says Petty. His research involved questioning a variety of market participants to grasp how such plays would be done in the coming years.

Working for Amroc, Petty spoke with several of the leading buyout firms already in Asia, such as Newbridge and Ripplewood. “We thought that the buyout players had the best-in-class due diligence for companies in the region,” says Petty. Given the absence of any local distressed investors, he also spoke with Western experts and Asian credit professionals to understand both the methods and the market.

Petty, along with Amit Gupta, who was head of Asian research at Amroc at the time, wanted three things before launching their own firm: experience doing distressed deals in the region, a legal framework for the transactions and confidence that the legal precedents of that framework had proved effective. “We wanted concrete evidence that these transactions were possible, and by 2001 we were comfortable we had the precedent and the experience to execute these deals, specifically in Korea.”

Despite the evidence, working the spectrum of distressed and credit opportunities in Asia involves major risks, requiring intensive due diligence. “Naturally we perform a deep, pure-asset valuation, though the best thing about tackling distressed assets is if the company's in trouble, forensic accountants can get a great deal of good financial info,” says Petty. “The other element that we look at is management – not simply their ability to pay, but their willingness to do so.”

LOCAL TALENT
Distressed experts frequently stress the importance of “soft diplomacy” while working on credit transactions in Asia. Choosing the right assets often involves gauging intangibles such as a management's attitude towards the recovery plan or the court's bias on a given investment. Without majority stakes or Western legal mechanics, the ability to influence local management and courts is paramount to successfully employ whatever framework exists. Clearwater understood the importance of such intangibles, and how local talent can have a distinct advantage in gauging these elements of a deal.

“You've got to be there in person to understand the people involved – the management and the regulators,” says Petty. “Moreover, you've got to have a staff of locals to be seen as a collaborator. The best way to overcome the bias against foreigners is to build a team that consists of locals.”

While most foreign firms employ some number of local executives, Clearwater goes one step further. “Our offices outside of New York are staffed with only local professionals,” says Petty. “Every step of the process involves local talent, making it more difficult for the folks across the negotiating table to brand us as outsiders.”

Part of Clearwater's ability to source investment talent involves their long history of working in the region, which stretches well before Clearwater's founding or even its founders' tenure at Amroc. Petty worked in Japan back in the mid-1980s as part of Lehman Brothers. He explains that his time there allowed for the building of a robust network of relationships, not just for sourcing, but for recruiting as well. “We rarely use headhunters for our own professionals – though we sometimes employ them in hiring senior management for our portfolio companies,” says Petty.

The other recruiting advantage Clearwater enjoys may simply be that its strategy requires skill sets that are in greater abundance. While buyout and venture capital skills are in short supply in Asia, there are many credit professionals within local banks who could be looking for a new application of their skills. “Our talent pool tends to be credit analysts. Essentially we're in an industry that leaves us tapping the banking sector for talent,” says Petty.

“We don't go after many senior professionals,” he adds, “but rather those that will grow over a five- to seven-year time frame to be best in class. They like our very flat structure with its access to real deal experience. In some ways they embody the best of both worlds – aware of the culture without being bound to it yet.”

ENTER THE DEBT
Clearwater prides itself on achieving that balance of respecting local culture while applying Western techniques, not only in recruiting but in managing deals as well. “We knew that we could assist management, particularly of the region's often capital-constrained SMEs, to create financial and operating restructurings that would allow their companies to succeed,” says Petty. The diplomacy applied by the firm's professionals to traditional distressed debt and credit plays could be easily applied to more operational issues.

“Debt can be seen as simply another entry point into the company's capital structure,” Petty explained at a recent conference for the Emerging Markets Private Equity Association (EMPEA). “15 to 20 percent of our current portfolio is dedicated to debt-for-equity swaps, where we take our equity stake and dig a little deeper into the company's operations to help it along. Though the truth is we do this across the entire portfolio.”

Clearwater's partners counsel their portfolio company managers on a few key themes. First, they communicate the virtues of thinking like board members, with a focus on enterprise value, a concept that's relatively new to managers in the region. Second, they work on cleaning up broken balance sheets for the long term so executives learn to manage their finances outside of a crisis. And thirdly, they help build a board of directors. Clearwater recently upgraded this capacity by bringing aboard Pierre Everaert, a seasoned senior executive with global management experience, as an advisor on operational turnarounds.

In their more operationally focused investments, Clearwater will bring on board local consultants to tackle issues pertaining to a given industry. “While we sometimes will employ outside experts for a geography we're learning more about, most are hired for a specific industry expertise.We're not jacks of all trades, so when we're looking at an undersea cable operator instead of a financial services company, we know it's time to reach out for help,” says Petty.

At present, Clearwater remains focused on maximising the value of primarily its debt holdings and on pursuing debt-toequity swaps. There are no plans to become more equity-focused in deals. While the firm does not seek control of companies, it does not avoid these situations when they develop.“We believe in participating as collaborative capital and we may be looking at more operational plays, but we still believe in the value of old technologies, and dying companies, where the debt may pay out,” clarifies Petty.

However, the firm is expansion minded when it comes to geography. Three milestone deals in three different geographies attest to the firm's effectiveness in sourcing, recruiting and expanding into new countries within Asia.

CLEARWATER CAPITAL PARTNERS