It was the summer of 1985 or ‘86 and my pal Feeney spent an afternoon trying to convince the cat owners in the neighborhood to offer up their felines for a sparring match with his family's black lab, Benny. It was a pretty boneheaded idea and Feeney wasn't having any luck.
Eventually, old man Moran got wind of what Feeney was up to and called out from his stoop to the pack of us kids as we lurched from alley to alley in search of a stray cat stand-in. “What da hell youse guys tinks is gonna happen wit dat cat and yer dog?”
“Benny’s gonna kick some ass!” replied Feeney.
“Never happens dat way,” Old Man Moran called back over the top of The Racing Form, “Youse guys gotta understand dogs and cats; dey want different tings. Dogs just wanna jump around and bounce off da walls and lick people. Cats just wanna be left alone and get fed. But when a dog comes over all crazy and tries to bother dat cat, the cat’s gonna claw dat dog to pieces.”
Cats and dogs and debt and equity: two pairs of things that are more alike than not. And I'm wondering if I should start getting worried because half the PE managers I talk to nowadays are looking to pick up debt that’s trading on the cheap. And half the bankers I talk to are getting tons of calls from GPs looking to buy out the debt of distressed companies – sometimes in the very companies in which those PE guys own the equity.
Now I’m not against people looking to be opportunistic - or better yet, trying to retire debt and give their companies some breathing room - but a surprising number of folks are out there looking to buy up their companies' paper as a money-good investment that pencils out to a nice standalone return while their equity enjoys some sweet upside.
But here’s my question: debt and equity are like cats and dogs, no? I mean, they want totally different things: the debt wants stability, predictability, visibility. The equity, on the other hand, is the call option on the excess assets of the firm. And like any good option, the payoff is asymmetric: wins can be very big. And the losses? Well, c'est la vie.
Or maybe debt and equity are frenemies. That's more like it. They're close, but there's a huge amount of tension in their relationship; they simultaneously love and hate each other; they can't stand each other, and they need each other. Their relationship is complex and contentious, vital and complementary.
And as any contemporary teenager or Simple Life aficionado knows, sometimes the hardest place to be is in between two frenemies. Ever-shifting sands and constant demands for loyalty can be a recipe for headaches. I'm positive there will be some screaming good deals out there, but I just hope that GPs have a keen eye for the inherent tension and potential conflict of owning both debt and equity during stressful times.
Sure, low price can cure a lot of sins, but I fear that if things stay bumpy a bunch of people who bought a side dish of debt to go with their equity entree may find themselves in the middle of a furball melee. Old man Moran's admonition echoes across the years: more often than not, it's the cat (the debt) that ends up sitting smugly in the tree while the dog (the equity) whimpers away to lick its wounds. Either way, it's a fight no one wants any part of.
Before debt was free like herpes, the difference between the two capital classes was stark. Back then, just by walking into a debt group versus an equity group you could tell which was which. Debt guys are very serious with big models that actually incorporate every last cash flow, amortization schedule and asset listing. Equity guys were fun, wore good suits and had good hair. I haven't been in Wall Street for a long time, but I'm guessing that dynamic eroded over the last 5 years as the leverage orgy progressed. I wouldn't trust an equity guy to review a debt document if I were given his two star players and five draft picks. Someone will get hurt in this transition.
Of course the flip-side to all of this is, if the debt is trading at 20 cents, then what really is the difference between debt and equity at that point? As I've been pontificating on twitter far too often: we're all bad credits now.
Posted by: Jake | March 03, 2009 at 06:52 PM