Q&A: BB LevFin - Mezzanine - Opportunistic PE

About

I have been a longtime WSO reader (6-7 years) and some years down the track, I thought it would be helpful to do a quick Q&A I think this could be helpful in particular for (i) those looking to switch over from credit to equity investing, (ii) those interested in mezzanine / sub debt, and (iii) those interested in operationally focused / distressed PE

Background

- c2 years Bulge Bracket LevFin (ANL) - c2 years mezzanine / sub credit investing (ANL / ASO) - c2 years opportunistic / loan-to-own PE, mid-large cap, (ASO / VP)

Comments (46)

 
Oct 18, 2019 - 4:33pm

Thanks for doing this.

  • How has loosening of credit agreement terms for lenders in recent years affected the loan-to-own model? Seems like lenders in the mid to large syndicated deals have less and less recourse when a company isn't performing IE no covenants on the term loans, widening baskets etc.

  • Do you look at primary debt issuances given the distressed sector has been relatively slow the past few years and have a need to deploy capital

  • Does your fund utilize operating partners post-ownership? how hands-on is your investing team in the company post-close / post-restructuring. Do you think you're getting good operating exposure where you can exit to industry if you wanted (understand operational experience in traditional PE are usually overblown)

 
Most Helpful
Oct 18, 2019 - 7:12pm
  1. Yes - covenant erosion has had a significant impact on loan-to-own investors because (i) businesses tend to be in a deeper degree of operational distress (and hence less valuable / salvageable) by the time there is a payment default vs. covenant breach, and (ii) sponsors have more options to essentially prime lenders via additional debt issuance (super senior, secured debt incurrence carveouts etc), reducing lender recoveries in certain cases. Increasingly, the constraint for many large cap funds (who can demand the most aggressive terms) is more lender relations than the specifics of the credit document, e.g. a fund that is constantly in the capital markets will probably take a longer term view of its lender relations than just on one deal

  2. Yes - liquid distressed is very crowded (particularly in Europe) and there are not many attractive investment opportunities. As a result, many credit-focused distressed funds have migrated to direct lending opportunities. We are a control-focused high cost-of-capital investor (20% IRR target) and so unfortunately hard for us to look at pure primary issuances. We would potentially look at rescue financings (e.g secured debt + equity warrants)

  3. Yes - we have operating partners (in-house) as well as an external network with specific functional capabilities (e.g. cash management, organizational design...). Similar to most private equity funds - there is a clear delineation between investment & operating team, where investment team focuses on acquisitions and the operations team focuses on post-deal value creation. I think by virtue of being a bit closer to the coal face (strategy pivots, operational restructurings, management changes, new product launches...), I have probably developed a better understanding of business operations but in my view still very much a finance skill set

Array
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  • Associate 2 in CorpDev
Oct 18, 2019 - 4:36pm

Thanks for doing this - could you share a case study on a loan to own deal you worked on? Would be great to understand why bank lenders couldn't participate, how you got comfortable on the deal, the credit thesis, and how you turned the company around.

 
Oct 20, 2019 - 11:12am

Some types of assets that are typically of interest to distressed / opportunistic PE
1. unloved subsidiaries that are part of larger conglomerates (price-insensitive and reputation-focused parents are generally good sellers since they will not run a broad process & often have considerations other than value)
2. overlevered buyouts (enterprise value breaks in the debt, most plain vanilla PEs do not understand credit documentation, restructuring processes and loan-to-own deal structuring well enough to attempt control)
3. legacy PE assets (successful buyout shops tend to have legacy assets from previous funds that they are looking to exit and do not want to spend time monitoring or managing and can potentially be bought at a discount)

Value creation generally involve some combination of
1. operational improvement (depending on degree of underperformance)
2. up front discount (if a healthy business trades at 8x and you can recreate one for 6x through the debt then you can potentially bank on some multiple expansion in a successful exit)
3. deal structuring (processes are often bilateral and buyers can sometimes push consideration into earnouts, deferred etc, which protect downside risk. Some deals can also be structured with secured debt to ensure capital recovery in a liquidation)

In short - buy it cheap, improve the business and push risk onto other parties

I can't really share case studies on a public forum but I would read Stuart Gilson's book (some good detail on case studies)

Array
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  • Investment Analyst in AM - Other
Oct 18, 2019 - 5:01pm

Thanks for doing this.

  • Could you please share a credit analysis case study?
  • I don't have single credit analysis experience but have credit fund investment experience ( was at a credit fund of funds). I would like to break into credit funds (private credit - direct lending, mezzanine, special situations, etc.) I am considering to do some case study on my own as practices. Do you have some recommendations in choosing the companies for my case study?
    -Any other suggestions for me?

Thanks so much and much appreciated!

 
Oct 19, 2019 - 6:47pm

My advice would be to start by reviewing old HY prospectuses and try to form an investment view of each of these assets (market dynamics, company strengths / weaknesses, suitability of cap structure etc)

Since these are public issuers are it should be relatively straightforward to get hold of financial information. You can fast forward to reflect on current trading updates (1-2 years down the line) to assess whether your investment view was justified

For special sits credit - I would focus on sectors that are currently in distress (retail, energy, shipping etc) to better understand market dynamics and how businesses in each sector "breathe"

Keep practicing to sharpen your skills and keep doing more and more case studies; investment skills develop cumulatively and over time

Re breaking in - you should focus on (I) deepening content knowledge and learning about the industry through reaching out to professionals and (II) applying to many roles / speaking to relevant head hunters / networking in order to maximise interview prospers

I believe that if you really apply yourself then you have a very good shot of being successful. Good luck

Array
 
Oct 18, 2019 - 9:04pm

Thoughts on CCC? Very happy I got out of FTR after they traded flat in my PA for 3 months straight. Thought they should've rebounded along w/ broader market but it never really happened.

Also, any advice for someone without strong credit/lev fin/ib background to breakin?

Array
 
Oct 19, 2019 - 7:34am

CCC credits are experiencing wide spreads right now despite very low base rates

Typically - the spread between B and CCC credit in a bull market should be c250-300bps. In Europe the spread seems to be 500bps plus

In other words - very low quality credit yields are not displaying as much sensitivity towards loose monetary conditions as you might expect

In my view this is probably related to market fears of global economy being late cycle / recession risk... in general, these low grade credits are typically the most speculative / marginal and often quite sensitive to macro conditions

I have much more of a security analysis background than a macro one - my approach is to continue monitoring companies on a bottom-up basis whilst keeping a close eye on key macro / market data

Array
 
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  • Anonymous Monkey
  • Rank: Chimp
Oct 19, 2019 - 1:49am

can you explain making the move from LevFin to mezz? curious about how you switched, how you liked one vs. the other, and if you feel like there were any important skillsets you picked up in mezz that are not applicable in LevFin. Thanks

 
Oct 19, 2019 - 7:34am

Mezzanine is a hybrid product between private equity and credit (in line with where it sits in the cap structure)

We tended to look at everything from junior debt (eg 2L debt) through to senior equity (subordinated PIK notes, pref equity etc) as well as some dislocated credit (eg relatively good companies trading in the 80s)

I really enjoyed the work I did (broad sector coverage, thorough but balanced DD approach, deep understanding of cap structures, docs negotiations...). It was definitely somewhere where I ramped up my security analysis skills

For me - the main downsides were (I) being removed from the action when it came to dealing with mgmt teams, (II) less direct exposure to operations and (III) somewhat commoditised nature of sub debt in what has become a very mature / developed market... (in my view increasingly true of a lot of private equity)

Lev fin was a great place to learn the building blocks of credit analysis (modelling, cap structures, exposure to deal process & credit markets), interact with PE investors and build an industry network. Having an IBD background is also a quality assurance to many employers and in hindsight I am glad I started my career there

Having said that - I personally found the hours very demanding, environment hierarchical and the job quite repetitive after a while (both in execution and pitching). I am personally better suited to security analysis which is not really a core part of levfin (or for that matter any IBD role). In the end - everyone will have different experiences and preferences and I don't think there is a one-size-fits all solution

Moving from lev fin to sub debt is a relatively straight forward career move (particularly after 1-3 years) given a lot of the building blocks are transferable. I used one of the main London-based recruiting firms to transition

Array
 
Oct 20, 2019 - 6:12pm

While your first move is very common, how did you think about your second move and how did you execute it? Are shops like yours open to backgrounds in both PE and Mezz? Or do they focus on people with an Rx background. Without being too obnoxious about pay, what is the pay structure, is your fund a closed ended one or operating more like a HF?

 
Oct 20, 2019 - 4:13pm

Could you talk about your modeling experience at your BB? I know some groups do but some don't. To what degree did having/not having this kind of experience matter in terms of exit opportunities and would you recommend looking to pursue groups that model as opposed to those that don't?

 
Oct 20, 2019 - 5:43pm

We tended to run LBO models within the group. In reality we normally used off the shelf templates and so didn't usually build models from scratch. Modelling is a core part of IBD skill set so I would try to build your skills as much as possible

Most PE interviews will involve a modelling case study (eg 90 min LBO model from scratch). Even if you are not getting a ton of experience in your team you can sharpen your skills at home practicing from a blank excel sheet and pass these tests

My modelling improved in PE as a result of working on complex operating models for live deals (not as relevant in levfin or mezzanine)

Array
 
Oct 21, 2019 - 8:16am

I have seen a couple of people move from real estate PE to special sits PE

There is some overlap to the extent that some special sits investments are based on value of hard assets vs value of the actual operating company (which is often distressed and limited / no 'P&L' value, e.g. distressed retailer, nursing home operator etc which owns all of its own real estate)

Clearly in this hybrid propco / opco investment approach (balance sheet rich / earnings poor), knowledge of both asset and corporate investing is relevant

Array
 
  • Associate 2 in CorpDev
Oct 21, 2019 - 1:51pm

Thanks, is my impression correct then that hard asset based credits are more "simple" to conduct analysis on if it's just a leverage ratio to asset value? How do funds compete for these deals then - is it just pricing and leverage amount (which just seems to be determined simply by who is more aggressive)?

Separately, do you mind if I PM you?

 
Oct 21, 2019 - 9:32pm

Really appreciate you doing this. I've been in Lev Fin for a little over 2 years. Our group performs the modeling and the analysis on all deals. I enjoy the work and definitely have learned a lot.

What would you say some of the ideal exit opportunities are from LevFin? Obviously PE is the main one I think of. But would a hedge (equity long / short) fund be realistic? Curious to hear your thoughts.

 
Oct 22, 2019 - 5:29am

I don't think there is such a thing as an ideal exit opportunity - it really depends on what you want to do

L/S equity would be quite uncommon since not really adjacent to levfin (unlike PE, distressed debt, mezzanine etc) but in the end you just need to test the market and see which interviews you can get called for.

It would be easier to go via PE or L/S credit in my view but if L/S equity is what you really want just testthe market and try to move directly

Array
 
Oct 29, 2019 - 7:34am

Hi - mezzanine fund was €1-2bn, AuM across the credit platform was closer to €10bn

Associate comp was in line with market (c€200k cash all in).

Probably stating the obvious but junior comp (€10-20k here and there) doesn't have too much bearing on long term career earnings and in my view its best to focus on accumulating skills that will end up commanding a big premium in the talent market

Is it a well recognised fund? Are the people first rate? Are they active in capital deployment? Is there room to grow? Where do the people who leave go to etc..

Array
 
Dec 19, 2019 - 2:16pm

Hi, thank you so much for doing this! I have just started FT in equity research at a BB. How feasible do you think it would be to transition to LevFin and join an analyst class next year (given that I have HY credit/distressed debt fund so I want to best position myself to make that a realistic exit opp.

 
Dec 27, 2019 - 7:34am

Sure - you are still very junior and should be opportunities to move into a different field

I would look for internal and external opportunities to maximise your prospects

In my experience, the more disciplines you have exposure to (equity research, levfin, M&A, restructuring, private equity...) the better an investment professional you will likely be

Array
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Dec 27, 2019 - 11:50am

Thanks for doing this. I am an intern in a Credit Fund. Given your experience in LevFin do you think it's wise for me to do the two years in the leveraged finance department of an investment bank, provided I get in to a programme. Is buy-side experience viewed favourably for these junior roles in LevFin.

Also, Credit question here, do you think there is a liquidity crisis right now? With capital being as prevalent as it is, it is very likely firms are going to make risky decisions to lever up. Are you at all concerned for the leveraged loan/ credit markets in the short to near future (1-2 year time-span) and if you are, what do you think the tipping point will be ?

Cheers

Array

 
Dec 28, 2019 - 5:07am

Hi - I think it depends on what you want to do with your career but in my view starting out in levfin at a bulge bracket probably gives you better optionality than being an analyst at most credit funds (with just a handful of exceptions)... eg better access to recruiters, better industry network and potentially broader exit opps (to corporates, other IBD roles and possibly PE)

Buy side internships are definitely considered relevant experience (particularly brand names) although direct IBD experience probably will be more useful (most analyst work is process management and ppt / excel crunching at high speed - much less about credit analysis)

if you can get a seat at a top credit fund out of undergrad it would be worth considering since (presuming you like investing) the work is more interesting, lifestyle will be better and there will still be opportunities to exit to HF / PE later

Re liquidity - yes capital markets are too frothy (debt, equity...) and this situation has been going on for a while now. There will be a correction and a distressed cycle at some point and some less disciplined funds across asset classes will lose money.

Given we can operate in the distressed PE / loan to own space we would probably 'net' see this as an opportunity but clearly could have ramifications for our existing portfolio

Array
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  • Intern in PE - LBOs
Jun 30, 2020 - 6:37am
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