LAVA: Private Equity
Yesterday’s LAVA meeting was about private equity, featuring three panelists from private equity firms. I’ll talk about them one post at a time.
Oaktree Capital Management specializes in purchase of distressed companies. These are typically mid-market companies (perhaps $50-$500 million net assets) which are having financial problems, such as a company with too much high-cost debt or a company suffering from recent management problems. Oaktree invests in these companies, usually by helping them pay their debts in return for ownership in the company, and may get involved in management by sitting on the board or requiring their own management team.
Much of the discussion focused on the way recent economic impacts have affected their investments and their acquisition & sale practices. Mike Norman, the panelist for Oaktree, recognized the fact that it is difficult, and perhaps impossible, to make significant gains in highly efficient markets. Economic downturns affect these markets very quickly. With a focus on distressed companies — companies that are already having issues with liquidity and who are not likely to raise investment funds on their own — Oaktree enters a relatively inefficient market (distressed companies), where they can use knowledge and good business practices to identify development opportunities.
Mr. Harmon pointed out that the effect of high gas prices and other pressures have not really hit consumer prices yet, and it is likely that many more companies will be in financial distress soon. Oaktree follows these trends and uses their research in the decision-making process. That is probably a good thing for Oaktree, which will be in a position to buy financially distressed companies with good products and smart management teams at relatively low prices.
He also pointed out that, every time the financial sector suffers from disaster due to poor risk management (examples: the Drexel-Burnham junk bond crisis, the S&L crisis, the dot-com bubble, Enron and related accounting scandals, and now the mortgage crisis), the problems are soon forgotten. Some new regulations go into effect, everyone gets cautious for a few years, then somebody starts making new promises of amazing returns on investment, institutional fund managers jump in with both feet, and (gasp!) the investments prove to be based on faulty accounting or insufficient risk analysis. This cycle will probably be no different. The key is to take advantage of conditions to position yourself for the upswing and to behave conscientiously so you don’t get caught in the downswing.
After the meeting, I asked Mr. Harmon if the recent economic downturn was affecting the due diligence that they perform on acquisitions. He responded that Oaktree is taking additional steps when buying companies, such as more thorough interviews of customers, to insure that the company’s books really indicate the health of the organization.