Distressed Debt Strategies for Private Equity

Distressed debt strategies can be classified three ways.  The investor can try to control the bankruptcy process by buying 33% of troubled company's debt.  Using this large position, the investor will take over the company by getting seats on the board of directors, obtaining ownership by wiping out the equity holders and converting the bonds into equity.  The large debt position allows the investor to influence any reorganization plan.  This is the riskiest strategy.  The investment period is two to four years and the target return is 20% to 25%.  The second strategy is to buy 33% of the bonds and use it only to map out the reorganization plan.  This is called an active investor not seeking control.  The holding period is one to three years and the target return is 15% to 20%.  The last approach is passive.  These investors buy distressed debt that is undervalued.  The debt may be used as part of a capital structure arbitrage strategy.  In this case, the investor buys the bonds and shorts the stock, hoping the stock will decrease in value more than the bonds.  The target return is 12% to 15% and the bonds are held for a year or less.