It is the biggest conundrum facing limited partners today when considering the recapitalisation of struggling funds and investments: are they simply throwing good money after bad? Zoe Hughes In deciding whether to invest additional capital to rescue original commitments, are they in fact throwing good money after bad? Is recapitalising a fund actually worth the financial investment, time and energy involved or is allowing liquidation the best option for all?
Caught between choked debt markets, declining occupancy rates and falling rents, many GPs have been forced to confront several unpleasant truths about their portfolios; mainly that they paid too much and employed too much leverage. In order to salvage some value from their funds and deals – and with it their reputations – GPs need additional capital to help restructure loans, pay down debt, cover tenant improvements and leasing commissions or reposition an asset so that some equity can be extracted from the asset.
However, in being asked to put up rescue capital, LPs face a dilemma. Even aside from the big question of whether the fund or deal is worth recapitalising in the first place, LPs are asking themselves whether they are actually rewarding GP failure by investing additional cash or just being pragmatic about trying to recoup some equity from a troubled situation rather than walking away with nothing?
That’s the situation currently facing Los Angeles Fire and Police Pensions (LAFPP), an investor in the $1 billion Stockbridge Real Estate Partners II fund, which closed in July 2006.
San Francisco-based Stockbridge spent much of the first half of this year urging LPs in its second opportunity fund, which also includes the California Public Employees Retirement System, the California State Teachers Retirement System and New York Common Retirement Fund, to support a recapitalisation of the vehicle. “Several” recapitalisation plans were rejected by LPs during that time, LAFPP said in a report of the issue for its August investment committee meeting.
Unable to also attract outside investment, though, Stockbridge put forward a new, final plan to LPs. That plan addressed five keys issue of concern to LPs including priority payments for recapitalisation capital; fewer loan pay downs; the restructuring and recapitalisation of assets and a lowering and subordination of management fees. After winning the backing of one major pension, which invested $125 million into the recapitalisation, smaller investors, such as LAFPP, have also agreed to the deal.
Under the more conservative estimate, that means following an initial $30 million commitment, and an extra $3.75 million of capital under the recapitalisation plan, LAFPP might recover $10.5 million of its $33.75 million investment. Had the pension done nothing, Townsend predicted recovery of just $3 million of the original $30 million commitment.
Of course, there is a caveat in all this: the word “might”. LAFPP might recover $10.5 million. Even given the priority repayment status of the preferred equity, there are no guarantees for anyone taking part in this – and other – recapitalisation plans. Townsend warned LAFPP in the report that the $3.75 million was “also subject to loss”.
And that is the crux of the problem facing limited partners. In deciding whether to invest additional capital to rescue original commitments, are they in fact throwing good money after bad? Is recapitalising a fund actually worth the financial investment, time and energy involved or is allowing liquidation the best option for all?
For LAFPP, Stockbridge’s last-in, first-out subordination structure, its ability to have extended loan maturities by two to six years, together with the promise of a 33 percent fee reduction, were key reasons for backing the recapitalisation plan. Despite that though, they, and other LPs considering recapitalisation plans, will continue to question whether rescue capital kick-starts a turnaround for a fund today, or merely postpones inherent problems until tomorrow. Townsend declined to comment, Stockbridge was unavailable for comment at press time.
In deciding whether to invest additional capital to rescue original commitments, are they in fact throwing good money after bad? Is recapitalising a fund actually worth the financial investment, time and energy involved or is allowing liquidation the best option for all?