Distressed vs. Credit vs. Special Situation vs. Turnaround PE

Alt E S's picture
Rank: Orangutan | 331

What is the difference between all 4 types? I've been able to find a lot of PE funds with credit arms, but what are the big names in special situations and turnaround PE?

Private Equity Strategies

The following was originally posted by certified user @I Invest", a private equity associate, and has been formatted for this post.

All 4 of those areas are very related. You would have a hard time finding a fund that takes one of those four strategies but not the others. Like minimal growth tends to come with maturity, a business in distress usually comes with a turnaround opportunity and maybe a special situation. A special situation doesn't always have to be distressed though. I'll try to provide some distinction between the four below:

Distressed Private Equity

This should be straightforward. The business is suffering and needs help. There are tons of things that could cause distress. The distress could be an operational hardship, industry hardship or a mix of both. It's possible that the industry could be great, but management sucks. Conversely, management could be great, but the industry is in a rough spot.

Private Equity Credit

Many distressed PE shops will also play in the secondary credit market (loans and bonds, but mostly high yield bonds). Unlike most hedge funds, a PE firm is all about an opportunity for control. Therefore, in most situations, they are buying debt with the idea that there is some angle to gain control of the enterprise. The opportunity for control could come about via bankruptcy or some debt for equity exchange. Let's not get things twisted here though. With the proper fund mandate, a PE shop will buy some paper for a juicy yield even if there is no angle for control. You might be bullish on the industry/enterprise and find yourself in position to buy something with little debt ahead of you well below par, get paid out at par and in the meantime collect a nice high yield coupon payment.

Private Equity Special Situations

Imagine a small regional company wants to do some M&A but has an extremely low chance of raising the $70mm they need via traditional financing at a bank or something. One solution is they could contact a HF or PE shop to provide the financing. The HF or PE shop has required returns higher than that of a bank on a term loan so obviously, this is going to be expensive paper. The PE fund might provide mezzanine(PIK) financing PLUS demand penny warrants so they can have some ownership in the business. The PE shop might even propose doing all $70mm via equity, if it makes sense of course.

Turnaround Private Equity

This should be straightforward. Flip the house. Note that a turnaround doesn't necessarily have to be a distressed business. My shop looked at one opportunity recently: The business wasn't distressed. It didn't NEED a capital injection. It was simply not being run as well as it should be. There were very identifiable opportunities for cost and efficiency improvements.

Key takeaways:

You should understand under all these scenarios a PE shop is looking for an angle to gain control

The whole reason people look at opportunities like the ones above is because of deep value. We want to buy a 7x-8x business at 4x-5x. We want to buy a business that should have $100mm EBITDA while it's only doing $65mm EBITDA. We want a respectable margin of safety.

Firms that have made a respectable business out of distressed investing are Cerberus, Apollo (Apollo is huge and does a lot more than distress stuff but has done well at buying distressed debt for control in the past), and Sun Capital. There are TONS more firms who take a distressed approach. Google for yourself. I sometimes hate giving the "household" names because it's exceedingly easy for you IB analysts (assuming you're an IB analyst) to get narrow-minded and think the only place in the world to go do distress is at Cerberus or something. Do some googling and you'll find firms who have a great track record.

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Comments (5)

Jan 15, 2016

Thank you...Incredibly helpful. +1

Also, I'm an incoming SA who's just bored over winter break and doing some reading/research.

Mar 24, 2016

Bump for fantastic post by I Invest

Apr 9, 2018

Is a distressed debt HF similar?

May 30, 2018

Of course there are the obvious similarities, like in fundamental analysis/ due diligence, but the main difference will be gaining control in PE opposed to HF who may just invest in the higher yield bonds. Overall though, for the most part, many situations involve improvement through control or turnaround and it's going to be different for different firms. So as far as I know most firms who do this tend to be PE focused.

from what I can tell, that's probably mostly obvious though

Oct 13, 2018