Coming out of lock-down and avoiding FOMO
As Spring turned to Summer and we complete 100 days since lockdown began, I reflected on the fact that across the world humanity had been hibernating for an entire season. This was most apparent from a socially distanced walk along a high street where mannequins proudly showed warm weather outfits that no one could try-on or buy.
We are all now on day release or probation, with greater freedoms but certain responsibilities. Every step we take outside our homes must be carefully considered with PPE and the welfare of others front of mind. Our transport system is returning from its “seasonal” or Sunday service; our retailers - both essential and non-essential - are welcoming us back; and we can once again seek out leisure and hospitality.
For investors, we are told that now is our time! Not a day goes by without some reference to the super returns that fearless investment firms generated in the eye of the last great storm (the GFC).
However, we need to sound a note of caution. This crisis has reduced the entry price for a range of distressed businesses across travel, casual dining, retail, leisure, aerospace and automotive... but there is good reason for this. The “entry ticket” is likely to be just the start of the operational and financial support these businesses will need. With liquidity for stressed businesses scarce, new owners will be called upon to fund from day 1 through to a sustained recovery. If it’s “V-shaped” recovery for the business, then it could prove to be a great value investment… but if it’s a “U” or “W” shaped recovery then this will prove very costly.
The early onslaught of special situations investment “opportunities” were almost entirely in structurally challenged sectors where market forces have markedly undermined the business model:
- High Street and shopping centre retailers have been impacted by rates, rent, living wage and the trend to online delivery models
- Restaurants saw a Private Equity and LevFin-fuelled land-grab through the noughties and now in recent years the market saturation has driven countless restructurings, CVAs and pre-packs
- Automotive continues to grapple with the emissions scandal, decline of diesel, rise of electric vehicles, changes in ownership models
However, there are many other businesses now seeking a financial rescue that do have high “bounce-back” potential. Their viability may have been challenged by the pandemic but a lack of readiness is entirely forgivable as few (if any) could have foreseen or prepared for this particular rainy day. There are numerous businesses offering a service or product for which demand collapsed in Q2 as they were “non-essential” during the crisis. Even if management made extensive use of labour cost support, tax deferrals, financing support, rent relief and broader cost mitigation strategies, many companies will have a major job on their hands to build-back their working capital. Easing out of lock-down means companies will also likely only “build-back” to full operation over time (which brings its own challenges). I am extremely hopeful that this class of investment opportunity will be well placed to source new equity and debt funding across private equity, banks and funds. It’s been really uplifting to see recent high profile examples such as Clayton Dubilier & Rice’s investment in SIG and Towerbrook’s investment in CarTrawler
On a personal note, whilst it’s summer time (and the living is easy)… typically there’s a lull in corporate activity with M&A on pause for the holiday season. This year I can truly say I have never felt as energised after three months of lock-down. I feel that the months ahead will undoubtedly bring many compelling opportunities and for Aurelius (as for many of our peers) it will be a time to deploy capital and invest widely. If nothing else, the Fear Of Missing Out will keep us hard at work! We must stay open-minded and be keen to learn – and, above all, remember that we are privileged to have “risk capital” to deploy in possibly the most unpredictable market backdrop seen in a generation.