2 June 2009
by Michael G. Clark, Principal
From the time we sent An Awakening out in January until now, the government has taken unprecedented steps towards the goal of stabilizing the U.S. economy. This herculean effort/spending binge has been met with an overall increase in confidence by the marketplace that can mainly be attributed to the diminished fear of the Great Depression 2.0. However, America’s rebound in confidence and the rise of the stock market should not be a bellwether of an imminent return to economic sanctity.
Talks of “green shoots” have dominated the press, but let us not confuse a lack of bad news with growth, or an increase in confidence with progress. Jeffrey Rosenberg of Bank of America states in the Financial Times on May 20, 2009, “The price for that near-term stability is long-term below-trend growth and above-historic-norm unemployment – The Great Recession.” To Mr. Rosenberg’s point, there is a price for stability and the bill has yet to come. So much of the conversation has been about short-term stability that we have failed to properly address an equally important aspect – long-term growth. We are in dire need of real economic growth and nobody seems to know from where it will come.
In the past we had the industrial revolution and more recently the computer revolution. What is our next revolution? Without a strong growth catalyst, stagnation is a likely and highly undesirable consequence. The good news is that the U.S. has a long history of proving its uncanny ability to compete, create and innovate.
An important concept crystallized in my head six months ago – distressed investing, all the rage in today’s economy, has so many meanings and styles that the phrase on its own has little meaning. Is it macro, micro, growth or what we call value-add repositioning? Earlier this year, Meridian began a partnership with a firm called GPO Capital. The premise behind GPO is to provide assistance, executive leadership and capital to emerging private equity managers dedicated to repositioning the distressed sectors of the United States.
Bruce MacFarlane, a founding partner of GPO and our Chairman, has stressed that the key differentiator for GPO is its focus on partnering with firms that create value and solve problems versus those simply focused on trading distressed assets. The model calls for actively working the investment, solving problems and building sustainable and valuable assets. His definition of distressed investing struck me profoundly.
Every firm that is in acquisition mode is capitalizing on distress, but few firms have talked about how they intend to create value. The “D” word has been so perverted in the past twelve months that it is used interchangeably to describe everything from people buying homes at auction, to investors buying blue chip stocks at historical lows, to people getting great deals on hotels and handbags. In a reversal of sentiment from the past decade, getting things on the cheap seems to be in vogue. “Distress” is now trendy.
The problem is that this trend will not lead to growth. There is a difference between generic distressed investing and the value-add style of investing that Meridian and GPO advocate. Both start with an acquisition at distressed pricing, but value-add investing creates further value over price arbitrage. Many investors look to buy assets at prices that they deem to be below-market and wait until the markets improve to sell at a profit. This is simply a trading strategy – and other than creating some liquidity for a troubled seller who in turn can utilize that capital – there is little value creation in that strategy.
Additionally, a typical distressed investor is solely at the mercy of the macro environment and hopes that the price he/she paid is less than what prices are in the future. “Distressed repositioning,” or value-add investing, combines distressed investing with expertise and hard work to fundamentally transform the investment on a micro level. It would be the difference between buying the bonds of a company at a discount and selling them a year later when the bond market improves, versus buying the bonds, obtaining control of the company at a discount, overhauling management, re-envisioning the product line, honing the value proposition of the company, increasing profit margins and building a sustainable company that produces economic goods demanded by the marketplace.
In distressed investing, you control one variable, entry price, and you are hoping for an overall improvement in the macroeconomic environment. In the distressed repositioning style of investing you control many variables on a micro level, and are not solely dependent on a macroeconomic turnaround. If the macro environment improves it is a bonus. In fact, if enough buyers incorporated the distressed repositioning style of investing, the results would directly drive a turnaround in the macroeconomic environment.
The largest “distressed investor” today is the U.S. government. The problem is that the government is notoriously terrible at repositioning and building out their investments. Injecting capital into banks, saving companies from bankruptcy and bailing out the consumer may be a necessary antecedent for growth, but it will not be the generator. Typically we tend to think of repositioning in reference to companies, delinquent debt or real estate. This time it is our country that needs restructuring and repositioning.
We may have taken steps to stabilize the U.S. for the time being, but we now need to reposition it for growth. Howard Marks, founder of Oaktree Capital, is known for his intelligent views on the world. In one of his widely praised memos, he claims, “Of the two things I think are most wrong about American business, the worst is short-termism. Companies are rewarded for short-term success and penalized for short term failure, whereas few people ask about the long term.” I think he would agree that our country’s success will depend on our ability to blend the demands of short term stabilization of the economy with the creation of economic engines of long term growth. Now is the time to build the engines.
Michael G. Clark is a Managing Director at Meridian Development Partners, a real estate private equity firm in New York focused on repositioning corporate real estate assets. He is an adjunct professor at Columbia University’s Masters of Real Estate Program where he teaches Development Case Studies, Private Equity and Real Estate Development. He can be reached via email at michaelc@meridiandp.com.
