For most people, the next twelve months are packed with economic uncertainty. For special situations funds, it could be the best year yet.
Background: 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).
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:
“I think when people think of this space they think bankruptcies, but that can destroy value and the costs can get out of control really quickly.” It’s always an option, but we really try to avoid going there if we can identify other value-maximizing solutions. Distressed investing encompasses much more than just bankruptcies.”
Ann Miller, Co-Head of Special Situations Advisory at Stout
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.
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.”