Distressed debt investing in Europe has continued to evolve and deals regularly top the billion dollar mark. What does it take to pull off a mega-deal and what else is in store in 2014?
The unassuming façade of the period building at , belies the global reach of its occupant. The 3,300 sq ft office is the London headquarters of Lone Star Europe.
It is from this base that the private equity firm, which has $45bn (£27bn) of funds under management, has engineered some of the largest European distressed-debt deals of the cycle.
Most recently, the Dallas-headquartered firm scooped the majority of €7bn (£5.2bn) of IBRC loans, paying £3.5bn for the entire two-tranche Project Salt and 12 of the 14 tranches in Project Rock.
Far from being a stranger to winning debt auctions, Lone Star’s European team, led by Angus Dodd, has also bought Nama’s €373m Project Holly ?for around €220m, and taken more of ?the IBRC’s loans, investing a total of €13bn into debt this year alone.
However, Rock and Salt were Lone Star’s largest deal to date and will see the firm and special servicer Hudson take control of loans related to nearly 300 borrower groups backed by more than 15,000 assets in the UK, Germany and the US.
Putting together a bid for these portfolios is a massive undertaking in itself – and not a cheap one. David Edmonds, a partner in restructuring services at Deloitte, says that a single deal can cost up to £10m in due diligence. And any one point can involve up to 250 people in the field, including internal staff, external real estate advisers, valuers and lawyers.
As John Knowles, national investment team partner at Colliers International, puts it: “Private equity firms have developed a slick process to deal with a blizzard of debt deals. You need the ability to co-ordinate a multidisciplinary team of advisers to deal with each new Pandora’s box of assets.”
It is not just the number of people you have working on a deal, but also when they start that can make the difference. One source says Lone Star did six months’ pre-emptive work before the IBRC sales process began. By taking an educated guess at which of the former Anglo Irish-backed assets were likely to be included in the sale, it had seen many of them before the sale went live.
Lambert Smith Hampton chief executive Ezra Nahome, who has advised Cerberus in the past, says Lone Star is not unique in employing this method. When data rooms open and the best information supplied to bidders is just two sides of A4 for each asset, any extra information you can supply or extra time you spend working on a deal is crucial.
He says: “The more information you have, the better position you will be in – not to bid less, but to bid value.”
Global experience is another key to success, according to Edmonds. He says: “If you look at who has been successful in buying, it is the firms that have already bought in Asia and the US. It is often the same individual within the fund from Japan or Korea who is now based in Mayfair – they have seen the movie before.”
However, there is a distinction to be drawn between two types of bidders.
Edmonds explains: “You have the likes of Lone Star, Cerberus, Apollo and Fortress, which are very large with ?multi-strategy investment funds with billions to spend. These very large funds tend to have big in-house teams of investment professionals and a captive servicing platform, so they can exert leverage in the diligence review process.”
He says the second tier of buyers are those with around £1bn-£2bn in AUM.
“They have a sharper focus and are more asset-specific. They are selective about what they participate in because they may not have the capacity to look at a deal in the same way as the big players do,” he says.
One such buyer is Patron Capital. The private equity firm led by Keith Breslauer has teamed up with RBS and TPG to complete distressed-debt deals as diverse as UK hotels and Dutch sheds.
Breslauer explains that Patron has a very granular approach. “We are the guys who know the assets. Some guys buy the portfolio, some guys buy the loans, but we buy the properties,” he says.
The market for both of these types of players has a long way to run, according to specialists such as Cushman & Wakefield EMEA corporate finance partner Federico Montero. His firm estimates that the European commercial real estate loan sales market is going to hit €50bn this year – up from €30bn in 2013. In the year to date, a staggering €29.8bn has been transacted – just short of last year’s total (see box).
While the IBRC has exhausted most of its pipeline, other so-called bad banks will step in, with the trend towards large books here to stay. Following its largest deal to date, the £4.5bn Project Eagle won by Cerberus, Nama is expected to launch a handful of follow-up “mega-deals” this year, while RBS and Ulster Bank will also gain traction. On the continent, Spain and Germany are to a certain extent dominating the market, but Montero also name-checks Poland, Portugal, Italy and the Netherlands (see box).
Montero says: “The next market everyone is talking about is Italy. Investors are already flying to Rome and Milan, but the question is really, is there supply? Are the banks going to do something?”
Unlike Spain and Holland, there is no state bad bank set up in Italy and, as one source says, the Italian domestic lenders so far have only declared small non-core books “because to take the hits you have to make profit”.
The other continuing evolution in the market this year will be churn from portfolios that the bigger players are digesting.
Montero says: “The mega-deals are great for the market because the winning bidder is effectively buying a superstore. Once they have taken control and decided what they want to keep, they then open the doors to other investors and let them come in and pick what they want to buy.”
A quick exit is a strategy Breslauer promotes for bulk-buyers because he believes a lack of underlying economic growth outweighs the debt markets opening up and a surge of liquidity pushing up values.
“The big guys are playing the beta. Some of them think that Europe will ?be a repeat of the US in the 1980s, where there was a strong rebound in growth, but I think they are kidding themselves,” he says. “The smart guys will sell quickly and generate a quick return for investors, but the less smart guys will hold stock and think that they can fix everything and make money because the market will improve.”
The churn of stock from at least some parties and continued deleveraging by banks – boosted by ECB stress tests – will provide plenty of activity for the Lone Stars of the world as the European NPL market continues to evolve.
bridget.o’connell@estatesgazette.com
