Two investment strategies in Europe

The seller is usually willing to dispose of the company for a nominal price of equity whilst?transferring cash and asset rich company, creating “net negative price deals”. The logic is that continuing losses, unpopular restructuring losses and drag on top management time can be averted by selling distressed subsidiaries to turnaround investors.

?Turnaround investors have well understood this situation and have exploited the opportunity that it creates with two different business models: option value investing and industrial value investing.

?The former do as many deals as they can, accepting in essence whatever price the seller is willing to dispose of the company at and hope for the best. The latter will be very active post acquisition in driving operational changes to increase the likelihood of success.

?The strategy of option turnaround investor is very profitable and has proven to entail limited risks. High management fees without real contribution and the occasional lucky outcome have made more than one investor rich. In all practicality as long as the investors stay away from any operating decisions and protect themselves behind a long cascade of holding companies they are in effect out of reach.

?This strategy results in high profits for a low risk, it is also generating network effects that perpetuate their apparent success. These investors are sure business partners: you can rely on them to close the acquisition, you can count on them not to ask too many embarrassing questions in the due diligence process, you can count on them to believe hockey stick projections. Therefore they are very attractive to sellers, bankers, administrators, lawyers and most stakeholders in the little world of bankruptcy.

?As much as the option turnaround investor’s business model is profitable, his performance in turning around companies is dismally low, and when companies do get turned around it has nothing to do with the investor.

?On the contrary, the industrial turnaround investor will do much fewer deals, will be much more selective in picking its target, will very often act as the legal representative of the company and drive operational improvements from the inside.

?Although his success rate will be much higher, and his contribution to the turnaround (as opposed to luck) is equally higher, he will be seen as a more difficult business partner by the ecosystem of turnaround actors because he says no very often, and ask a lot of questions.

?The consequence of a failed turnaround can be much more daunting. He has invested a lot of time, will usually have to fend off legal actions by the liquidator (civil), or the District Attorney (penal), and may end up paying part of the cost of liquidation.

In short, it may be profitable but it is a much more difficult road to take.

How is it then that these investors manage to operate at a profit in an environment designed to deter their success? When industrial turnaround entrepreneurs struggle to find good opportunities when the system should really wish for their success?

Thomas Kermorgant