Oaktree Capital Management has shifted from investing in vanilla distressed debt and instead is raising a $1.25 billion fund that will take control of distressed companies. "The strategy is to look for a company where, through a restructuring, the old equity will be wiped out and the old creditors will become the new equity. You then figure out which class of creditors optimizes that process," said Howard Marks, chairman of Oaktree.
Marks said the decision to raise OCM Principal Opportunities Fund III was taken last year, when at the same time, Oaktree decided not to move forward with OCM Opportunities Fund V, which would have targeted distressed debt. "In May, we concluded the market was rich and that we should not raise Fund V. In fact, we started selling what we had, [from the OCM Opportunities Fund IV and IVB] not every holding, but the ones that were fully priced," he said. Approximately $3.5 billion has been returned from Fund IV and IVB, with returns last year of 72% on average. "Rather than hold securities that are fully priced and collect management fees, a managers' obligation is to sell and perhaps return capital. We don't think that our clients hire us and pay us 1 plus 20 to hold 8% bonds," he stated.
Oaktree is planning to target smaller companies, rather than a WorldCom or Enron. "[The targets] are companies that are going to require a lot more work. A lot of the money that was made in distressed debt in the last two years was made in companies like Corning, Lucent [Technologies] or Tyco [International Group], which frankly did not require too much work. You just had to analyze them and buy them. They did not go through a restructuring, they did not require a reorganization or bankruptcy, but were restored to creditworthiness. Companies in this fund will not escape reorganization and in fact we are counting on a reorganization to deliver the equity into our hands," he stated.
Oaktree intends to bypass the mass of new vulture funds targeting distressed names. "People shy away from doing reorganizations and from long-term holds," Marks explained. The companies that the principal fund targets will not be bond fund candidates, he added. "They are workout and bankruptcy candidates. It's a more specialized market and we think relatively less crowded." Commenting on Oaktree's decision to not raise Fund V last year, but to pursue this fund while others were raising new distressed debt funds, he noted, "The important thing in the investment business is to be a contrarian and not a trend follower. You have to buy them when they hate them and sell them when they love them."
The first closing of the OCM Principal Opportunities Fund III was last November at over $500 million. Then last month, a closing took the fund to $1 billion and the final closing will be in another month, said Marks. The target is $1.25 billion and $1.4 billion is the limit.