Would invest in their debt but not equity
What are some examples of this? Large, scaled businesses without much room for further multiple expansion? Crowded subverticals without opportunities for m&a exits?
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Cyclical businesses, out of favor sectors, steady but unimpressive margins (manufacturing etc.)
I've done some killer debt and pref equity deals in the QSR sector
Telecom, Strong steady and stable cashflows, maybe the operating company is located in an area that is already pretty competitive for expansion, but not competitive enough to be overbuilt.
Any sector that has a large hard asset base (lots of industrials businesses fit this category), because if the business is too capital intensive (relative to the ROA) then the equity returns won't be as attractive. But assuming they are still productive assets, they can be good security for a lender making the debt attractive.
An example of this would be airlines, a traditionally difficult sector for equity due to the capital intensive nature of owning a fleet of planes (and the high competition on profitable routes). But for a lender, the planes make good security (as they can be seized and easily re-sold in a bankruptcy).
Yes but more important is cash flow stability and visibility. Defensible businesses that are recession resilient. Asset base helps but in a BK it’s often difficult to recover 80%+ of the actual underlying asset value, especially if they are physically located outside of the US. Lenders underwire cash flows first, then the asset base / security second. Unless of course, you’re an ABL or structured finance lender which can change the equation but this in the context of traditional sponsor backed buyout debt.
Huh. Hard assets are safer to underwrite against than cash flows? Are they not?
He's talking about in the context of a sponsor backed buyout where they're probably looking for cash flow loans at 3-5x EBITDA. Have seen many instances where loan of this type recover = 50 cents when the business blows up and you need to rely on asset value, especially if there is an ABL with waterfall priority on working capital. This area of finance makes little sense to me as a lender unless you want to try owning the company one day. Hard money loans are much better, but their advance rate is probably not interesting to a sponsor looking for buyout capital.
When its a good business but valuations are too high. If you have a decent LTV you should have enough equity cushion in the scenario that valuations normalize, and if the fundamentals are still intact then they should still be able to service your debt. I agree businesses that are already strong and don't have much room for growth will have little equity upside, but they will also have little debt upside in the form of a lower coupon so risk/reward profile may not necessarily better.
Utility companies as well as midstream energy
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