With distressed assets, one investor’s loss can be another’s gain.
Robert Lomison has worked in the funeral business for nearly four decades, building his wealth buying mismanaged cemeteries and funeral homes. One of his standout acquisitions was a collection of struggling funeral homes and cemeteries in central Texas.
Bruce Deifik saw a different opportunity to resurrect a business from the dead. He bought the Revel Casino in Atlantic City, which opened in 2012 but had fallen in and out of bankruptcy.
Buying a business out of bankruptcy might seem like a good deal. But it is a risky investment, even in a booming economy. After all, someone else tried with the same business and failed.
If the new owners are savvy, they stand to make a considerable return on their investments. But sometimes they are lucky to break even or escape without going bankrupt themselves.
Bankruptcies are at a low point, but given the amount of debt that companies have borrowed at low rates that will eventually rise, the number of bankruptcies and distressed sales are expected to climb.
“Anyone who wants to make money by buying businesses out of bankruptcy has to have a stomach that will digest anthrax,” said Scott H. McNutt, founder and principal of the McNutt Law Group, which focuses on insolvency.
The opportunity for a buyer is that any equity in the business held by former investors is wiped out in bankruptcy. Banks that hold debt on the company will accept a lower amount than they are owed. Still, the process takes time and a lot of money.
“If you want to buy something from a bank, you’ve got to hire lawyers and accountants and you generally have to produce a valuation methodology that justifies your price,” Mr. McNutt said. “You also have to overcome objections from the people who are getting wiped out. That said, if you have a lot of capital and a strong stomach, it’s sometimes an opportunity.”
That opportunity calls for as much caution as strategy. Here are some takeaways from people who invest in bankrupt businesses and have survived to tell their tale.
Know Your BusinessMr. Lomison saw an opening with a group of three funeral homes and two cemeteries in Texas that he said had been mismanaged.
“Families were buying something — grave markets, headstones, burial vaults — and they wouldn’t deliver it for six months,” he said. “Families were at the gates protesting.”
Mr. Lomison paid $800,000 for a $4.6 million loan in default. But he knew that was just the beginning of his investment. He had to give clients the headstones and markers they had purchased. He also upgraded a fleet of limousines and hearses.
That was 10 years ago, and now he is realizing the return on his investment. “It’s a slow process,” he said. “It isn’t something that happened overnight. It was customer by customer.”
Yet he knew the space, having bought and sold some 45 funeral homes and cemeteries in his career. He also knew that well-run funeral homes and cemeteries were highly profitable.
Some investors in distressed properties find partners with expertise.
Ivan Q. Zinn, the chief investment officer of Atalaya Capital Management, a $3.5 billion investment fund, said he formed a partnership with a real estate investor in Colorado to buy properties at a steep discount. He said he could do that only by having someone there with a deep knowledge of the market.
“He’s really adding value in the context of being the on-the-ground operator,” Mr. Zinn said of his partner, Andrew R. Klein of Westside Investment Partners. “He can figure out how something can go from one type of operator to another and know what these residential lots should trade for.”
Mr. Klein gave an example of a 700,000-square-foot-building they recently bought where the main tenant, who occupied 400,000 square feet, was leaving. That would be unappealing, if not disastrous, to many owners. But for Mr. Klein, “it’s about managing that risk,” he said.
Past Losses Don’t Mean Future Success“The big false indicator is how much money the other people have already lost,” Mr. McNutt said. Buyers think it is an indicator of value, but it often is not. Distressed properties often require more investment.
The Revel Casino, on the north end of Atlantic City’s boardwalk, cost more than $2.4 billion to build. Mr. Deifik paid $200 million to buy it out of bankruptcy, then spent another $200 million to update it. He plans to reopen it on June 28 as the Ocean Resort Casino.
“I’m betting that it’s a great buy,” Mr. Deifik said. “My operating expenses are substantially less than the group that opened it in 2012.”
But someone else tried before him. The previous owner, Glenn Straub, a well-known Atlantic City property owner, paid less than $90 million and reportedly spent $1 million a month for two years to cover its costs.
Mr. Deifik was granted a casino license on Thursday, only a week before the casino is scheduled to open. He knows he has a lot of work still ahead. He still has to meet a $115 million annual payroll. But he is optimistic: He has plans to complete 12 unfinished floors and increase the number of rooms to 2,000 from 1,400.
“If we give the customer what he wants, if we deliver service at a high level, I think the casino has an opportunity to rise,” he said.
Additional Investment May Be RequiredSandy and Jim Cannon bought Geets Diner in Williamstown, N.J., out of bankruptcy last year, having each gone there as children. The diner, on the Black Horse Pike between Philadelphia and the Jersey Shore, dates to the 1940s. But it had fallen into disrepair before its 2017 bankruptcy.
“The previous owner owed everyone from the food and beverage people to the taxman,” Mr. Cannon said. “It was in bad shape.”
The business’s economics had fallen so far that he had to compete with a buyer who wanted to tear down the diner and redevelop the land.
The couple paid $3.9 million for the property, on the basis of the diner’s reputation and its location at a busy intersection. Committed to restoring the property, they set about renovating it and re-establishing relationships with suppliers.
Yet Mr. Cannon said their philosophy since reopening in March was to just give it a try. “We kind of fell into it,” he said. “We weren’t planning for it.”
One of the risks in buying any bankrupt business is that wiping out the debt may not be enough to make the business profitable. It may just make it less unprofitable, Mr. McNutt said.
“It’s like the old rule about buying vintage cars,” he said. “The fact that some dermatologist wanted to spend $150,000 restoring his old Beetle does not mean it’s worth $150,000. It means some dermatologist had $150,000 and wanted to spend it on his old Beetle.”
Create a Business PlanSo what should buyers do? Hire experts and take to the white board.
That’s what Peter Patel did when he bought a coal mine outside Pittsburgh.
At the time, Mr. Patel had experience owning pharmaceutical companies and hotels. He had never owned or even worked at a coal mine. But when he got a call in 2016 to buy one, the opportunity made sense to him. The mine had failed for two reasons: poor management, caused by fighting between the partners, and a collapse in coal prices.
Mr. Patel bought the mine for $5 million at a time when coal was trading for $80 to $90 a ton. He upgraded the equipment by buying newer pieces from other struggling companies. And he brought in a marketing team to find new markets for the coal. Then the price of coal began to rise, topping $300 a ton.
Mr. Patel said his lack of knowledge about coal was not an impediment.
“The most important thing I understood was, every industry needed a structure and you needed to stick to a business plan,” he said. “Most often, a business isn’t well organized and we don’t stick to the plan.”
He is looking to buy a second mine in Arkansas. “You’ve got to stay focused no matter what happens,” he said. “With a distressed asset, a lot of problems are coming at you.”
That’s good advice for any business.
