Carlyle eyes restructurings in uncertain market

The firm is raising its third distressed debt fund in an environment of high asset valuations that is ‘only a few events away’ from a significant re-pricing.

The Carlyle Group is seeking capital for its third distressed debt fund for investments in a market that is increasingly uncertain as sovereign debt crises roil Europe and the US approaches a potential default on its obligations.

Carlyle has been raising the fund, called Carlyle Strategic Partners III, for several months, according to a person with knowledge of the situation. The fund has a target of $1.5 billion, according to people who have seen fundraising documents. The second Strategic Partners fund closed in 2008 on $1.35 billion.

Carlyle declined to comment.

The fund buys corporate debt of struggling companies, including those that are in default, and tries to establish control positions and exert influence over restructurings. The Carlyle Strategic Partners team has a global mandate and targets industries “where Carlyle has extensive experience” like aerospace, automotive, consumer, defense, energy, healthcare, industrial, media, retail and technology, according to the firm’s web site.

Management fees on the fund are set at 1.75 percent during the three-year investment period, and 1.25 percent on invested capital thereafter, according to a potential investor who has seen information about the fund. 

Carlyle’s prior two distressed debt funds have performed well. The debut fund, which raised $211 million in 2004, was generating a net 1.8x return multiple and a 35.6 percent net internal rate of return as of 31 December, 2010, according to market sources. Fund II was producing a net 1.3x multiple and a net 13 percent IRR, according to the sources.

Carlyle’s distressed debt investment team is co-led by former Oaktree Capital Management executive Brett Wyard and Raymond Whiteman, who joined the firm from Credit Lyonnais.

Appetite for distressed

LPs may not be as motivated to commit to distressed-related funds this year, however, sources told Private Equity International. While distressed-focused firms worldwide collected $17.3 billion for distressed debt last year and $6.9 billion for turnarounds, according to research from placement agent Probitas Partners, this year LPs may not be as generous to distressed managers.

Some LPs took losses in their distressed portfolios because they committed capital to funds that put money into the strategies too early, in late 2007 and the first half of 2008, according to Kelly DePonte, a partner with Probitas Partners.

LPs were then told to expect strong distressed opportunities in 2009, which never materialised as the markets rose and companies tapped the high-yield market to refinance their debt, pushing back maturities and avoiding defaults.

By last year, LPs had cooled on distressed. “I think there are a lot of LPs who won’t be rushing to the table,” DePonte said.

Prices are higher this year, so distressed deals will be harder to come by, which has turned some LPs off to the strategy, sources said. LPs that do commit to distressed funds will be doing so as “more of an insurance policy for future events than a bet on what is going on right now”, Lamar Villere, head of private equity at the Tennessee Consolidated Retirement System, said in a prior interview.

“It’s about having the money so that if there’s a shock of some sort, we’ve got some” exposure to managers in that strategy,” Villere said. (Subscribers to Private Equity International magazine can read full distressed investment coverage here.)

Several firms are raising capital for distressed investment vehicles this year, including Oaktree, which is targeting €2.5 billion to €3 billion for distressed debt investments in Europe, and Avenue Capital. American Securities Opportunities Fund announced this week it closed its second distressed investment vehicle on $753 million. Also, California-based Platinum Equity has been talking to investors about its third special situations and turnaround fund, which will target $3.75 billion and is expected to launch in the next few weeks, according to sources.

‘Massively leveraged’

Even without a shock event like a Greek default, distressed managers have been able to find opportunities, especially in Europe, sources have said over a series of interviews.

Europe on whole is “massively leveraged”, one distressed investment fund manager said, and various kinds of institutions will be selling assets to take off the pressure.

“You’ll see a continuous stream of assets coming off of various balance sheets, including over-leveraged corporates, banks and sovereigns,” the source said.

Kohlberg Kravis Roberts' distressed debt team has been reaping the harvest in Europe for months, according to Nat Zilkha, co-head of KKR’s special situations groups. The nationalisation of European financial institutions after the market crash in 2008 has already led to a massive sell-off of troubled assets at cheap prices.

“There are not enough buyers to take in all those assets,” Zilkha said. “We’re deploying capital at attractive rates of return.”

There are less “easy money” opportunities in the US, where turnaround firms that focus on operational improvements have the best chance of finding quality deals, sources said.

While pricing for distressed assets in general is not ideal, the environment is only “a few events away from a significant re-pricing”, according to one distressed investor. “It’s a tight market; it’s a good time to raise money and only do some of the things you absolutely have to do [namely, amazing] buys with extreme downside protection. Otherwise you’re better off waiting.”