The Bankruptcy King Is Back BOTTOM FISHING IN A TOP-DRAWER MARKET
(FORTUNE Magazine) – With the market on a seemingly unstoppable joy ride, those dark days in the early '90s when junk--oops, high-yield--bonds were going bad and companies were going bankrupt seem far, far away. Clearly, only a true contrarian could be looking for trouble in these prosperous times. Enter the contrarian: Wall Street's bankruptcy king, Wilbur Ross, senior managing director of Rothschild Inc. Not only is Ross looking for trouble, he's predicting it--enough of it to earn him 30% annually from distressed securities. And more than a few sophisticated institutional investors agree with his view; they recently handed over $200 million to Ross' new Rothschild Recovery fund for just that purpose.
The Recovery fund is the newest venture for the 60-year-old, who's been an investment banker since the 1970s. Though Wilbur looks more cherubic than ferocious, his reputation is formidable. He has earned Rothschild--and himself--millions in annual fees by restructuring ailing companies and helping stock and bond holders salvage scraps of their investments. Ross has been involved in some of the ugliest bankruptcy cases ever, including such infamous disasters as Trump Taj Mahal and Drexel Burnham Lambert. And he's taken on some of the more famous (and fearsome) financiers, like T. Boone Pickens and Carl Icahn.
Now that he has money to play with again, he's bottom fishing in an obvious spot: Asia. Up to one-third of his fund can be invested overseas; happily, right when Asia began imploding, money began pouring in from investors. "It came so easily even we almost got frightened," says Ross. On Dec. 23, for example, he bought Korean Development Bank bonds. Pre-turmoil, the bonds yielded just a slight premium to U.S. Treasuries; at the time Ross stepped in, the bonds had plunged in price and were yielding a fat 20%. On Dec. 24, the IMF and others speeded up the release of $10 billion in aid to South Korea, and the bonds soared. "The key is to buy in the middle of a crisis," Ross says. Now he's buying in Hong Kong and traveling to Asia to sniff around elsewhere.
But Ross isn't relying on Asia alone to produce those 30% returns. He thinks he'll find plenty of opportunity right here at home. Ross believes his future bargains are being created by Wall Street's high-yield bonds and leveraged buyout funds. His logic: The major causes of that earlier wave of bankruptcies in the '90s--over-aggressive leveraged buyouts and overly risky high-yield bonds--are building. Once that market crashes again, Ross says gleefully, "the only one who will buy [the distressed securities] is someone like us."
There's no question that the U.S. market has plenty of both high-yield bonds and LBOs. Since 1991 the volume of high-yield bond issues has risen more than 13-fold, to over $110 billion in 1997, according to Securities Data. And the risk level is rising. In the midst of the early '90s tidal wave of defaults, less than half the securities issued then were rated "B" or below. Now over 70% of new issues fall into that category.
And there's no shortage of supply on the horizon. In 1997 alone, enough LBO capital was raised to support some $140 billion of deals. "There's enough money sloshing around to support four back-to-back record years of LBO activity," says Ross. He notes that all those hungry buyers are pushing up prices, almost back to the highs of 1988 and 1989--a time when everyone agrees pricing was insane.
Are there any reasons to think that Ross is right--that the default rate on high-yield bonds, now under 2%, will soar once again? Well, even in this almost perfect economy, bankruptcies are happening: In 1996 the number of companies with less than $1 billion in assets declaring bankruptcy hit an all-time record. Is it mere coincidence that most of them had less than $250 million in assets, which Ross notes has been the average size of '90s-style LBOs? These tiny tragedies don't make headlines, but there have been a few more sizable crashes too. Consider Bruno's, a Kohlberg Kravis Roberts-led LBO that collapsed into bankruptcy over the first weekend in February. Some $400 million in bonds--not exactly a negligible amount--lost over 50% of their value between the markets' close on Friday and the open on Monday. (Ross hasn't pounced on them yet--he thinks the bonds will fall still further.)
Obviously the market doesn't agree with Ross--Wall Street is continuing to sell massive amounts of high-yield bonds at not-so-high yields, and investors are pouring money into high-yield bond funds. Beyond Ross, few are raising much capital to invest in distressed securities. Then again, no one saw it coming the last time either.