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September 14, 2007

Distressed, But Not Stressed -

Marc Raybin
September 14, 2007

Earlier this week, distressed investor Angelo, Gordon & Co. announced it had started raising two new funds targeting a total of $900 million. The New York-based private equity firm could be on to something as the credit market continues to fall. Investors should not be surprised to see more announcements of distressed funds being raised. The time is right for bargain hunting.

"It is always a good time for distressed investing as far as I am concerned," says Gregory Segall, a managing partner with Chrysalis Capital Partners, a private equity firm in Philadelphia that focuses on the distressed market. "There are always distressed companies."

Segall says the environment has changed. Up until about a month ago pretty much anyone with a business plan on a napkin was able to get financing from a lender. Today, things are different. Companies are going to have to work a little harder to prove themselves these days.

Although the credit crunch itself does not seem to be targeting a specific sector as lending was overly generous across the board, the nature of the business cycle does work against a few types of businesses. Daniel Collin, a founding partner for distressed investor Monomoy Partners, has noticed companies in basic manufacturing, auto and consumer retail are those hit the hardest by the increasing scarcity of credit.

"Where we are seeing opportunities is that businesses that historically could buy their way out of trouble, cannot anymore," says Collin. "They are forced to restructure, which takes capital not just in the form of changing the balance sheet, but also expertise to take the prior cost structure and operations and make it better."

While there could be some short term relief as it relates to what the Federal Reserve Bank does with interest rates, the bottom line is that similar to the subprime market, which is credited of course with triggering the current state of the credit market across the entire economy, a lot of businesses that should not have been lent money were in the last three to four years. In order to survive, these companies are going to need to refinance their loans or seek some sort of relief from their lenders. Collin predicts the pullback in the credit market could last for as much as the next 24 months.

"We believe we are in a position to take advantage of the market opportunity," says Collin. "Firms that survive will be those that can add to the operations of the [portfolio] companies, and not just capitalize on the market sentiment."

A recent Monomoy deal involved the acquisition of Transeo, a provider of integrated vehicle solutions to the armored vehicle industry. The company designs, engineers and manufactures armored trucks and similar vehicles for the transportation of cash. Although specifics about the deal were not made public, Monomoy typically makes control investments in companies that require operational or financial restructuring, acquiring these businesses through bankruptcy, out-of-court restructurings, corporate divestitures and other types of complex deals.

Not surprisingly, Collin says Monomoy has seen deal flow steadily pick up as the credit markets become more volatile. Transeo, which will operate in partnership with Western Recreational Vehicles, also a Monomoy portfolio company, and represents the firm's 10th transaction in the last 20 months in the smaller end of the middle market. He calls the current state of the market the "tip of the iceberg."

Bringing some pragmatic thought to the situation, Segall points out that after the credit market popped on about Aug. 12, it was not as though businesses filed for bankruptcy protection on Aug. 13. He says the market is just starting to "unwind" right now and investors should expect to watch the air gradually come out of the balloon. Perhaps the sound in the credit market that we are hearing is a fizzle more than it is a pop.

As the basic study of economics tells us, the investment cycle is a zero sum gain. Meaning for every positive transaction, there is a negative and vice versa. When someone is earning money, that means someone else is losing. When the market is down, as credit environment seems to be headed, someone, somewhere is making money off of it. At some point, the cycle will start over again, with the credit markets loosening up. However, in the meantime, do not be surprised to hear a lot more about distressed investors making a bundle in the next few years.

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