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5/1/2011 Print an article

Inv estors Snap Up Distressed Debt in Em erging Markets
01 Oct 2 009
Virginia Munger Kahn
The credit crunch has created plenty of distressed debt, and several money managers see the best
investment plays in emerging markets. Long-term investors are snapping up bonds or loans of troubled
companies at deep discounts.
A rebound in com m odities prices and signs of a global recov ery hav e renewed confidence in em erging-m arkets
econom ies and rev iv ed inv estm ent flows to their equity m arkets. But som e m oney m anagers say the m ost lucrativ e
em erging-m arkets prospects m ay lie in the detritus of the credit crunch: the debt of distressed com panies in these
dev eloping econom ies.
Distressed debt is a staple of recession-era inv esting. Long-term inv estors with patience and restructuring
experience can snap up bonds or loans of troubled com panies at deep discounts and negotiate new financial term s
that ensure strong returns, and often get the com panies back on their feet. Most m oney m anagers hav e tended to
stick to the U.S. and other dev eloped Western m arkets, where the legal protections afforded to creditors are well
established.
Em erging-m arkets specialists insist that the potential gains outweigh the risks in their dom ain, howev er, and
sev eral firm s hav e recently launched funds to capitalize on the situation.
“As som eone who’s been doing distressed debt in Asia for m any y ears, there hav e been only two tim es with great
inv estm ent opportunities — 1 9 9 7 to 1 99 8, and now,” asserts Robert Appleby , co-founder and chief inv estm ent
officer of Asia Debt Managem ent Hong Kong, which m anages $2 .2 billion in distressed debt. “Today is better by a
long shot. The underly ing business of the com panies is m uch better.” In August, ADM launched a new fund, Galleus
Fund II, to focus on the strategy .
Other inv estors share that optim ism . The opportunity in em erging-m arkets distressed debt is “unprecedented,” say s
Robert Rauch, director of research at Gram ercy , a $2 .3 billion Greenwich, Connecticut–based firm founded in the
wake of the Russian debt crisis in 1 9 9 8. In April, Gram ercy launched the Gram ercy Distressed Opportunity Fund,
which now has $2 00 m illion in assets.
Also in April, Ashm ore Inv estm ent Managem ent, a London-based em erging-m arkets specialist, launched a new fund
in partnership with Swiss bank UBS. Modeled on the Russian Consolidation and Recov ery Fund that Ashm ore
created after that country ’s 1 9 9 8 debt crisis, the Ashm ore Global Consolidation and Recov ery Fund is designed to
take distressed assets from banks, insurance com panies and other financial firm s in exchange for units in the fund.
Ashm ore, with its experience in restructurings and special situations, will m anage the fund to m axim ize recov ery
v alues.
“The objectiv e is to work with banks and other institutional inv estors to help them solv e the problem of getting
illiquid assets off the balance sheet,” explains Jerom e Booth, head of research for Ashm ore. “We’re looking for
inv estors who would prefer us to m anage the assets.”
The am ount of distressed debt — generally considered to be debt y ielding at least 1 0 percentage points ov er
com parable Treasuries, or about 1 3 .5 percent or m ore currently — is relativ ely m odest in em erging m arkets. ADM
and Gram ercy estim ate the eligible pool to be $2 50 billion to $3 00 billion, prim arily in corporate debt, or roughly
half the size of the m arket during the Asian financial crisis.
In the U.S. som e $3 2 billion worth of corporate debt is trading at or below 50 cents on the dollar, according to
analy sts at JPMorgan Chase & Co., but the quantity of distressed U.S. m ortgage assets is far larger. Bruce Richards,
co-founder of Marathon Asset Managem ent, recently put the v alue of eligible assets for the Public Priv ate
Inv estm ent Program , which cov ers the securitized m arket for residential and com m ercial m ortgages, at $2 .5
trillion to $3 trillion.
The play ing field m ay be sm aller in em erging m arkets, but the potential rewards are outsize, m oney m anagers say .
Bonds hav e traded with y ields to m aturity of 2 5 to 3 5 percent “without being candidates for default,” notes Rauch.
Gram ercy has already profited from a rally in what Rauch calls “distressed perform ing” bonds. In April the firm
bought the 9 .5 percent senior unsecured bonds due in July 2 01 8 from Indian m ining com pany Vedanta Resources
when they were trading at less than 7 0 cents on the dollar. In August, the firm sold the bonds when they rebounded
to its target price of 9 0 cents.
Also in April, Gram ercy began buy ing the 4 .7 5 percent senior unsecured notes due in May 2 01 4 of Mexican cem ent
com pany Cem ex. Fears that the com pany would be unable to refinance $1 5 billion in debt taken on for its 2 007
acquisition of Australia’s Rinker Group had depressed the bond’s price to the low 50s, where they y ielded about 2 1
percent. Cem ex reached an agreem ent with creditors in August to extend m aturities on that debt, and Gram ercy
sold its bonds the following m onth when they were trading at 82 .50.
Gram ercy anticipates a surge in em erging-m arkets bond defaults through 2 01 0. Som e $2 1 0 billion in corporate
bonds is due to m ature in 2 009, with a sim ilar am ount in 2 01 0. With banks continuing to pull back on lending, all
but the “bluest of blue chips” will face problem s refinancing their debt, say s Rauch. He expects to be able to pick up
senior debt instrum ents at 1 5 to 2 5 cents on the dollar, with ultim ate recov eries expected in the 50-to-7 5-cent
range.

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” notes Booth.” he explains.S. “There is m uch m ore underly ing strength and v alue. giv ing bondholders a sm all am ount of cash.” ADM is also looking to strike sim ilar refinancing deals in India. but ov er the next three to fiv e y ears. In Septem ber 2 008 the firm began buy ing the 1 0.S. including ADM’s $50 m illion loan. a Chinese m aker of solar energy cells.. Durango em erged from bankruptcy in August with its debt load cut by m ore than half. The firm inv ests in distressed. that today ’s rich returns are not likely to last long as the global econom y recov ers: “It’ll be a short-liv ed opportunity — m ay be two to three y ears. which was seeded with $1 00 m illion in assets from UBS. are sim ilar to those in the U. Gram ercy expects that the deal will ultim ately be worth 45 to 50 cents on the dollar. but the courts are untested. a 6 percent equity stake in the com pany and new bonds due in 2 01 6 that pay an interest rate rising from 6 percent initially to 1 0 percent in later y ears. a Mexican paper and packaging com pany . which was created after the Asian financial crisis. The fund m anager retains the warrants. when it was wound down. it’s highly likely y ou’re going to want to do it out of court.” say s Appleby . Galleus — nam ed after a ty pe of shark found in tropical waters — has prov ided net returns of 1 1 percent annually since its inception in April 1 9 99 . In April.” Rauch points out. The firm ’s initial foray into distressed em erging-m arkets debt.” he say s. ty pically as the head of an organized creditor com m ittee. “The rules are on the books. ADM also obtained 4 . The com pany paid the loan back in January 2 009 .3 tim es. and debt-to- cash-flow cov erage ratios were 5 to 6 tim es. The goal is to recy cle capital as quickly as possible. But when Yingli was looking to refinance. ADM helped refinance Yingli Green Energy Holding Co. Appleby expects the fund to generate net annual returns of 1 5 to 2 0 percent. Two y ears ago such loans ty pically carried 8 percent coupons. He cautions.” Rauch notes. Although bankruptcy laws in som e jurisdictions. which are well in the m oney . ”We try not to buy other people’s cooking. banks were not lending and the public bond m arkets were v irtually shut. Ashm ore ty pically does not get inv olv ed in the day -to-day m anagem ent of the com panies it inv ests in. such as Hong Kong and India. countries like Indonesia and Russia do not offer good legal protection to creditors.6 4 . That produced a lev erage-adjusted y ield (coupon div ided by cov erage ratio) of 8.” asserts Appleby .7 6 last m onth. which m anages $2 4 . Yingli raised close to $2 03 m illion in a share offering and used the proceeds to retire debt. Project financings and public and priv ate equity are also expected to be part of the portfolio.2 percent from July 2 000 through Decem ber 2 005. underv alued or ev ent-driv en opportunities and generally seeks to buy out existing creditors and take an activ e role in restructurings. The opportunities in em erging m arkets are m ore attractiv e than in dev eloped m arkets because com panies there are not as lev eraged. ADM offered a fresh $50 m illion senior secured loan to Yingli at an interest rate of 1 2 percent. He declines to disclose the details of the Asia Pulp and Paper settlem ent.1 m illion warrants to buy the com pany ’s shares at a price of $5. “We think the current env ironm ent offers ev en greater potential than what we saw in that earlier period. the $7 80 m illion Gram ercy Em erging Markets Fund. but there is still substantial uncertainty about how the sy stem will work in practice. “It is extraordinarily exciting.9 billion in assets. ADM prov ided the com pany with a new loan carry ing a coupon of 2 0 percent and giv ing the com pany a cov erage ratio of just 2 . priv ate loans and conv ertible bonds from com panies in Eastern Europe and Asia. Its Asian Opportunities Fund.com/…/PrintArticle… 2/3 .” say s Appleby . “China is littered with these kinds of opportunities. Ashm ore Inv estm ent Managem ent. Last y ear it posted a 1 3 percent decline. generated gross annual returns of 3 4 . with Yingli’s New York Stock Exchange–listed shares trading at $1 3 . which is still open.” asserts Rauch. to $2 50 m illion. is taking a different tack by m arketing its Global Consolidation and Recov ery fund as a v ehicle for financial firm s to get illiquid assets off their books. say ing institutionalinvestor. he adds. is currently inv ested prim arily in tradable loans. with a $1 50 m illion senior secured loan. The firm ’s flagship hedge fund. “I’v e nev er seen that in m y life. “We try to get a new piece of debt with extended m aturity and lim its on the com pany ’s ability to get cash out until we’re paid off. Gram ercy ended up hav ing to reach a priv ate deal with an Indonesian indiv idual to resolv e its claim s against the com pany .6 percent in the three y ears following its April 1 9 9 9 inception. The com pany filed for bankruptcy the following m onth. courts ruled in fav or of creditors. The new fund has a fiv e-y ear lockup period. generated gross annualized returns of 2 3 . ADM takes a sim ilar approach to corporate restructurings in Asia. Booth expects the fund to generate returns sim ilar to those of other Ashm ore special-situation funds.3 percent from its May 1 9 98 inception through March 2 009 . “If y ou hav e to do a corporate reorganization in em erging m arkets. an Indonesian com pany that defaulted on $1 4 billion of debt in 2 001 .. at about 1 5 cents on the dollar.S. Gram ercy headed up the creditors’ com m ittee and struck a deal in April to restructure the debt. Although Indonesian and U. howev er.” explains Rauch. “We consider this a m ultiasset class fund. China has passed new bankruptcy laws com parable to those in the U. Its Asian Recov ery Fund. In August 2 008. y ielding at least a threefold return on its original inv estm ent. say s Booth. ADM does not look to operate its target com panies and often leav es m anagem ent in place. Gram ercy learned a lesson about legal pitfalls with its inv estm ent in Asia Pulp and Paper. but rather seeks to add v alue by working with local partners to consolidate assets and restructure target com panies. Gram ercy has targeted gross com pound annual returns of 4 0 percent ov er the next fiv e y ears for its new fund. returned 1 7 .5 percent senior unsecured bonds due in 2 01 7 issued by Corporación Durango.7 percent.5/1/2011 Print an article Gram ercy takes a proactiv e approach to reorganizations.. The fund. In June. Managers of distressed-debt funds acknowledge the risks of inv esting in em erging m arkets.

fund m anagers say ..S. By contrast.” say s Ashm ore’s Booth.” he notes. there is m uch less com petition for distressed assets in em erging m arkets. “Our approach has been to choose strong partners. institutionalinvestor. In light of the risks inherent in em erging m arkets. including the integrity and objectiv es of the owners of the business. In the U.” explains Mark Patterson. “That’s what giv es rise to the potential for outsize risk-adjusted returns.” say s Rauch.com/…/PrintArticle… 3/3 . distressed inv estors are “tripping all ov er each other. chairm an of MatlinPatterson Global Adv isers. and dev eloped m arkets on a risk-reward basis.” Such v iews are m usic to the ears of em erging-m arkets specialists.S. “We like the law here and the opportunities here.5/1/2011 Print an article only that “it was a reasonable recov ery .” Inv estors also need to consider other factors when assessing potential inv estm ents. though.S. The key to success is building long-term relationships and gaining knowledge of local play ers. m any Am erican fund m anagers are m ore than content to stay at hom e and concentrate on the am ple supply of distressed debt av ailable in the U. a priv ate equity firm in New York City that specializes in distressed situations and m anages m ore than $9 billion. “The facts of this cy cle ov erwhelm ingly fav or the U.