Turnaround investments: A waiting game

Turnaround investors, with their highly specialised focus, bottom end valuations and reduced dealflow, rarely make the headlines usually reserved for high-profile transactions. Nevertheless, while one might expect little activity from turnaround investors in a buoyant economic climate, in theory a downturn coupled with the current challenging outlook should clearly favour such funds and supply them with an endless stream of faltering companies waiting to be rescued.

Well, that was the theory. In 2010 turnaround deals have been few and far between, with unquote" recording just four transactions in the UK, including the acquisition of Reader's Digest UK by Better Capital and the Privet Capital buyout of Thermal Engineering. Indeed, as Privet founder Stephen Keating notes, the expected surge in turnaround activity hasn't materialised: "There's been lots of talk about a whole flood of deals coming, but that has certainly not happened. So far we've seen a patchy trickle of deals coming through."

One possible - and somewhat ironic - explanation for this situation is that the downturn could get much worse. "Yes, the economy is poor; but most of the businesses that are fixable are being held onto by the banks, because there is no absolute crisis" says Keating. The term ‘extend and pretend' continues to make the rounds, with banks said to avoid substantial restructurings and subsequent write-offs of debt holdings by amending existing loan terms in the hope that this will be enough to see the company through the crisis. "Low interest rates aren't crystallising any cash flow issues; underperformance has to really be quite bad for businesses to run out of cash" sums up Keating.

Additionally, a tough economic environment is as much a challenge as it is an opportunity for turnaround investors. Without the prospect of a general uptick in the portfolio company's sector, businesses are often left with little room to manoeuvre as Stephen Keating explains: "As part of our investment thinking, we'll be wondering: ‘can this business survive for another year or two with no upturn?'". This puts an extra emphasis on fixing the business internally rather than relying on exogenous factors, which further reduces the number of truly attractive companies to choose from.

Nevertheless, with fears of a double-dip recession and expectations for a hike in interest rates currently growing, turnaround dealflow could still see a long-awaited rise, as companies could face substantial cash flow pressures that not even favourable bank loan terms will be able to alleviate. The coming months should therefore be an interesting waiting game for turnaround investors; meanwhile, they will have to keep picking their targets carefully.

 

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• Topics
• UK / Ireland
• Buyouts
• Credit/Special Situations
• Turnaround/Special Situations