Do PE funds stop caring about certain investments once the fund has crushed it?

I'm tracking a distressed high yield issuer right now that is owned by a prominent PE firm within an older vintage fund (they've since raised several multi-billion dollar funds). The fund itself also holds several other assets that have crushed it, and thus the fund itself is top decile for that vintage. My theory is that the GPs will be less likely to salvage this distressed investment (via new capital infusion) and more likely to let the issuer simply figure it out for itself, without obviously breaching any fiduciary duties and doing unnatural things. For those who still work in PE and at a senior enough level to have a sense for what I am talking about, can you opine on how you think about these types of situations?

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Aug 5, 2019

Hey, generally the GPs mandate is to maximize value across the entire portfolio. But other factors come into play, notably if this is a tail-end asset in a fund that is nearing the end of its life cycle, and if the lead partner running the deal is still active with the firm (and whether her/his overall track record is meaningfully affected by this single deal (can it be salvaged and improve the partner's standing? does the partner have enough good deals to chalk this one up to "lesson's learned" category during reviews/fundraising).

Generally, at the tail end of the fund (when the fund is nearing end of its harvest period, or perhaps it's already in extension), the goal will be to generate liquidity promptly. The burden of monitoring this company, in the context of the fund's overall returns may not make economic sense for the fund or its investors.

Internally at the GP, it's possible that the lead partner on the deal has either left, or transitioned responsibilities to another individual (so the partner can focus on bigger and better things). Some firms are better at adding value to struggling investments, others are better at maximizing their total return with cap structure antics, while others are great at asset gathering not because, but in-spite of their returns. If the sponsor has been in the news, or has other PortCo's with public debt, or IPO'd its companies in the past, you can dig around for a sense of how they handle different situations.

In short, your intuition is not wrong to think that some sponsors will pay less attention to struggling companies in funds that are at their tail end, especially if the rest of their portfolio is performing well enough to raise capital. Many, however, are merciless about squeezing every potential dollar out of every investment. While the industry is full of hyper-competitive individuals who strive to maximize every dollar, at some point these individuals can make the sometimes rational choice that the amount of attention a struggling PortCo would require to fix is better spent (for themselves, and for their investors), maximizing value elsewhere in the portfolio.

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Aug 6, 2019

Tacking on to this, there are some situations out there in which the sponsor has already achieved enough of a return through levered recaps to the point where an exit would simply be the cherry on top. This can happen through a number of different scenarios, but it's usually the case that the company is too levered for a successful public exit, doesn't have enough cash flow to organically de-lever quickly enough, and the sponsor's thesis around a strategic exit/sale to another sponsor turned out to be optimistic (due to timing, company performance, etc.).

It's a corner case, but wanted to shed some light on a situation in which a "stranded asset" isn't necessarily considered a negative outcome. The principle still applies: if there are more productive ways to spend your time within the portfolio, then that's what will attract focus.

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Aug 6, 2019
Classica:

It's a corner case, but wanted to shed some light on a situation in which a "stranded asset" isn't necessarily considered a negative outcome.

Solid point, sponsors can make a great return on recaps alone.

For the benefit of high yield investors posting/reading here - it would of course be a "negative" outcome for the debt holders.

Aug 5, 2019

Awesome response, thank you!
FWIW, I checked the sponsor's website and it appears the entire deal team is still there, with a few having since gotten promotions. The fund is still technically investing, but should enter harvest mode in the next year or so, when it needs to address debt maturities. This sponsor isn't known to be a terribly aggressive one -- not in the sense of levering its portcos to the point of no return, but more in the sense of isn't notorious for repurchasing implied (reorg) equity value through the structure or doing debt exchanges to extend option value. Will be interesting to see how this plays out.

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Aug 5, 2019

Shorter answer: If they are in the carry they have 20% of the profit so hell yes they care. If they aren't near the carry... They will focus on their other funds more unfortunately.

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Aug 6, 2019

^ This

Aug 6, 2019

I've discussed this with friends at the principal level in the past - at least in what was communicated to me there is a component of portfolio theory where they know everything won't work out. That said, if there is value to be extracted they won't just walk away. No one is throwing good money after bad but at the same time no one is walking away from value b/c everything else has crushed it. Also there is a component of internal politics at play.

From a credit perspective, to a degree its a win-win. If you think you're creating the company at an attractive level and you take control great. If the sponsor infuses capital and the bonds revert to par maybe moic is lower but you still got a solid return.

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Aug 6, 2019

This reminded me of the time (2015) I was looking at the distressed debt of EDCON, the largest retailer in South Africa, which was owned by Bain Capital. The question was whether Bain would step in and inject further equity to shore up the balance sheet or allow a debt-for-equity swap that would rid them of the asset and leave creditors in control. A simple back of the envelope calculation showed that Bain would have needed a sky-high exit multiple to achieve an IRR that would justify deploying additional capital into this asset. In the end (2016) they walked away, allowing creditors to take control of the asset.

Aug 6, 2019

Ovechkin08 hits a good point I forgot to mention, you can always run a quick LBO to see what assumptions the sponsor would need to believe to put more money into a deal

Aug 6, 2019

Following up on this, I am confounded to why sponsors bother dribbling in dollars in the form of equity at this point. Given looseness of credit docs today, why wouldn't I as the PE sponsor do the following: a) buy a blocking position in the fulcrum security at a deep discount to par, initiate a distressed exchange, end up effectively re-owning the business with a manageable cap stack and accomplishing the same thing while putting in less dollars; b) provide a liquidity bridge into the business by moving assets into an unrestricted sub and levering against that, thereby structurally priming the entire debt cap stack... would consider doing this if the company is simply going thru a short-term litquidity need and too levered to access the revolver (breaching springing covenant test). Maybe it's b/c we're not in a true credit cycle yet to see PE firms do this systematically, but Apollo can't be the only sponsor out there who actually feels comfortable doing this, right?

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Aug 7, 2019

Working in Secondaries - this type of analysis is basically what we do on a daily basis; what do we think the GP will do with this company?

There a ton of different variables to look at, but the short answer is that GPs hate to lose any capital, and the reputable ones will work portfolio companies for years in order to prevent that. There is nothing more frustrating for a GP than to answer the question of "why did you lose capital on this deal". But working a portfolio company to death vs putting in additional equity are two different things. Having a loss of capital is bad, putting in even more LP capital into a failing investment is even worse (if it fails). Unless the capital being injected is senior and has some sort of preferred return, its highly doubtful that you'll see an equity cure into a failing/over lever business. Its not about time or internal resources, (to a GP those are expendable), its being a fiduciary of LP capital.

A few people have mentioned returns on the total fund level, and while somewhat important, you also have to look at any potential Co-Investors that this specific deal may have. You may be looking at what looks like a great fund in totality, but if that specific investment has Co-Investors, then the GP will be highly incentived to work things out - CoInvestors tend to be the largest LPs in funds to begin with, and you don't want to upset them.

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Aug 7, 2019

This is great insight! The name I am following happens to have a yuge LP co-invest check...

Aug 7, 2019

.

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Aug 7, 2019

What was this comment?

Aug 7, 2019

I replied to your comment and accidentally posted it here vs as a reply. I moved it to a reply and deleted this one.

Aug 12, 2019
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