Distressed Investing: This Time It's DifferentSubscribe
One of the most popular stories from the GFC was from those that made incredible money on the recovery. To hear them tell it, distressed investing was simply finding formerly strong companies that had taken a hit during the crisis, picking up their equity at bargain prices, and riding the wave up as their markets came back to life and the investments prospered. Anyone calm enough to stay liquid and buy at the right time could make a mint.
Talk about rose-colored glasses. I remember very logical, educated people arguing that the capital markets had been permanently damaged, and the global economy did not have the levers required to restart economic activity at pre-GFC levels. Being an investor when the prevailing sentiment is that the world is ending takes brass balls and more than a little faith. Remember, there are two sides to a trade - there were sellers at low prices that were more than happy to escape with cash.
I've been thinking about that time lately, as I've come across dozens of investors who are licking their chops. The groupthink seems to be that this is going to be easy - the economy is in the toilet after three calamitous weeks, and businesses are suffering. Anyone with liquidity can scoop up good businesses going through a rough patch for a fire sale price, and ride it out until the economy roars back to life.
If this seems too good to be true - it is. A couple counterarguments:
The economy can stay irrational longer than you can stay liquid. Or whatever the quote is from When Genius Failed. Assuming the economy will bounce back unchanged is an optimistic view, but not an informed one. There is not consensus for what sectors are going to bounce back, and when, and what the long-term effects of this pandemic will be. Just like on a short, someone can be right on an investment thesis but have the timing wrong and come away empty.
There are still two sides to every trade. If it's obvious that a company is going to return to its former greatness, then why would a seller sell? Unless they're in a liquidity crunch and have no choice, but there's way more liquidity in the marketplace for operating businesses this time around than there was during the GFC. The system is being set up to give relief to the very small- and mid-sized business owners that would otherwise find themselves in a bind. Nobody's going to give away something valuable for no reason.
We have a much more crowded investor landscape. There are just more hungry people going after the same deals than there were 12 years ago, which will stretch pricing on deals to the ballsiest bidder. I don't think we're going to see the prices drop out for a while, either - at least for the rest of the year, I could even see them going up. If a company pre-CV was making $10M of EBITDA and it's down to $4M this year and the buyer thinks it's a temporary dip, then who cares if a $60M purchase price is 15x TTM EBITDA? People are going to get over "multiple shock" pretty quickly if they think the return profiles make sense.
Net/net, I don't think distressed investing is easy in a volatile environment (or ever). It takes a lot of specific knowledge and analysis, combined with vision, to figure out if a business is temporarily inconvenienced or if it's a falling knife, and what can be done to influence its future performance.
Would love to hear from others looking at distressed assets over the next 12 months, or from those who have done it successfully over the last decade. Or if anyone just thinks I'm flat wrong.