Categorising the opportunities in distressed debt

Asia is set to enter its next big cycle of distressed debt opportunities. Ironically, that comes at a time when even experienced managers find it tough to raise money to capitalise on those deals.

The dedicated distressed debt funds in Asia manage several billion dollars in capital, but most of them are fully invested. To partake of the new opportunities, they will have to raise more money. Of the ones that still have cash to spend, there are the likes of Mount Kellett Capital, who has raised an estimated $1.5 billion cash pile and might be expected to spend a third of that in Asia.

There is always the banks, whose prop trading desks used to be very active in Asia. However, today, many are beholden to their homeland taxpayers and their governments, who do not want them mucking about with distressed companies in far flung parts of the world. They are unlikely to be so active in the new wave of distressed debt investing.

Back to the hedge fund world, Justin Ferrier (pictured) had 10 years in the distress business before setting up his own fund management firm, Myo Capital, in Hong Kong just over a year ago.

He estimates that there is currently $200 billion in distressed debt in Asia, split as follows:

1)      $40 billion in public bonds

2)      $50 billion in leveraged loans (divided two-thirds in Australia/NZ and one-third the rest of Asia)

3)      $40 billion to $50 billion in special situations (private debt deals across the Asian region)

4)      $50 billion in domestic NPLs written by banks (he estimates the total burden is $200 billion, of which a quarter is nearly ready to hit the market).

He defines 'distress' as potentially something that is trading at a distressed price, a spread of over 1000 basis points.

He also divides those opportunities into three categories. He explains.

"The first is the debt of the good companies where there are forced sellers. Here you buy value and hope it will trade up, though there may be no specific catalysts. Secondly, there are operationally good companies that have too much debt and requite financial restructuring. Thirdly, there are the companies who have operational problems, where you need to roll up your sleeves. That third area may offer the highest returns, but they take up more time and are riskier."

What distressed investors are looking for are companies that can make money operationally via their products and for which a solid forecast of working capital requirements can hold good, even though their debt burden might wallop their profit and loss account below the Ebitda line. What Myo is trying to steer clear of are those situations he describes as 'black hole scenarios' where the operational outlook is unsustainable.

It is worth noting that the name Myo is that of a character in Star Wars. He was an extremely resourceful but bizarre-looking alien prone to waving his light sabre in the Star Wars saloon. According to Wookieepedia, because of his desert upbringing and his regenerative abilities, Myo was able to survive in barren, waterless areas for a long period of time, eventually becoming a well trained, expert survivalist.