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A $21 billion hedge fund predicting a wave of bankruptcies breaks down its playbook for distressed investing

  • Canyon Partners focuses on strategies like distressed loans, event-driven equities, and arbitrage.
  • The hedge fund is eyeing opportunities in stressed companies, new loans, and the consumer staple market. 
  • Canyon has also seen more leveraged buyouts of building product companies. 

Rising interest rates and weakening demand are making it more expensive for companies to finance their businesses, giving hedge funds like Canyon Partners more opportunities to find distressed deals.

Canyon Partners — which focuses on strategies like distressed loans, event-driven equities, and arbitrage — is currently timing when the next wave of bankruptcies and restructurings will occur. That depends largely on how long the Federal Reserve keeps raising interest rates to rein in inflation. Indeed,  Fed chair Jerome Powell said last week that the path to quell inflation will result in some pain for US households and will not be quick nor easy,  CNBC reported

The Dallas-based hedge fund is waiting to see the effects of demand destruction –  when the price of a product remains higher than historical norms for a longer period of time, hurting the demand for that product. That could determine when defaults will start to pick up, Todd Lemkin, chief investment officer for Canyon Partners, told Insider. 

“Across the board, we anticipate companies will experience some slowdown given the macro environment we’re in,” he said. “It’s not geographically specific and spans sectors from industrial companies to consumer companies, gaming companies to companies making truck parts to plastic bottles, just to name a few.”

Lemkin highlighted the asset classes and sectors in particular that Canyon Partners is eyeing as they prepare for a rush in bankruptcies and defaults, particularly stressed companies, new issues, and consumer staples.  

“There’s a multitude of strategies at different parts of the capital structure that one could theoretically focus on if there’s a perception of bankruptcy coming,” he said. 

The firm declined to share information on the amount of money they expect to see within the bankruptcy and credit markets. They also declined to share the amount of money flowing into their strategies. 

Investing in companies that others avoid

Canyon Partners is considering more stressed companies in this environment, since the firm is known to look for companies that other investors might run from entirely.

“As an example, there are companies that ironically have a ton of demand for their products, but are hindered
by gigantic costs and difficulty sourcing the inputs to make those products,” he said. “This creates a conundrum where in some respects, a slowdown in demand might actually be welcome, because it takes strain off of their sourcing and production challenges. This is exactly the kind of opportunity set we look for.” 

The firm is also looking into the new issue or the primary market, which includes new loans coming to the market, either to refinance existing debt or to do something new, such as a private leveraged buyout transaction.

“Another form of that would be the structured products market where you have serial issuers of securitizations that clear their balance sheets every month regardless of whether we’re in a global recession or the best of times,” Lemkin said. “There are some great opportunities there as they become forced issuers in the current environment.”

For example, Carvana, the online used-car dealer, clears its stack of all the loans it wrote the month before. 

Consumer staples are a target

Lemkin also sees opportunities in sectors like the consumer staple-oriented businesses, like a company that is creating labels for food and product packaging, since they don’t fluctuate much during market volatility. 

“While high raw material input costs can be challenging for a company, they can make up for increased expenses with contractual, 30-day pricing pass-throughs,” Lemkin said. “Furthermore, slower demand can create relief for their business through improvements in supply and logistics chain pressure and freight costs, and in turn they can often hang on to some of the prior pricing pass throughs, enhancing margins going forward.” 

For Jeff Kivitz, a partner at Canyon who focuses on investments in the technology, software, building product, and retail sectors, he sees trends across different sectors and asset classes that could be early signs of repricing in the credit markets.

Very high-growth software companies have seen significant repricing of their shares during the first half of the year – companies that were trading at 10 to 30 times their revenue are now down 60% to 80%, and in some cases more. 

“While that doesn’t necessarily spell impending doom for levered technology companies, there is potential for increased distress,” Kivitz said. 

He has also seen more leveraged buyouts of building product companies in the last two to four years. There’s a lot of concern in that space, he said, which has been exacerbated by a lot of supply chain disruption caused by COVID-19. 

“So far, we mostly see one-off situations here as opposed to a broad wave, likely because we’re still relatively early in the downturn,” he said.