M&A Alerts, February 11, 2011

This week we had the pleasure of interviewing Tom Hayes, Founding Principal of NHB Advisors. NHB is one of the most experienced, if not the longest standing, advisory firms in the middle market.

Along with the firm’s advisory services, the company has formed affiliate NHB Capital Partners, LP, sourcing investment capital to be deployed in challenging situations throughout North America’s middle market. NHBCP’s institutional limited partners target investments between $10M and $30M with an average holding period of 3-5 years.

During his tenure at NHB, Hayes has served as CEO and Chairman or Advisor to the Board to both private and public companies. Hays began his career in 1969 as a CPA with Arthur Andersen and advanced to 3M and Conrail. He has also served as Chairman of the Turnaround Management Association. In addition, Hayes has been Chairman of the Association of Certified Turnaround Professionals and served on its Standards Committee for several years. He was an early supporter of professionalism for turnaround managers and holds the distinction of becoming one of the first Certified Turnaround Professionals (CTP) in the country.

M.A.: What should PE firms consider to best manage their remaining capital before their commitment periods expire in order to diversify their holdings of distressed investments?

T.H.: It mostly depends on the remaining capital, timing and degree of distress. Generally, an assessment of turnaround opportunities of distressed investments should be made to determine a course of action--that is, whether sell to immediately, liquidate to eliminate risks, hold on and hope for better conditions or actively engage in a turnaround that will either make the investment more attractive for a near-term sale or actually turn it around. Keep some “powder dry.” I have seen a couple of situations where a fund was literally tapped out, and it would have only taken a few hundred thousand dollars to have saved an investment.

M.A.: You have warned of a looming capital crunch, especially for marginal or underperforming portfolio companies. What should PE firms do if their portfolio companies are caught in the crunch?

T.H.: PE firms need to understand the needs of their individual portfolio companies and address those needs through refinancing, sale or operational improvement, and by extending maturities wherever possible.

M.A.: What are some steps PE firms can take to manage distressed investments that are not generating value?

T.H.: If there is time, assess whether the business can and should be fixed. If it can be fixed, at what cost? Analyze the probability of a successful outcome and expected valuation.

M.A.: What should PE firms with distressed investments be looking for in terms of capital sources?

T.H.: Funds looking at distressed investing should probably not be looking for longer term financing other than on the investment company level. Value creation in distressed investing comes from moving an investment from liquidation value to discounted cash flow. That can be done in a relatively short time. There are substantial risks in attempting to move a distressed purchase all the way to a strategic valuation. The mind-set and company culture must shift dramatically, and at least in my experience, that has been difficult to do.

M.A.: Do you think LPs will have to pare down the number of PE sponsor relationships they have going forward? How will this impact distressed investments?

T.H.: I think LPs will look carefully at the next fund series put out by a PE group. Distressed investing is tough business. Those that did well in their existing fund will be oversubscribed for their follow- up fund. There will be many PE groups that will not be able to generate the interest for follow-up on funds due to their performance.

M.A.: In 2011, do you think debt markets will remain strong through traditional bank and high-yield refinancing as well as amend-and-extends and exchange offers?

T.H.: Things should remain strong for a while. Down the road, I see a credit crunch caused by ongoing trade and government deficits exacerbated by the huge number of refinancings coming up in the next few years. The tight credit markets will force interest rates dramatically higher and cause huge problems for the currently large number of “walking wounded.” Thus, I would act aggressively to refinance long term or sell portfolio companies now while there is opportunity.

M.A.: Will we continue to see a climb in the issuance of high-yield bonds for refinancing? Should these be considered junk bonds?

T.H.: Probably for the near term as investors wish to gain current yield, but not for the long term with the anticipated credit crunch, where safety will be an issue.

M.A.: You point out that successful funds are increasingly concentrated in larger and larger pools of capital, with a shrinking pool of smaller funds in the middle market. What can middle market PE firms do to ensure they make it to fund II or III?

T.H.: Produce good returns for your LPs and treat them like future customers because they are.

M.A.: Thanks, Tom!