Rising interest rates, high inflation, and slow growth are usually not terms associated with great opportunity, but in distressed debt investing, it’s a different story.
Last month we briefly covered how private equity investors are increasingly looking to invest dry powder in distressed debt securities. Distressed debt investing is an exciting, yet complex and risky form of investing that gives investors the option to purchase a company’s debt securities at deeply discounted prices from their face value in order to realise gains.
While this asset class has its risks and rewards, understanding how to assess these investments can be a challenge. As we move into 2023, advances in AI are helping to facilitate distressed debt investors in their search for attractive opportunities.
If you’re curious about distressed debt investing, read on to discover more about what it entails, its risks and benefits, and how AI is helping distressed debt investors to make informed decisions.
What Is Distressed Debt Investing?
Distressed debt investing is also sometimes referred to as:
- Distress debt investing
- Distressed investing
- Distress investing
All these terms refer to a field of alternative investment in which the investor puts capital into the debt of a financially distressed company.
According to the Companies Act, a “financially distressed company” is one that is unlikely to be able to pay its debts on time within the next 6 months or is likely to become insolvent in the next 6 months.
What Constitutes a Good Opportunity in Distressed Debt Investing?
When evaluating potential investments, distressed debt investors have three primary criteria:
- The company is in financial distress,
- It offers a solid product or service that’s in demand,
- It has a viable business model.
In this instance, the ideal outcome for a distressed debt collector is for them to gain a substantial share of the company’s debt, influence business and organisational decisions in order to improve the distressed company’s fortunes, and eventually turn a profit when the distressed debt is settled.
This is the best-case scenario.
For companies that cannot be restructured and must sell their assets to satisfy creditors’ demands, debt holders are always compensated ahead of equity holders in bankruptcy. Some distressed debt investors will wait until a distressed company has reached near bankruptcy before buying distressed debt.
- The most obvious advantage is that these bonds can be bought at a highly reduced price, meaning a distressed debt investor can buy into the company at a much lower price than its nominal value. This results in potentially large returns when the distressed firm eventually recovers or pays off its debt.
- In the current macroeconomic climate, distressed debt investing is a particularly attractive option simply for the fact that there are so many distressed companies that have a viable business model and a good product or service that just need some form of financial relief.
In 2022, distressed debt issuance in the US rose by 300%, an indicator of just how ripe distressed debt investment opportunities have become.
- Unlike a private equity buyout, merger, or acquisition, distressed debt investing is not welcomed by owners and management of distressed companies for the reason that distressed debt investors typically want to replace existing management and often involve themselves in the distressed company.
This means that distressed companies’ management is usually eager to keep distressed debt investors at a distance, making it difficult for them to assess the company’s current situation and future prospects.
- Unlike distressed equity investing, distressed debt investors are usually not able to acquire control of the distressed company as creditors don’t typically get voting rights. Depending on your aim, this can make distressed debt investing a less attractive option than distressed equity investments.
- Finally, distressed debt investments are risky because distressed companies have a higher likelihood of failing and can result in a complete loss of capital.
How Can Symanto AI Help Distressed Debt Investors?
Given that distressed debt investors have limited information when evaluating potential investments, they need to make the most of all publicly available information and run due diligence independently.
That’s where Symanto can help. Symanto analyses written content such as consumer reviews, social media comments, and reports for consumer sentiment, customer loyalty, and more. With this information, distressed debt investors can get a better understanding of a distressed company’s current situation and future prospects.
With our aspect-based sentiment analysis, distressed debt investors can quickly identify exactly which areas of the company need attention and make informed decisions when considering a potential management overhaul. With these insights, distressed debt investors can make a more informed decision about their investments in distressed companies for an improved outcome.
Symanto also makes market analysis easy, comparing data of key players in the market to see how distressed companies are performing in comparison to them. This allows distressed debt investors to identify distressed companies that may be undervalued and have a good potential for recovery and high returns on investment.
You can take a look at an example of our due diligence with brand analytics report here (pdf).
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