FEG 2019 Forum Q&A Series: Distressed Debt

During the FEG 2019 Investment Forum, Victor Khosla, Founder and CIO of Strategic Value Partners, talked with us about the distressed debt opportunity set and ways to invest outside of crises.

Thanks for having me. I'm Victor Khosla. I'm the founder and chief investment officer of Strategic Value Partners.

I've been doing distressed debt and distressed private equity investing it seems like forever, for 30 years, at this point. As a firm, we've got about $8 billion in assets under management. All we do is we focus on distressed debt and we focus on distressed for control, taking over businesses through the distress debt process. We have about 120 people. Our team is equally split between the US and Europe. And, as far as our US business, we started in 2001. We set up our London office in 2004 and we've been...so, we have a lot of experience on both sides of the Atlantic.

Q: How has the distressed debt opportunity set changed since starting SVPGlobal in 2001?

The business has...it's not just an evolution which has taken place over those 18 years. It's 18 years. So, you don't really kind of see sometimes just what a revolution has taken place in this business. So, in 2001, there used to be about $500 billion of high yield debt. Today, there's about three and a half trillion dollars of high yield debt, and it's from this high yield debt, distressed comes. 18 years ago, the business was very US centric. It was almost all US. And, today, roughly about 30, 35% of the business is in Europe. Europe's just come out of nowhere now to have about over a trillion dollars of high yield bonds and loans out there today. The business has also changed because it's gotten a lot more competitive. It's gotten larger, much larger. It's gotten complex because it's not just the US it's US and Europe.

And, with all that has come just a lot more competition. So, to really win in today's distressed debt market, it's not just, you need to be much more than quote "the proverbial smart investor." You can't just say, "Hey, we are smart investors. We do things just, we are smarter than A, B and C. And, as a result of that, we are winning." We just don't think, we think to win today takes a lot more in skills than it did in 2001. All of us develop what we think is an edge. And, what we've done over the course of these 18 years is we said, "Look, we'd like to believe we have some of the smart investment people who are shrewd, who are well connected. We'd like to believe we have them." And, I think we've probably do, but especially 10 years ago, we started to go out and source directly from commercial banks.

The way banks sell, especially the banks in Europe, as they are selling today, they sell in this very quiet process. You want to be in that magic circle, doing deals with them rather than in this oh, hotly competitive US business, which is kind of what the US has become more and more, right? So, for us sourcing and origination, having teams of people, calling banks, we've developed all of those. Today, we have larger sourcing and origination teams than Goldman Sachs trading desk or the Deutsche trading desk or something.

The other thing, the other skills we developed 10 years ago, we said, "Look, there is a lot of low hanging fruit in bankruptcies." When a company goes bankrupt, a company has gone bankrupt, but they've lost generally the good management teams are gone. They're gone two, three years before the bankruptcy filing because that equity is worthless. Even good businesses, there's a lot of upside, but to get it, you have to be a lot more than a paper trader. So, what we started to do 10 years ago, we started to build operating teams in house. People who can work with the investment team to go out and build a new business plan with a company, hire a new management team and work with them in a pretty hands on way as we operate and run a business.

And, the other one is what I touched on earlier. We were literally one of the first investors in Europe starting in 2004. We did not discover Europe in 2014 or 15, like, quite frankly, much of our peer group. So, we had a lot of experience and by the way, not all good. Just because you're in Europe doesn't mean you're going to make money all the time. So, we had a lot of experience as we did it and for us, given that Europe is growing still growing, and Europe is much more inefficient than the US being early, it gave us an advantage in terms of kind of our business to find interesting things.

 

Q: Where do you see the most opportunities today, both in the U.S. and Europe?

So, just very broadly, if I was just step back, today, September, 2019, the overall opportunity for distressed is modest. The economies in the US and era they're still growing. So, the overall...there's no big crises. So, as a result of that, we are in kind of the modest opportunity years. So, in the context of those modest opportunity years, we find that in a three and a half trillion dollar high yield market, there's still interesting things to do. There has to be, right? And, we find that, right, with some of the sourcing and the direct reach we have. So, one of the areas we've been, so for example, one of the areas we've been most focused on over the last two years is infrastructure. Buying distressed debt on toll roads, buying distressed debt on waste to energy businesses, which are core infrastructure right now. You'd think, "Boy, there'd be no infrastructure never gets distressed."It's supposed to be just a great asset class, not true, right? So, for us, when we look at kind of what we like, And we like these toll roads, they are a monopoly or a duopoly situation. The debt is often held by a group of European banks who've lent money to these all over the world and we've gotten to know them well. And, it's an asset class where we've gotten to know the management teams, we've gotten to know the financing sources, we've gotten to know the people who go out and buy these toll roads once we fix them.

  So, for us, even in these modest years, there's just a set of investments we have been able to make in the distressed infra space. There's a toll road in Texas called SH-130 and we became the majority equity holder over the last year and a half through a debt equity restructuring. There are a group of toll roads in Spain and Portugal, where in most of those deals, we bought distressed debt and we've restructured it. In one of those we'll end up with control of the toll road in the others, it's been much more of a shorter term investment. But, I think for us the goal, if I was to step back in this, you've got to look for opportunity in a very focused way. And, I think our point of view would be in a three and a half trillion dollar market, you should be able to find some. And, we think we are finding those kinds of deals.

 

Q: Do you have any additional advice for institutional investors seeking th invest in distressed debt?

  We find that in this business, sure, there's an opportunity which gets created around a crisis. And, those are generally, typically good years to deploy capital. So, I think from an investor standpoint, most people are geared towards finding that one crises opportunity once every 10 years. And, I think what we would just tell investors is yes, that's a good opportunity. And, it's hard to figure out exactly when it's going to come also by the way. And, when it comes, everyone is a little concerned, "Is this a good time to invest?" Because, everything is going to hell in a hand basket. "Do I really want to be investing now?"

  So, I think our piece of advice about market timing is don't overdo it. And, I think there are groups like us, and there are some other people like us who tend to be more evergreen. Yes, we lean in after the crisis, but we are making a steady stream of investments. So, I think our advice to investors would be that think about investing with those sorts of people, rather than just waiting for that big crises, that moment to deploy capital or not being interested in this business otherwise.