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Special situations managers eye deals, prepare for competition

Special situations fund managers are assessing a range of opportunities as coronavirus lockdowns ease, but competition to snag those assets judged to be more resilient is likely to be strong.

Deal flow is beginning to tick up as markets move "out of the survival phase and into the future assessment phase," Oliver Jones, a partner at U.K.-focused Rutland Partners LLP said. Businesses that have survived but are unhealthy will assess their options, and big corporates will consider which businesses they want to support and which they want to divest, creating carve out opportunities.

Pan-European outfit AURELIUS Equity Opportunities SE & Co. KGaA also sees corporate carve out activity growth. "I think corporates will raise all the equity they can, draw down all the debt they can, will look at the cash they've got and the sort of prospects, and will have exactly the same assessment, which is that they won't be able to bring every single business arm of their diversified companies through the crisis," Aurelius Managing Director Tristan Nagler said.

But Aurelius doesn't believe these opportunities will emerge immediately. "There's very little corporate disposal activity now. Corporates are so busy with … debt raising, drawing down on [revolvers], doing an equity capital raising from the listed markets, furloughing their people — slowing everything down and sort of working out what's what," Nagler added.

Pre-crisis, carve outs accounted for about 80% of its activity, and of its last seven completed deals, six were carve outs. The firm typically looks to a lesser extent at distressed M&A, buy and build and debt opportunities, but in the immediate term has seen "a complete switch over" in what it's been assessing, Nagler said. Distressed M&A "has just gone bananas," and now accounts for about 80% of its opportunities pipeline, he added. Once corporate disposal activity begins in the next few months, Nagler expects distressed deal flow to settle down to about 50% of its pipeline as corporate disposal activity picks up.

Genuine distressed M&A opportunities only account for around a third of all assets in the market looking for buyers, Nagler said. But competition for assets that fall into that segment is high, with a number of special situations players on the lookout for attractive deals, lenders with a variety of strategies, and serial entrepreneurs with experience in buying up distressed assets.

U.S.-based Siguler Guff & Co. LP, which invests across a wide range of distressed and special situations strategies, invested during initial market dislocations by "purchasing higher quality, liquid corporate credit and equity," a spokesperson said in an email. The firm has also evaluated rescue financing and secondary LP stake acquisitions. It is now preparing for its second investment phase "that will involve a sustained default cycle exacerbated by the excess in credit markets leading up to the crisis," its spokesperson said.

"The economic shutdown caused a solvency issue for companies across numerous industries," the spokesperson said. This is seen in increased ratings downgrades, a pickup in defaults, several corporate bankruptcies and some straight liquidations. It will create opportunities across asset classes, including distressed corporate credit, rescue financing, structured credit, loan-to-own and control private equity, non-performing loans, and liquidations, the spokesman said.

Competition for stand out assets is expected from private equity funds in some instances, but special situations-focused firms' experience will likely give them an edge, the three spokespeople said. There will also be situations that are too difficult for buyers who are risk-averse. "The businesses completely unaffected are going to be worth gold dust. [With] any business impacted by COVID … people are going to be scratching their heads a little bit to sort of work out what's it worth, is the impact done, what if there’s another pandemic?" Nagler said.

And not every business looking for backing can expect special situations-focused firms to sweep in at the chance to invest. When actionable deal activity picks up for special situations managers, there will be stress tests focused on how businesses performed during the lockdown, resilience on the business' demand side, and the degree of downside protection in the case of a second wave, among other scenarios, Jones said. His firm has been looking at opportunities, but concluded they weren't quite right in terms of profile. "I think largely because it's very uncertain to call demand in some sectors," he said, adding that all investors will be looking "at that word resilience. There has to be a bottom line of stability of what you're investing in."