We can be guaranteed one thing when doing business in frontier markets and that is that things will go wrong; whether it be management failures, political unrest leading to economic meltdown or simply shifts in demand and changes in taste which result in a company’s products or services being no longer wanted. In turn these events lead down the scary path to restructuring, selling non-core assets and bankruptcy. The risk inherent in frontier economies means there is a greater likelihood of disaster, but these market’s greater volatility and higher growth rates also provide the hope that ventures can turn themselves around and recover.
For the well informed, eagle eyed and resourceful investor there are real opportunities available in terms of providing the advice and financing that can turn troubled ventures around. These kinds of deals are often difficult to find and even harder to execute and usually require extensive local contacts and knowledge, along with a hefty bank balance and keen appetite for risk.
In developed markets distressed companies and bankruptcy can be a messy business with reputations ruined, jobs lost and debts unpaid. But there are well designed laws, experts and liquidity which means that for many companies some value can be found in an ailing venture and creditors may see some recompense.
In comparison emerging and frontier markets investors rarely have the luxury of a just and open legal system where redress is easy. As well as corrupt, the legal system may be slow and perhaps worse of all unpredictable. In these markets company downturns will be the result of uncontrollable events, war, civil strife and unforeseen government intervention such as the propping up of government favourites in direct competition to independent firms. But more often than not it is poor management (perhaps combined with market conditions and other factors) which is the root of the issue, but for social or political reasons it can be difficult to fire staff in many countries resulting poor corporate leadership and overcapacity.
So turning round or refinancing a company is not always as simple as putting in new management, launching new product lines or cutting back non-key assets. Instead you could be turning round a company with no court protection, a predatory government and an immovable workforce.
It can be hard enough to get finance for projects in frontier markets, but getting them for failing business might seem nothing short of impossible, but if the underlying business is strong then it is possible to inject funds into an ailing enterprise. IFIs like the World Bank and Asian Development Bank are options in many regions, as are specialised fund managers and private equity firms such as Apollo Asset Management, Guggenheim and Oaktree Capital Management.
What do you need?
Turning round a distressed asset can involve international experience as well as locals with insider knowledge and turnaround specialists that can accurately diagnose the issues facing the firm and resolve them. Perhaps most importantly you need to have leverage with the firm and the ability to remove the management team if it is they that are causing the problems (highly probable).
You also need to analyse whether a firm is fundamentally sound and is able to restructure financially and operationally and turn a profit at some future date, but has been blown off course temporarily through mismanagement or market forces or perhaps even short term liquidity problems. Fundamentally a distressed company is a just a mispriced asset, a bit like an unfashionable stock which has been overlooked, but in this case effort is required in order to correct it to a favourable value.
More generally investors will need knowledge of bankruptcy laws, the ability to negotiate with multiple stakeholders, a high degree of patience and ability to make tough decisions.
Why would you put yourself through this torture?
Of course there is the challenge factor and the excitement of such a difficult task, plus the fact that you can pick up bargains finding undervalued companies facing temporary difficulties, then resell to make yourself a fortune in the process (at least thats the theory!).
Also the recent slowdown in many large emerging economies like Brazil and Russia opens the door for more companies running into difficulties. Firms like Guggenheim and Cerberus have taken the opportunity to prepare large warchests in preparation for refinancing distressed firms in emerging markets.
The aftermath of the Asian financial crisis
I spoke with a senior banker who had spent the best part of a decade in Indonesia sorting out the chaos left over from the Asian financial crisis in 1997, which hit that country particularly hard, leading to a severe recession that put many ventures out of business. He and his bank then spent the best part of a decade picking through the wreckage of fallen companies that had financially overextended themselves in the good times, often borrowing from abroad, they were caught short as their markets dried up and borrowing costs soared thanks to the fall in the Rupiah. What he emphasised was that to get results it took a great deal of careful and painstaking negotiations, this was not a fly in and turn it round to make a quick buck style operation, but through patience and understanding the local dynamics of the market it was possible to realise a return on failed assets.
Broadly there are five ways in which you can become involved in distressed securities:
Firstly: Buy and sell securities that are fundamentally mispriced and will gain value without you doing anything, this could be thanks to a company, sector or country level mispricing. This would be typically done through identifying and buying them on a stock exchange, according to EMSA this has expected returns of 12 -18% with a timeframe of anywhere between 2 weeks to 2 years.
Secondly: you purchase a sizable share (but minority) of debt/stock and influence the company – helping it achieve an improved performance or ride out a stick patch in the economy. Historically returns are between 15- 20% and with timeframe of 1 to 2 years.
Thirdly: take a controlling position within a financially distressed firm and get involved in the restructuring process, this could mean giving the firm you benefit of your experience or perhaps hiring a turnaround expert to make the necessary changes. This will normally take 2 to 5 years.
Fourthly: get involved in a financially and operationally distressed company and attempt to restructure it and refinance it. This is particularly tricky as there is risk of things going wrong through the refinancing and also trying to improve operations, but the potential returns are the highest: 20 – 25% if the turnaround is successful.
Fifth: Buy a portfolio or package of debt or stock/NPLs and work with the individual borrowers to reach agreement. This is more of a scattergun approach and may need a larger team, it will also involve a great deal of administration and paperwork.
Recovering distressed assets is likely to be a lucrative hunting ground over the next decade as businesses boom and bust in fast growing markets, but it will take a great deal of business and political acumen to navigate the choppy waters of this particular market and should not be taken lightly.