Alfred C. (“Fred”) Eckert III was Chairman and CEO of GSC Partners, a private investment fund with $4.5 billion under management. Eckert was a former partner of Goldman, Sachs & Co. who had once run its LBO activities and later 6 Ibid 5 headed a distressed securities investment fund that Goldman Sachs had organized, but later discontinued after corporate clients began to complain of competition and aggressive treatment from Eckert’s team. Afterwards Eckert remained involved with distressed investments and formed GSC Partners in 1994. GSC began buying up Regal’s subordinated debentures in the market in the 2nd Quarter of 2000 and over the course of the following twelve months, buying $180 million of subordinated debt at an average price in the 20’s. GSC also began buying bank debt in the first quarter of 2001, accumulating roughly $50 million of senior debt in the low 70’s. In total, Eckert acquired a stake valued at approximately $175 million. Eckert believed that KKR and Hicks Muse would do one of three things given the situation at Regal: 1. Pay the next coupons on the sub-debt that were due in December 2000 an amount of about $40 million, try to renegotiate the bank debt and buy themselves another six months until the next coupon became due, and hope for a turnaround in the business in the meantime. But if the business didn’t turn around, KKR and Hicks Muse would be in the same predicament again. 2. Walk away, write off the combined $1 billion investment, and let the company enter bankruptcy. This of course assumed that in bankruptcy the existing equity in Regal would be worth nothing and the GSC subordinated debt would be converted to new equity. In this case, GSC would have to implement a plan to pay off the senior debtholders and restructure the company. 3. Buy the debentures. This would cushion the bankruptcy because KKR and Hicks Muse would then own the both equity and the subordinated debt in the bankruptcy, giving them more of a say in the bankruptcy process. Question:What do you think KKR and Hicks Muse will do? What sort of investment strategy might Eckert have? What return is he aiming to make and what sort of downside exposure does his fund have?
The Correct Answer and Explanation is :
Correct Answer:
Eckert likely believes that KKR and Hicks Muse will choose to buy the subordinated debt. This is the most strategic and favorable option for them, as it would give them leverage in the bankruptcy process. By owning both the equity and subordinated debt, they would have more control over the restructuring of Regal. This would maximize the chances of protecting their investment and potentially extracting value from the distressed company.
Eckert’s investment strategy is rooted in distressed asset acquisition. By buying Regal’s subordinated debentures at a low price (in the 20’s) and senior debt at a discounted rate (in the 70’s), he aims to profit from the company’s eventual restructuring or bankruptcy proceedings. His strategy indicates an expectation that the company will face financial difficulties but may eventually recover through a structured debt-to-equity conversion. If Regal goes bankrupt, Eckert’s subordinated debt could be converted into equity, offering a chance for significant upside once the company is restructured.
Eckert’s target return would be substantial, given the steep discounts at which he acquired Regal’s debt. The goal is likely a return of several multiples of the original investment, as the restructured company (post-bankruptcy) might be valued higher, especially if the senior debtholders are paid off or negotiated down. Given the risk, he would expect a return of 2-3x or higher, depending on the restructuring outcome and the management of the bankruptcy process.
In terms of downside exposure, Eckert’s fund faces significant risk if the business does not turn around or the restructuring fails. If Regal’s bankruptcy is poorly managed, his investments in subordinated and senior debt could end up being worth much less or nothing at all, depending on the final distribution of assets in the bankruptcy proceedings.
Explanation:
Eckert is making an investment in distressed assets, focusing on the possibility of debt-to-equity conversion and restructuring through bankruptcy. The three options listed by KKR and Hicks Muse each outline different approaches, with the third option (buying the debentures) being the most strategic for gaining control over Regal’s financial and operational restructuring. By accumulating significant positions in Regal’s subordinated and senior debt, Eckert is positioning himself for substantial potential upside if the company is successfully restructured.
The investment strategy of GSC Partners centers around acquiring distressed debt at significant discounts. The value proposition lies in the expectation that Regal will need restructuring, with GSC potentially converting its debt into equity, allowing them to benefit from any post-reorganization recovery. This approach also provides GSC with leverage over Regal’s bankruptcy process, ensuring that they can have a say in how the company is restructured.
Eckert’s return aims to be high, considering the low price at which he acquired Regal’s subordinated and senior debt. However, this comes with substantial risk. If the bankruptcy proceeds unfavorably or Regal does not recover, the investments could be wiped out. The downside exposure for GSC Partners would be the total loss of their $175 million investment if the restructuring fails to deliver value, making it a high-risk, high-reward strategy.