Sob story of the day, vulture-fund edition

By Felix Salmon
April 11, 2011

Matt Wirz probably can’t be held responsible for the headline the WSJ put on his story today — “For Vultures, Slim Pickings.” But there’s no doubt that distressed-debt investors in Lee Enterprises are angry. And they’re angry for a very weird reason: after buying Lee’s debt at a 20% discount to face value because there was such a high likelihood of default, they’re now set to be repaid in full. That’s a 25% return in just over six months. Which certainly isn’t my idea of “slim pickings.”

The calculation behind the vultures’ investment, as far as I can tell, was that Lee was a solvent company with a liquidity problem. Their plan was to buy up the debt, see it default, seize control of the company, and end up with assets worth much more than the face value of the debt.

If they think the company is worth much more than its $1 billion debt load, of course, they can always go out and buy Lee’s common stock: it’s trading at less than $3 per share, valuing the company at just over $100 million. But that’s not the way that vulture investors like to make money: instead they specialize in bankruptcy-court legal maneuvers, and identifying the exact point in any company’s capital structure where a relatively modest tactical investment can ultimately result in complete control of the firm.

It’s hard to see how this kind of skillset adds value to the economy. It looks like a negative-sum game to me: the bondholders who sold below par lose money, the original shareholders get wiped out completely, the courts and lawyers take their tithe, and the vultures — if they’re successful — rake in everybody else’s chips. I suppose the investors betting on default do help to support the price of the debt at the point when the company’s outlook is bleakest. But there’s nothing there to justify annualized returns of well over 50%. So well done to Lee Enterprises, and its bankers, for managing to remain afloat.

As for the vultures: stop whining. You made a large amount of money in a very low-interest-rate environment featuring precious few defaults. Go enjoy your spoils, rather than kvetching to the WSJ about how you missed out on even more.

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