When asked what makes him angry Fred Eckert pauses, raises himself slightly in his seat and his eyes narrow. The pause suggests fleeting but vivid recollection. “I don't like bullies,” he says. “And I don't like liars.” You believe him: Alfred C. Eckert III, chairman and chief executive officer of GSC Partners is not a man to be taken lightly. “When people try to tell me something that I know is not true I get really angry. And when I see people mistreat other people – that gets me angry too.” This episode in the interview is memorable not because Eckert can get angry but more because he clearly cares; cares about the way people interact with each other, and cares about the way that interaction can shape his company's future.
GSC Partners was founded by Eckert and former Blackstone Group managing director Keith Abell in 1994 and has grown to become a multi-faceted alternative asset manager with over $7.4bn of assets under management. It's distinctive, although not unique, in having a multiproduct strategy (see accompanying table). The firm has taken vanilla private equity and morphed that into a distressed investing business that specialises in fishing in the increasingly rich waters of troubled corporate America. And it has also grown a European mezzanine operation that is presently raising a second fund to service European buyout activity. The third product line – and one that catches many peoples' eye on account of the $3.8 billion (€2.9 billion) of capital managed within it – is structured finance: the firm has raised seven collateralised debt obligation (CDO) funds so far.
There are more product lines on the way. In March this year Eckert hired old CDO hand Fred Horton, formerly of Trust Company of the West (TCW), as partner and managing director to lead the firm's new investment activity specialising in structured credit, mortgage-related securities and asset backed securities (ABS). Eckert clearly has big plans for this part of the business, smiling in agreement when asked if this group might represent 25 percent of GSC's capital under management in three years time: “that's a reasonable target.”
“When people try to tell me something that I know is not true I get really angry.”
Perhaps unsurprisingly too, when asked about hedge funds, Eckert reveals that GSC is going to be launching a hedge fund product also. “I like them, I want GSC to offer them and I do see them as competition,” he comments. “The beauty of hedge funds is that you can have a fairly broad investment mandate and you can raise funds pretty easily. But the problem is that when the world turns, then not everyone will be able to get through the door at the same time and that's going to be very ugly.” Focus is important and Eckert sees a logical fit for a hedge fund product alongside the group's distressed investing – being able to short a distressed stock is a classic hedge fund methodology of course – and it's no big leap to see the firm running a distressed arbitrage fund that exercises many of the same skills that GSC has developed in control distressed investing.
It is this latter business that arguably has helped define GSC's character, not least because it requires rigorous credit analysis. The ability to anatomise a company – in a good let alone a parlous condition – has relevance to all aspects of GSC's business. Says Eckert: “Our core competence is deep credit analysis of financial structures – whether it's to do with our control distressed investing or our CDO business or our European mezzanine lending – we're analysing the balance sheets of leveraged companies and looking how to best arbitrage the inefficiencies in the credit markets.”
It is also something close to Eckert's own heart: much of his 18-year career at Goldman Sachs (from 1973 to 1991 – and a partner from 1984) having been shaped by this art-cum-science. He founded Goldman's leveraged buyout department in 1983 and had senior management responsibility for it until 1991. Eckert was also chairman of the bank's commitments and credit committees from 1990 to 1991 and a member or co-chair of its investment committee from inception in 1986 until 1991. Being able to read a company's past, present and future – and the opportunities it presents – matters to Eckert a great deal.
GSC is currently investing its third distressed fund, closed in January 2002. It's a business that in Eckert's view can deliver compelling returns whilst not exposing investors to excessive risk or volatility – so long as the discipline is there. “It's effectively a mid-market buyout business where you are buying companies through the debt markets and the bankruptcy process rather than from the auctions run by the investment banks,” he says. And that means the prices are lower – Eckert has been monitoring what GSC pays and says that the firm is buying companies at two multiple points of EBITDA less than the average paid for such businesses. These lower prices mean that the acquired companies do not have to be so highly leveraged – and hence the risk of the firm crashing to earth when trading conditions get tougher is reduced. “Your five to one [gearing multiple] can get you in much greater trouble than my two to one.”
This is not to suggest that buying distressed companies is simply a case of finding diamonds in the rough. Eckert likes being able to pay low prices but is very much alive to what is given up: quality of information. Many of the target companies will seem opaque, with different agendas causing different – and, at times, conflicting – information to circulate around them. As a result GSC treads more carefully than a vanilla buyout operation when deploying capital. “With distressed investing you need to make more investments,” says Eckert. “Our rule being to invest no more than 10 percent [of the fund] whereas buyout guys can put up to 20 percent in a deal. You don't want to do that given the greater opacity of targets and the possibility that one in ten investments will have fraud. If you have only seven percent of the fund in such an investment then it won't compromise the fund.”
Although at present Eckert says the distressed market is relatively quiet, he can see the cycle bringing a new round of opportunities closer. “There's no question in my mind that the bonds that are being sold today to finance acquisitions are mispriced: they are not yielding enough and their credit statistics are terrible.” The GSC distressed team, headed by former Blackstone staffer Robert Hamwee, are therefore watching market trends closely, and Eckert seems confident that investors will increasingly tune into an investment story that many had until recently regarded as the domain of a few specialists.
Eckert himself declares that returns on distressed funds can be more stable than many buyout funds. According to Eckert, a successful control distress manager should deliver 20 percent net IRR and two times money. In comparison, investors with exposure to relatively recent buyout funds are going to be feeling the pinch. Continues Eckert: “1999 vintage buyout funds are going to lose money – full stop. And most 2000 vintage buyout funds will lose money also.”
Besides the fact that this chastening experience may encourage more investors to allocate to more specialist managers, there's the implication that more buyout funds are going to be wrestling with more troubled companies. In the US the key solution to many such problems is Chapter 11 and it is the absence of a coherent and stress-tested set of bankruptcy legislation like Chapter 11 in other parts of the world that has prevented GSC from participating in distressed opportunities elsewhere. Eckert is keeping a close eye on events in certain other markets though.
“We have looked at ways of how you could do something by going direct to a company and have them grant certain concessions – a kind of external Chapter 11 – but nothing has been done yet. But,” he adds, “It will be interesting to see what happens when some UK buyouts come unglued.” Clearly in Eckert's view it is a case not of if but when this happens – and whether the UK authorities then institute a system that enables a troubled company to be rebuilt, not just dismembered.
“Your five to one [gearing multiple] can get you in much greater trouble than my two to one.”
EUROPEAN MEZZ, CDOS AND MORE
The buyout industry in Europe already occupies a significant part of GSC's thinking of course. Its European mezzanine business is in the midst of raising its second fund, building on the first $1.1billion fund closed in July 2000. When asked how this part of GSC happened, Eckert evidences the pragmatic realism that continues to shape the entire business. “US mezzanine is highly cyclical and is also subject to adverse selection on account of the high yield market – meaning that mezzanine providers can be taking on equity style risk but for inferior returns. So when we were looking to expand in 1999 we studied Europe.”
Initially there was some thought about coming to Europe with an orthodox private equity fund but it soon became clear that not only was the buyout industry already pretty crowded but that a growing number of US LBO groups were heading over to Europe too. “Did I want to be the 150th mid-market buyout shop hitting town?” asks Eckert, “Does the world need this? I don't think so.”
Instead GSC looked at how they might provide sponsor groups in Europe with the finance that the high yield market in Europe wasn't. The aim was not to compete with the GPs (“we told sponsors that we wanted to be their partners”) and also not to rely on the equity upside – in the form of warrants – unlike some other mezzanine providers. The GSC-style of mezzanine return was going to be distinctly contractual. According to people acquainted with the firm, the composition of the first fund's returns have been around 40 percent in cash, another 40 percent in payment in kind [PIK] and less than 20 percent via warrants. The fund has delivered a net return of 15 percent having built a diversified portfolio of 30 credits.
Eckert agrees that the mezzanine market in Europe has become much more crowded compared to 2000 but that the increase in demand has more than offset this. “Sure there's been a bit of erosion in credit and you're seeing more competition in the big deals from the junk bond market, but there's a better supply and demand dynamic than there was two years ago.” Although refusing to be drawn on the details of the fund-raise, Eckert is confident the new mezzanine fund will have comparable firepower to the previous one (which, leveraged on a one-to-one basis, had over a billion dollars to deploy).
If assets under management though are a criterion when assessing GSC's core businesses, then the structured products operation dwarfs both the mezzanine and distressed groups: in five years it has grown to now manage $3.8 billion in seven funds.
This group manages leveraged debt arbitrage products that are designed to take advantage of the difference between the fund's investment grade cost of borrowing and the higher yielding returns available from the fund's underlying investments. GSC's CDO funds are structured primarily to invest in leveraged loans and highyield bonds issued by sub-investment grade companies.
“There's more grey hair than in some places: that's conscious and it's increasing.”
CDOs have garnered something of a mixed press on account of their sudden proliferation and the fact that a significant number of funds have sunk without trace. Eckert himself is alive to this view, recollecting that: “We did our first CDO in 2000 – a low grade bond CDO –and in that year some 30 CDOs were set up and there's only us and one or two others who haven't since blown up. Why? Because we used some smart structures, we didn't buy telecom paper and we were lucky.”
Unsurprisingly, the key value-add in the CDO investment process is granular credit analysis – plus the structural advantage of investing in securities that hold relatively senior positions in the capital structure of the issuing company. Eckert is also alive to how this part of the business can be grown: “Once the credit analysis techniques have been refined then it's very scalable. Putting $3 million into a deal rather than $1 million doesn't require any extra effort.”
It's clear too that there is considerable demand from investors all over the world for these types of products – the most recent fund saw two thirds of its capital come from investors based in Asia. And Eckert clearly likes to see GSC tap into such demand by offering a diversity of product. “We have grown: originally we offered just bond CDOs but then added bank loan CDOs and today we are effectively lending new money – although we are not a bank, and wouldn't want to be one.”
THE GSC FUND PORTFOLIO
|Total Control distressed debt [$1.4bn]|
|Fund name||Closing date||Size|
|GSC Recovery IIA L.P.||January 2002||$497.4 million*|
|GSC Recovery II L.P.||November 2000||$438.0 million*|
|GSCP Recovery, Inc.||July 1998||$472.8 million*|
|Total Private equity [$1.1bn]|
|Fund name||Closing date||Size|
|Greenwich Street Capital Partners II L.P.||July 1998||$874.5 million (excluding GSCP|
|Greenwich Street Capital Partners L.P.||November 1994||Recovery, Inc.) $227.7 million|
|Total Structured finance [$3.8bn]|
|Fund name||Closing date||Size|
|GSC European CDO II, S.A.||Warehousing||$156.9 million|
|GSC Partners CDO Fund IV, Ltd.||December 2003||$431.4 million|
|GSC European CDO I, S.A.||July 2003||$449.7 million|
|GSC Partners Gemini Fund, Ltd.||August 2002||$631.6 million|
|GSC Partners CDO Fund III, Ltd.||December 2001||$581.1 million|
|GSC Partners CDO Fund II, Ltd.||March 2001||$621.9 million|
|GSC Partners CDO Fund, Ltd.||April 2000||$510.3 million|
|Total European mezzanine [$1.1bn]|
|Fund name||Closing date||Size|
|GSC European Mezzanine Fund L.P.||July 2000||$1.1 billion*|