Private equity’s enduring love affair with distressed assets is like a bad romance movie plot. No matter how many times a potential partner has a shady past, high debts, and questionable business practices, private equity (PE) still sees a hidden gem and a huge payday at the end. But like any romantic folly, things can go horrifically wrong.
The Lure of Distressed Assets
Distressed assets are companies that are in financial trouble or are underperforming. They make for an exciting prospect for PE firms for a number of reasons. Firstly, they are cheap. PE firms can pick them up for a pittance compared to their potential value. Secondly, the normal rules don’t apply. PE can swoop in, change management, restructure operations, offload unnecessary assets, and generally shake things up in a way that would be impossible with a stable, profitable business.
The Danger of Distressed Deals
But distressed asset deals are also fraught with peril. In theory, they should work like a charm—with a bit of financial engineering, some cost cutting, and some strategic sell-offs, the business should be back to black. But the reality often plays out differently.
Case Study: Sears
To illustrate, let’s take the case of Sears. Once a retail titan, Sears was eventually acquired and run by the hedge fund ESL Investments, led by Eddie Lampert, who employed many private equity-style tactics. Under Lampert’s leadership, the company was subjected to aggressive cost-cutting, asset sell-offs, and real estate spinoffs. While these moves generated short-term cash and management fees, they also starved the core business of investment. The result? Years of decline, massive store closures, and ultimately a high-profile bankruptcy filing in 2018.
Red Flags and Warning Signs
Therein lies one of the major issues with private equity’s approach to distressed assets: value extraction at the cost of long-term stability. Tactics like sale-leasebacks, dividend recaps, and massive layoffs are commonly employed to “improve” the balance sheet in the short term. But often, these tactics do nothing for—or actively harm—the long-term health and viability of the business.
Coming Full Circle
Despite the ugly odds, the allure of distressed assets remains irresistible for many PE firms. The potential for profit, the freedom to upend business as usual, and the lack of competition from more risk-averse investors combine to make distressed assets a siren song that just won’t quit playing. But as case after case has shown—from Sears to Payless to countless others—this is a game where the house often loses, big time. And when it does, it’s the workers, the creditors, and the economy that pay the price.
So here’s the rub: even though the PE playbook for distressed assets keeps delivering losses, tragedies, and financial chaos, the rules of the game don’t seem to be changing. It’s like watching a horrible movie on repeat, knowing how it ends, but hoping against hope that this time, things will be different. Like love-blind fools, many in private equity continue to play a risky game that they’ve perfected in losing.