NEW YORK -- With the junk bond market in its worst shape ever -- and experts predicting the outlook will grow grimmer -- a new breed of would-be corporate takeover artists is gaining prominence on Wall Street: the debt raider.
Rather than buying up a large stake in a target company's stock and threatening management with a takeover, these investors snap up pivotal pieces of a troubled company's debts and then try to thrust themselves into power if the company is forced to reorganize.
The typical targets are companies that were the subject of a leveraged buyout and are now struggling under huge debt loads. Many troubled companies are now trying to lighten that load by offering to exchange debt for stock in the company, thus giving big bondholders a significant stake, or sometimes control, of a restructured company.
"Almost all cases now have a change-of-control issue," said Wilbur Ross, senior managing director at Rothschild Inc., an investment advisory firm.
Consider the takeover of Allegheny International Inc., the maker of Sunbeam and Oster products that filed for bankruptcy protection two years ago. Japonica Partners, a group of New York investors, got final approval from a bankruptcy judge recently to take effective control of the reorganized company.
Japonica entered its messy battle for Allegheny by purchasing so many of its junk bonds -- high-yield, high-risk debt securities -- that Japonica was able to block any Allegheny reorganization plan that didn't meet with its approval. Japonica then gathered enough investors to fund a reorganization of the company. Allegheny is expected to emerge from bankruptcy next week with Japonica's Paul Kazarian as chairman.
The term "debt raider" seems to fit the style of these investors. They are as aggressive as their better-known, stock-buying cousins, such as T. Boone Pickens and Carl Icahn.
In fact, Icahn has turned into a debt raider himself. Among his prey is Leaseway Transportation Corp., a Cleveland-based trucking company whose 1987 leveraged buyout went bad. Icahn has bought up at bargain-basement prices a "meaningful" stake of a $192 million issue of subordinated bonds Leaseway is trying to restructure, a source said. First Boston Corp., the investment bank, has purchased a separate stake in the bonds, the source said, adding that Leaseway will likely have to negotiate sweetened terms for its restructuring to gain the support of these important stakeholders.
Most investors in distressed securities eschew the "debt raider" name, saying they're not attacking a company, but merely looking for profit like any other investor. The professionals also have been dubbed with the equally unflattering moniker of "vulture investors."
"No one is more maligned than us," groaned Martin J. Whitman, president of Whitman, Heffernan & Rhein & Co., a firm that invests in distressed companies.
"We invest with an eye to making as much money as we can as quickly as possible," said James Rubin, senior managing director of Sass Lamle Rubin & Co., a New York investment firm. "If the mechanism that best and most easily accomplishes that is to take control, we'll take a controlling position."
Rubin's group recently took control of Coleco Industries Inc., the once giant toymaker that hit hard times after piling on a suffocating debt load in 1986. Rubin initially purchased a large stake in Coleco's publicly traded subordinated debt and wound up chairing the committee of unsecured creditors after Coleco filed for bankruptcy protection in July 1988.
Dissatisfied with Coleco's reorganization plans, the creditors forced the sale of the business -- as well as the Coleco name -- to Hasbro Inc., the worldwide leader in the toy industry. In an exchange of old Coleco debt for cash, new bonds and equity, Rubin gained control of the successor company, which he renamed Ranger Industries, after his family's collie.
These investments, however, are fraught with risk. Unlike stock investing, gaining control of a class of debt is not as simple as amassing 50.1 percent of a company's publicly traded shares. Once an investor thinks he has control of a strategic debt stake he can easily find that he's been outmaneuvered by management or a rival creditor using a different interpretation of the complex wording in a target's loan agreements.
For example, although companies have to treat all common stockholders equally when making an offer to repurchase its shares, they are not under the same obligations when trying to buy back and restructure their bonds. That makes it easier for them to coerce bondholders to accept their terms.
A company's attempt to buy back its bonds or swap them for stock may not succeed. In that case, the rules could change again if it files for bankruptcy. A bondholder with a big enough stake to block an out-of-court restructuring can easily find his or her bond class mixed in with a larger class of debt, thus diluting his clout. "To be successful, you can't show up on the company's radar," said one savvy bond investor who asked not to be named. "You can't let them focus on you or they'll emasculate you."
Even if a strategic debt investor is successful in either taking control of or owning a large equity stake in the reorganized company, his risks do not stop there. Now he has to find someone to sell his stake to.
Much of the takeover frenzy of the 1980s was fed by the "greater fool" theory: the belief that no matter how high a price a raider bid for a company, there was always someone who would pay an even higher price for part or all of the target.
But finding a buyer may not be easy. Financing is hard to come by. Moreover, as more and more highly leveraged companies hit the ropes, so many companies could be for sale that prices would plummet.
Georgeson & Co., an advisory concern specializing in investor relations, noted that the number of companies trying to restructure their heavy debt loads has doubled since last year. "We think we've just seen the beginning of junk-bond distress," said Michael C. Singer, president of R.D. Smith & Co., a Manhattan brokerage specializing in troubled companies.
Despite the risks, many experts predict that would-be victors will crowd into this kind of investing, given the malaise of other opportunities as the economy teeters on the edge of recession.