Institutional Investor's Alpha Magazine - July/August 2008 - (Page 34)

Lending banks are facing regulatory pressure to shrink their balance sheets, so even companies with good credit are having trouble borrowing money. “That leaves the banks ill-equipped to provide the ﬁ nancing that companies will need in coming years,” says Richard Ronzetti, global head of investment management at Marathon Asset Management, an $11.7 billion hedge fund ﬁrm in New York. “We’re entering into a credit crunch that is really historic in its proportions.” And that creates opportunities for hedge funds like Marathon, which provides a variety of registered and unregistered corporate ﬁnancing, including structured-debt products. Marathon has a staff of 20 loan originators and 100 researchers, much of whose time and energy in recent months has been spent acquiring mortgage-backed securities, though the team is also adept at ﬁguring out how to structure a loan fast — in just a few days, in some cases. “We pride ourselves on being able to provide a SWAT team with all available resources,” Ronzetti says. In addition to their willingness to provide ﬁ nancing more quickly than banks do, hedge funds are often more ﬂexible. Daniel Farkas, a hedge fund analyst with Chicago-based investment research giant Morningstar, says many funds attach fewer strings to loans than do traditional lenders. But there are downsides as well for borrowers and lenders alike. Hedge funds may take a very hands-on approach that can affect a company’s management (since Citadel’s investment, E*Trade has changed its CEO, CFO and general counsel). The sheer speed of a deal can obscure risks. And because hedge funds often lend to companies in speculative sectors like mining and biotechnology, risks are inherent. But part of the appeal from a hedge fund manager’s perspective is that lending can create alpha. Marketing issues still have to be overcome. Ensconced in the collective corporate memory are dot-com deals from almost a decade ago, in which hedge funds lent money to struggling tech-sector companies under terms that ultimately hurt borrowers. But it’s clear that the notion of borrowing from a hedge fund has gained momentum and perhaps even become mainstream. Casino operator Tropicana Entertainment, which ﬁ led for bankruptcy protection on May 5, recently borrowed $67 million from Greenwich, Connecticut–based Silver Point Capital, choosing the $9.3 billion hedge fund ﬁrm over competing lenders. Liverpool FC, the English Premier League soccer team, and its American owners, Thomas Hicks and George Gillett Jr., are seeking hedge fund ﬁnancing for a $700 million stadium it broke ground on this summer and for Hicks’s proposed buyout of Gillett’s stake. Dendreon Corp., a small publicly traded Seattle-based biotechnology ﬁrm that develops cancer treatments, has an equity line of credit with Acqua Capital Management, a Toronto-based hedge fund. Some hedge fund firms build their core strategies around lending. LRG Capital’s two main funds, BayStar I 34 • INSTITUTIONAL INVESTOR’S ALPHA • JULY/AUGUST 2008 and BayStar II, “have collectively invested over $1.5 billion in more than 250 companies,” according to an LRG note to investors. CEO Goldfarb is seeking to raise $500 million for a new fund, BayStar III, to make structured-debt investments in small- to mid-capitalization public and late-stage private companies, mostly in technology and life sciences; $50 million in capital had been committed by early May. Though the BayStar vehicles are hedge funds by deﬁnition, Goldfarb says the term doesn’t mean much anymore and that he prefers to think of LRG simply as a money manager looking to generate returns by providing ﬁnancing. Firms like Yorkville Advisors, a $1 billion manager based in Jersey City, New Jersey, that specializes in making loans to publicly traded companies, hedge their investments by requiring borrowers to meet substantial conditions. Yorkville looks for sufficient collateral to cover its loans — though that’s not always possible — and prefers to receive options and warrants (in addition to debt payments), which make a proﬁt for the fund if the stock price goes up without diluting the borrower’s equity position at the time the deal is negotiated. Yorkville senior managing director Troy Rillo argues that the combination of debt and equity, through a warrant or conversion privilege, serves both the investor and the borrower. “We prevent companies from doing things that are injurious to themselves,” says Rillo, co-chairman of his ﬁrm’s investment committee. Admiralty Resources, an Australian mining company, has raised capital three times through lines of credit with Yorkville, according to Phillip Thomas, Admiralty’s chief ﬁnancial ofﬁcer. The ﬁrst line of credit, for $2 million, was approved in 2006; the second, in 2007, was for $6 million; early this year, the company added a $20 million line. During that period, Admiralty took an iron ore mine in Chile from exploration to production, and Thomas notes that Yorkville’s support was crucial. “Investment banks don’t want to get involved until the assets are proven,” he says. “We talked to all the major suspects,” he adds, but banks would not step up while the company was still in the exploratory phase. Rather than doing extensive geological due diligence, Yorkville concentrated on the company’s cash ﬂow and its ability to meet payments; the collateral value of the mines was secondary. EMED Mining, a mining-development company based in Cyprus with only £5 million ($10 million) in assets, signed a line of credit with Yorkville last fall. The agreement lets EMED raise funds as needed without taxing its balance sheet or diluting its future earnings per share by increasing the share count at a faster rate than net income. The whole notion of hedge fund lending has what Harry Anagnostaras-Adams, EMED’s founder and managing director, says is an undeserved bad reputation because so many strings have traditionally been attached to it and the results have sometimes been disastrous for

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - July/August 2008

Institutional Investor's Alpha Magazine - July/August 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Mr. Big Goes Small The Good Guys: Adopt This School! Interview: Man's Great Hope Cover Story: The Gentleman Activist Strategies: The New Bankers Profile: Staying Alive Research Center: The Best of the East The Asian Sensations Alpha Bytes: Into the Light Unhedged: Commentary: Speculating on Washington

Institutional Investor's Alpha Magazine - July/August 2008

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