Friday, November 20, 2015

Off the rails can connote chaos or may denote a business opportunity. In the 1880’s, a train carrying furniture manufactured in Western Michigan derailed near High Point, NC. Local woodworkers were gathered to repair the broken furniture. The effort to reassemble the pieces became a cram course in reengineering. The workers realized that their new found knowledge could be put to work amidst the large supply of nearby hardwood trees and the recently opened rail line supplying transport to distant markets. Within ten years, seven furniture factories had opened in NC and by the 1980’s, half the furniture purchased in the U.S. was made in that state.

Private equity is replete with similar stories of train wrecks becoming the basis of a profitable enterprise. In the mid 1980’s, Canaan Ventures was formed by several GE employees purchasing the portfolio they built at GE, at a large discount to GE’s cost. GE provided part of the financing for Canaan’s purchase. Years later, the pension manager for American Express purchased Amex’s private equity holdings at a discount to Amex’s value to form Venture Investment Associates. In the early nineties Apollo, led by Leon Black, purchased junk bonds at deep discounts from Executive Life, which had purchased the bonds from Drexel Burnham, where Leon Black sold bonds to Executive Life and other clients a few years earlier. Mid Ocean Partners was formed at the turn of the century when the internal Deutsche Bank PE team purchased the portfolio they built at DB, again at a sizeable discount. Each of these firms required creating an ersatz version of the original buyer’s platform, with a new corporate name, (except Apollo) and generated a great investment performance simply by recovering original cost basis - a reassembling of the financial furniture not unlike the craftsmen in NC.

The inverse of the above process is now taking place in US Bankruptcy court as Judge Gerber permits creditors to pursue a “claw back” case versus selling shareholders in the 2007 sale via LBO of Lyondell Chemical. The buyer in 2007, Leonard Blavatnik, used significant leverage in his purchase which proved unmanageable a few years later when profits fell, leading to bankruptcy. Remarkably, the Judge is letting the argument continue that the creditors may pursue a claim against the shareholders that sold to Blavatnik, even though the company has long exited bankruptcy. Creditors are trying to dissemble the “Safe Harbor” provision of bankruptcy code, suing over pre-bankruptcy deals. This is analogous to you selling your home to a buyer who borrows 90% of the purchase price from a bank, loses his job two years later and defaults on the mortgage resulting in the bank pursuing you, the seller, for this mortgage loss.

I’m Rob Morris and I approved this blog.

Off the Rails