Distressed investing involves an investor buying into securities such as stocks or bonds in a company that have lost value. This could happen for a variety of reasons, such as taking on too much debt, a disruption on the financial markets or a completely unforeseen technological change. Chand Sooran, chief investment officer of Point Frederick Capital Management, told Financial Pipeline that such investing is very complex and demands, among other things, a good understanding of the underlying business and outstanding understanding of the company’s strategy.
CS:The process expertise comes in play at both ends of the spectrum. On the corporate reorganization stuff, one has to have a very sophisticated assessment of the strategic changes that the company wants to make and to be able to make the judgment that if they can make these strategic changes, then that’s the right decision and the company can get back to where it needs to be.
So that requires a good understanding of the underlying business, an outstanding understanding of strategy and the ability to assess management’s ability to execute. And quite often this is paired with a change in management and so you have to be able to understand the change in management and the people that invest in distressed (companies) though because of the process orientation of it typically are generalists. So they’re the people that have to pick up things quickly, which is another key skill, so they have to look at an industry that they may not have looked at before or they may not have looked at recently and quickly come up to speed in terms of the dynamics of that industry.
It also requires a fair amount of courage because things have been going so badly for so long that the conventional wisdom will be that things will continue to go badly and this type of investing that some people would call contrarian investing where you have the intellectual courage to stand up to the crowd and go the other way. Contrarian investing in its most majorative sense is to just say to someone that you’re a contrarian investor because you just do the opposite of what everyone else is doing, which in certain markets can be a very profitable strategy in and of itself, not as intellectually appealing to say that you’re a sophisticated guy that understands all this stuff.
The real process imperative for a distressed investor comes when a company can’t rebalance or can’t renegotiate its balance sheet outside of the protection of the courtroom and seeks protection inside of a formal insolvency process. Because you have to understand the dynamic between the different creditors in the structure, you have to understand a more specific sense of the valuation of the company, current and prospective and you actually have to understand a fair bit about the process of chapter 11 and all the different aspects of chapter 11. So who gets to control the plan for taking this company outside of insolvency protection. How long does that particular constituency get to control the plan? What kind of financing is available to them? Because they’re going to need ongoing financing. Who can try to repossess their assets and at what point? What are the different rights and obligations of creditors based upon their differing contractual nature? And that is something that just comes with experience, you really can’t learn that from a textbook.