The recent misfortune of American businesses — many of which are struggling to raise cash to stay afloat — is creating new moneymaking opportunities for hedge funds and private equity firms, big investors that have been relatively unscathed by the pandemic.
With hundreds of billions of dollars sitting in reserve, these firms are plotting strategies to extend high-interest loans to companies, especially smaller, already troubled ones that banks have largely shunned over the past decade. Private equity firms, in particular, are also exploring buying minority stakes in public companies, which would provide them with an immediate cash infusion. But for companies exploring these so-called alternative lending options, the relief may come at a high cost.
“The problem for companies today is everybody has less money, and the cost of capital has just gone up a lot,” said Marc Lasry, co-founder of Avenue Capital Group, a $14 billion investment firm that specializes in distressed assets and loans to medium-size businesses.
Ever since the coronavirus pandemic shut down major parts of the economy, companies of all sizes across a swath of industries have raced to shore up the cash on their books. Big-name businesses with good credit have turned to commercial banks and big Wall Street firms for financing help, or issued bonds directly to investors. But there are far fewer options for companies that already carry a lot of debt, or are deemed risky by investors because they operate in industries like retail, entertainment, energy or tourism that have been hit especially hard by the pandemic.
Avenue, along with Fortress Investment Group and Apollo, are among the big investment firms with dedicated funds for making loans to smaller companies. These firms and smaller ones such as PennantPark and MGG are working with existing borrowers and also looking for companies that are showing signs of distress.
One of Apollo’s lending funds recently bought a portion of a $2 billion loan that a group of banks arranged last month for United Airlines, a person familiar with the matter said. The deal, reported earlier by Bloomberg News, will give the airline much-needed access to cash after the pandemic battered its business. It also allows the banks to reduce some of their risk.
In late February, just before the coronavirus slammed the U.S., a group of alternative lenders including PennantPark, Antares Capital and Ares Management put together a $345 million loan package for NSi Industries, an electrical products manufacturer, according to Dealogic, a deal tracking service.
“We had some of our best returns coming out of the global financial crisis,” said Art Penn, founder of PennantPark, which has $3.5 billion in assets and lends to about 135 companies with an average of $300 million in revenue. “We are having discussions, and we are exploring avenues to allocate capital.”
There are few deals at the moment. But there are preliminary signs of activity in the alternative lending market, which Preqin, a data firm, estimates has $58 billion in untapped lending power in North America.
Dylan Cox, a private equity analyst with PitchBook, a division of Morningstar, said that most private equity firms are focused on keeping their portfolio companies afloat. But he expected that in the coming months, big private equity firms will look to buy stakes in strapped companies ahead of full-blown takeovers down the road.
“Everything is in a bit of a lull now,” said Mr. Cox. “That starts to happen as soon as the dust settles.”
Hedge funds and private equity firms are pursuing ways to profit off the current crisis much as they did during the 2008 financial meltdown. At the time, a type of deal known as a “PIPE,” or private investment in public equity — in which a publicly traded company sells stock or debt to private investors — became especially popular with private equity firms. Hedge funds are also scouring for opportunities to short the stocks of public companies amid the market turmoil. Shorting involves buying shares with borrowed money and selling them, betting that the share price will drop and the fund can buy them back at the lower price and pocket the difference.
Restructuring lawyers said that in a bid to avoid bankruptcy, some companies may reach out to private equity firms for help.
Medical device company Nevro said this week that it would sell stock and debt to raise financing. Nevro said it expected to price the shares at $84 each, a discount to its closing price of $89 the day before the announcement.
It’s expected that the deal will attract bargain-seeking hedge funds and private equity firms. In the offering document, Nevro noted that some investors in the convertible bonds — debt that can convert into shares — will “employ a convertible arbitrage strategy” that could have them shorting, or betting against, the company’s stock.
Taking a stake in a beaten-down company is not without risk. In 2008, the private equity firm TPG gave a $1.3 billion lifeline to Washington Mutual, once one of the nation’s largest savings and loans. But when the federal government took over WaMu less than six months later, TPG took a big loss. But the temptation for private equity firms to pounce may prove irresistible. In the U.S., the industry is sitting on $740 billion in so-called dry powder: the amount of money that pension funds, sovereign wealth funds and other investors have committed to fund either buyouts or equity investments, according to PitchBook, which captures data on private equity firms.
“This crisis will present an opportunity for good lenders to participate in the great reconstruction to lift us out of this,” said Peter L. Briger Jr., Fortress’s co-chief executive officer. “But it is not clear when that will happen.”
With so many companies in need of cash, deep-pocketed investors can be choosy. Some may see the current crisis as an opportunity to renegotiate deal terms or even walk away, said restructuring attorneys and investment bankers.
Apollo-backed lender MidCap Financial, for example, just backed out of a $20 million loan it had agreed to provide to Senior Care Centers, a nursing home operator that is set to emerge from bankruptcy, court filings show. Lawyers for MidCap, which specializes in health care lending, cited “credit risks inherent in the growing Covid-19 epidemic and the particular risks posed to at-risk skilled nursing facility populations.”
The move sent lawyers for the nursing home operator scrambling to find an alternative lender. An executive with MidCap did not respond to a request for comment.