Firms Hunt For Bargains Among Debt Securities

Some Wall Street firms are already looking for investment bargains in the aftermath of last week's credit-market meltdown.

The prices of some assets, including bonds and other debt instruments, have collapsed to the point where Blackstone Group and other firms say they hope to profit on reliable securities that now seem undervalued.

"We're . . . starting to look directly at some of these . . . debt securities, which are trading at distressed levels, but they're not distressed from a credit perspective," Blackstone Chief Operating Officer Tony James said in a conference call with investors to discuss the private-equity firm's quarterly results. "We're starting to look at those as being very attractive investments. I think we may be able to buy the debt in these companies and get a higher return on the underlying equity, and we're looking hard at that, and that's pretty appealing to us."

The collapse in demand for securities backed by subprime mortgages has spread, roiling stock markets and complicating numerous private-equity deals involving big names like TXU, Sallie Mae and others that were supposed to be slam dunks.

The nervousness is creating opportunities for fatter profit margins, investors said. The sharp drop in price on certain assets, mostly mortgage-backed securities, has also dragged down some higher-quality investments that do not carry as great a risk of default.

James said buying distressed debt could bring bigger returns than the standard private-equity buyouts that Blackstone specializes in.

Longtime Washington area banker Robert P. Pincus said Blackstone and others are running a simple formula.

"It's called 'buy low and sell high,' " said Pincus, chairman of Fidelity & Trust Bank of the District. "They are doing this because there's been such an overreaction to these markets, much of which is emotional. I'm not Pollyannaish. I understand there are problems, but not to the extent that prices have been pushed down."

Goldman Sachs Group, which announced yesterday a $3 billion infusion of capital for one of its distressed hedge funds, said the market turmoil has driven the price of some assets below their true value. A spokesman for Goldman said the company thinks the volatility has created buying opportunities.

Two weeks ago, Citadel Investment Group of Chicago, a hedge fund known for buying beleaguered firms' assets, acquired the portfolio of Sowood Capital, a hedge fund whose holdings had lost half their value in recent weeks.

The credit market troubles, however, prompted one private-equity firm yesterday to issue a warning about its pending initial public offering. Kohlberg Kravis Roberts, which plans to raise $1.25 billion with its IPO, said an increase in borrowing costs for leveraged buyouts may hurt its performance.

The cost of issuing high-risk, high-yield debt has "recently increased significantly," and KKR may need to rely on financing from investment banks to fund current and future transactions, the private-equity firm said in a filing with the Securities and Exchange Commission.

KKR also disclosed in the SEC filing that the Justice Department requested "certain documents" as part of an investigation into whether private-equity firms violated U.S. antitrust laws. The Justice Department has been informally examining "club deals," an increasingly common practice whereby several private-equity firms team up in a consortium to buy a company.

The energy company TXU of Dallas, for example, is being bought out by KKR, Texas Pacific Group and Goldman Sachs's private-equity unit.

Blackstone, which went public in June, yesterday reported second-quarter profit of $774.4 million, compared with $224.1 million a year earlier. Revenue more than tripled, to $975.3 million.

The firm's corporate private-equity and real estate revenue also more than tripled, to $426.1 million and $320.2 million, respectively. Alternative asset-management revenue rose five times, to $168.6 million, and financial-advisory revenue increased 18 percent, to $98.6 million.

Blackstone stock closed yesterday at $25.71, up 43 cents. Share prices have fallen from $31 at the time of the IPO.

Staff researcher Richard Drezen contributed to this report.