The more insolvencies the better

Happy Sunday. Let’s get started:  

For most people, the next twelve months are packed with economic uncertainty. For special situations funds, it could be the best year yet.

Get Up to Speed on Special Situations

Special situations investors specialize in flexible capital solutions, handing businesses a third option when traditional debt financing is too costly (or impossible to obtain) and equity isn’t readily available. Without the restrictions of a typical private equity mandate, the strategy is free to operate across asset classes, markets, industries, and geographies.

The approach is relatively new, pioneered by Blackstone’s Tactical Opportunities fund (often known as TacOpps) shortly after the financial crisis. It thrives in periods of market turmoil and dislocation, or whenever normal sources of capital dry up.

Can’t Ask for a Better Set-up

While the pandemic kicked off a flurry of special situations activity, subsequent rock bottom rates and cheap money meant the party didn’t last long.

Now, after sitting on their hands for the last two years, special situations groups are gearing up for what could be the busiest period they’ve ever seen.

For many businesses, rate hikes have doubled or tripled their debt service costs. Inflation hasn’t helped, particularly for companies that have had a difficult time passing on price increases to customers. The upshot is that debt burdens which may once have looked relatively conservative are now pushing companies over the edge.

Even without performance or operational issues, businesses that last raised debt financing in a low-rate environment could be in trouble when that capital comes due. With over $100 billion of leveraged loan maturity over the next two years, anyone unable to refinance on the same terms could be forced to raise equity.

Chris James, COO of the TacOpps group, puts it bluntly: “I think this is a crisis.” Whatever happens, special situations investors are standing by to help (in exchange for hefty returns).

Target Deals

Special situations groups are heading into 2024 with a few key focus areas: corporate carve-outs, operational turnarounds, and balance sheet restructurings.

There’s also an opportunity for opportunistic credit investments — investors point to growing demand from sponsors trying to get deals done in a more challenging credit environment, building out complex capital structures in the absence of sufficient senior debt.

One thing that’s not necessarily a target is bankruptcy:

FTI’s Bob Del Genio provides more color, telling Middle Market Growth “there are a lot more financing options, whether those are bridge arrangements, rescue financing, or other workouts that are happening outside of court. Parties generally want to try to do that because then you can move into and out of a process faster and you have a concrete plan that you can tell to the market, to customers, to vendors, versus just going to court and trying to figure it out.”

It’s Getting Crowded

Blackstone’s TacOpps success meant it wasn’t alone for long — there are now more than a dozen managers offering special situations strategies, including Oaktree, Apollo, Ares, MidOcean, Towerbrook, Brookfield, Sixth Street, and KKR.

More firms and more capital chasing the same set of deals could just compete away any chance for solid returns. But TacOpps Co-Head David Blitzer says that’s the wrong take: “On all sides of the equation, this area is growing much faster than the capital set is growing.”

He’s not alone. Stout’s Miller thinks “there are more opportunities now for everyone,” and that “veteran teams are always going to find ways to invest and make a return.” The market is also recognizing the importance of investors that can play across the capital stack and there’s a preference for working with teams that have been there before, know the options, and can get a deal done. Providing certainty in an uncertain market is a great way to get an edge.

What’s Next?

No one wants to look like they’re profiting from the misfortune of others, but, for special situations investors, it’s getting hard to hide the excitement. Blitzer says “the market is just starting to get more interesting — when I look out three to twelve months, it’s going to be even more interesting than it is today.”

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 DEALS, DEALS, DEALS

1. The latest Cerberus bankruptcy.

• Off Lease Only, a Cerberus-owned used car dealer, filed for bankruptcy last week and laid off nearly 500 employees.

• Cerberus bought an 80% stake in the founder-owned business in 2019. Shortly after the purchase, Off Lease changed its pricing structure and rolled out a series of “dealer fees” that baked in thousands of dollars in added expense for each purchase. Long-time customers complained and Off Lease Only managed to develop a reputation for notoriously poor service (even compared to other used car vendors).

• The business blamed the bankruptcy on rate hikes and a tumultuous used car market, but that may not be the whole story — Cerberus also executed a series of sale-leasebacks for the company’s real estate holdings in 2020, presumably taking an early dividend while burdening the business with added expense.

• By the end, the company was apparently as much of a junker as the cars it sold — back in June, Cerberus hired Bank of America to lead a sale process that went flat nearly immediately. Materials went out to 79 parties, but only two opted to submit initial bids. Neither was deemed actionable.

• Cerberus isn’t done yet. Filings list the sponsor as creditor on a $52 million PIK note. For good measure, Cerberus also submitted a $4 million unsecured claim for technology consulting services provided to Off Lease.

2. Instacart is prepping for a ‘down round IPO.’

• Grocery delivery startup Instacart is closing in on its long-awaited IPO, pricing Monday night ahead of a Tuesday offering.

• Following positive market reception of chipmaker Arm’s float, Instacart announced it had moved its expected range from $26 - $28 per share to $28 - $30.

• The upward revision nears a $10 billion valuation but doesn’t do much for venture backers, including Sequoia, D1, and Andreesen Horowitz, who most recently valued Instacart at $39 billion in a 2021 raise.

• It’s probably not a reality they would’ve chosen to face if they didn’t have to. The IPO is in part forced by a need for cash to cover a $500 million employee stock comp tax bill that’s coming due. However, some investors think it’s a deeper discount than warranted — Sequoia and D1 have said they plan to increase their stake, rather than sell down the position.

• The other surprise from Instacart’s S-1: it’s just another tech advertising business. The company booked $740 million of ad sales in 2022, nearly 30% of total revenue. That mirrors the trend at places like Amazon and Uber, which have seen their advertising revenue grow in importance relative to their core businesses.

3. A CrownRock exit.

• Oil and gas producer CrownRock, backed by private equity firm Lime Rock Partners, is prepping for a sale that could fetch more than $10 billion. That would be the largest O&G transaction since ConocoPhilip’s $13 billion purchase of Concho in 2020.

• CrownRock has invited bankers to pitch for the mandate, with plans to launch a sale process in early 2024. Expectation is heavy interest Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), among the handful of producers with the capacity to take down a purchase of this scale.

• The potential sale follows this year’s rally in oil prices and reflects demand for coveted Permian basin operations, particularly with a tightening supply outlook.

The rest of the deal sheet…

• Walt Disney Co. (NYSE: DIS) is considering a sale of ABC to local broadcast business Nexstar (Nasdaq: NXST); it’s also reportedly received a $10 billion offer from media exec Byron Allen for ABC and a basket of other, smaller assets.

• Novartis (NYSE: NVS) shareholders approved a plan to spin off generics business Sandoz into a standalone entity.

• Estes Express offered $1.53 billion for the terminals portfolio of bankrupt trucking company Yellow, topping a $1.5 billion offer from Old Dominion Freight Lines.

• Apollo Global Management is among those considering a bid for the global gaming unit of International Game Technology (NYSE: IGT), which could be worth between $4 billion and $5 billion.

• Aspirion, backed by Linden Capital Partners and Varsity Healthcare Partners, acquired Infinia ML, a provider of clinical document processing solutions.

• Blackstone is considering a potential $1 billion takeover offer for Growatt Technology, a Chinese solar equipment manufacturer that had been closing in on a Hong Kong IPO.

• Chevron (NYSE: CVX) acquired a 78% stake in the world’s largest hydrogen production and storage development from Haddington Ventures.

• L Catterton is in talks to buy a majority stake in Japanese veterinary services firm Withmal.

• 777 Partners agreed to buy Everton FC, a Premier League club that’s been the subject of takeover rumors for much of 2023.

• Clearlake, Charlesbank, and Fortress agreed to acquire Learfield, a college sports marketing and content firm, as part of a debt restructuring.

• Markerstudy, a British insurer backed by Pollen Street Capital, is acquiring rival Atlanta Group for £1.2 billion, whose backers include Madison Dearborn Partners, HPS Investment Partners, and ADIA.

• Vista Equity Partners is prepping a sale process for Stats Perform, a sports intelligence and data firm.

• Co-operative Bank, a UK-based middle market lender, has kicked off a sale process and asked for initial bids by early October.

• WT Microelectronics agreed to acquire Future Electronics, a Canadian manufacturer, for $3.8 billion.

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