Institutional Investor's Alpha Magazine - July/August 2008 - (Page 35)

borrowers. Most hedge fund lending has come through lines of credit or private investments in public equity, commonly known as PIPEs. (Goldfarb’s BayStar funds ﬂourished through the use of PIPEs.) Such arrangements can cause considerable dilution if the principal on the debt can be converted into equity should the underlying stock price fall — potentially bringing down a company rather than helping it grow. At the end of the dot-com bubble, for instance, many companies were so desperate for ﬁnancing that they arranged lines of credit to be repaid in convertible shares. In June 2000 online retailer eToys sold $100 million in convertible preferred securities to funds managed by Citadel and Promethean Asset Management, a New York– based hedge fund that was an active tech-boom lender. By the end of 2000, most of the shares had been converted at bargain prices, giving the funds almost 20 percent of the company and diluting the value held by other shareholders. This drove the stock price down further, hastening the company’s demise. Deals like these earned the nickname “toxic converts,” and most loans today are structured to prevent them. Gregory Schiffman, chief ﬁnancial ofﬁcer for biotech company Dendreon, says its credit line with Acqua Capital Management is “a very ﬂexible means of ﬁnancing for a company our size.” Schiffman likes that he can pull down ﬁnancing in $8 million to $10 million tranches as needed for a low per-transaction cost of capital and controlled dilution. He also likes that Dendreon has no obligation to tap the line of credit. Rather than giving Acqua the power to convert Dendreon’s debt into equity at any price, stock issued under the line comes out at a range of prices. Dendreon’s key project is Provenge, a therapeutic vaccine for prostate cancer that has completed Phase 3 clinical trials but is still undergoing review by the Food and Drug Administration. Isser Elishis, chief investment ofﬁcer of Acqua, says interest in hedge fund lending isn’t limited by the size of a borrower. “We’re seeing larger companies interested in these transactions,” he notes, adding that Acqua requires borrowers to have a market capitalization of at least $150 million. He says most borrowers are simply businesses that need cash to grow rather than ﬁ nancing to stave off bankruptcy or hostile buyers. “There are so many companies struggling to get funding right now,” notes Seth Yakatan, co-founder of Katan Associates, an Hermosa Beach, California–based consulting firm. Last fall Katan helped XL TechGroup, a Melbourne, Florida–based company that helps commercialize medical technologies for larger corporations, raise a $25 million line of credit with Laurus Capital Management, a New York hedge fund firm that has about $1.8 billion in assets under management. Matthew Hoffman, chief investment off icer for Westport, Connecticut–based Weston Capital Asset Management, which runs a $130 million fund of funds that invests in hedge fund lenders, says some insist on charging higher rates and fees than do traditional lenders: “Usually the borrower will agree to pricing because the hedge funds will do the loan more quickly, even under stressed environments.” On the other hand, Noel Ryan, a managing director and a senior member of the private ﬁ nance group of Los Angeles investment bank Houlihan Lokey, advises clients in the market for a loan to consider borrowing from a hedge fund because the rates are sometimes better than what banks offer. “They are a very strong option for companies,” Ryan says. But his endorsement is tempered. He warns that hedge funds are frequently more interested in returns t ha n in long-term client relationships; they will often sell a loan in the secondary market; and they are prone to moving on to other types of investments, rather than serving as a reliable ongoing source of capital. “I think it’s going to — RICHARD RONZETTI, go away,” he says of hedge MARATHON ASSET fund corporate lending, notMANAGEMENT ing that companies have begun to look beyond investment banks — and hedge funds — to other funding sources, including private equity, sovereign wealth funds and holding companies. Of course, hedge funds that decide to become lenders face risks speciﬁc to lending. When Axium International, a privately held Los Angeles–based payroll services company whose clients included independent ﬁ lmmakers as well as big studios like Warner Brothers, ﬁ led for Chapter 7 bankruptcy in January, its biggest creditor was GoldenTree Asset Management, a New York–based hedge fund with $13.8 billion in assets under management that specializes in alternative financing arrangements for small companies. GoldenTree lost $87.5 million on its Axium venture and now finds itself competing with other claimants for whatever may be left of the company’s assets. For a traditional bank, such problems can simply become opportunities to sell another set of services. A hedge fund, by contrast, can be left holding the bag, especially if its loan was intended to bridge a private company’s ﬁ nances until its initial public offering. “In a late-stage venture deal, the exit could take longer or not develop,” says Rillo, the Yorkville executive. And unregistered securities like the ones hedge funds frequently underwrite are often illiquid, making them almost impossible to sell. But for Hoffman, the Weston CIO, the proﬁt potential is irresistible for one hard-to-argue-with reason: “We’re generating double-digit returns.” “We pride ourselves on being able to provide a SWAT team with all available resources.” JULY/AUGUST 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 35

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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