Fortune article: “Seeking Profits in Europe’s Woes”
FORTUNE — As Europe stumbles and markets quaver, Victor Khosla sees a rare opportunity. The founder of Strategic Value Partners, which has $4 billion in assets in its distressed-debt and turnaround funds, Khosla, 53, is a veteran of distressed investing at Citibank (C), Merrill Lynch, and Cerberus Capital Management. Since he founded SVP in 2002, its flagship Strategic Value Restructuring Fund has averaged 11% annual returns through Sept. 30, according to HSBC Hedge Weekly. We sat down with him in his Greenwich, Conn., offices for a rare interview to talk about the faltering Continent, European banks’ massive asset sales, and where he’s buying.
What’s your take on the European crisis?
This is distressed-debt cycle No. 1 in Europe. Europe discovered leveraged buyouts in 2002 or so, and as a result there were almost $1 trillion of high-yield bonds and loans issued in Europe, mostly between 2002 and 2007. So there is now product in Europe in the corporate distressed side where there never had been. You’ve also got a recession in Europe, which creates distressed debt. And, finally, the European banks have all these pressures and have been selling. When you add these things together, you’ve got size, scale, and sales. We have invested $6 billion in Europe over the past 10 years, buying senior distressed debt, and in the first 10 months of 2011 we invested $1.4 billion, about 65% in Europe. We’re buying from the European banks, and our average purchase price is about 60% of face value. Europe today is like J.F.K. airport at rush hour, and all the commercial banks are lined up to sell their debt.
What does it take for sovereign risk to come off the table? Are European policymakers doing the right thing?
In a slow, creeping, and sometimes backdoor way, there is a socialization of the European debt problem taking place. At this point, you can’t just go this slowly for the next 12 months or 18 months. Things come to a head — they’ve already come to a head. And we think you’ve got to make some decisions over the next three or four months. You’ll see support for Italy and Spain, and you’ll see systemic risk come off the table. Anytime you try to get 17 people to do things, there’s always a nutty chance, a tail chance, that there’s an accident. But our central case is, essentially, the Germans and the French, and maybe the IMF, and maybe the U.S. and China, writing checks to have systemic risk come off the table. An Italian default would shudder through and devastate the financial system, and avoiding it, I think, is not just a European issue, but a global issue.
Europe comprises many different countries, with a variety of risks and regulations. Where are you buying?
Our focus has been Britain, Germany, Scandinavia, Switzerland, and northwestern Europe. That accounts for about $700 billion of Europe’s $1 trillion high-yield market, and it’s a world where there’s the right set of bankruptcy laws and restructuring codes. In 2010 we did a debt-equity restructuring of Oerlikon, which is like a small GE (GE) of Switzerland, in four months. In the right jurisdictions in Europe, you can do these restructurings. That’s not true for France or Italy, or in the peripheral countries where the economies are really damaged.
Are you seeing opportunities outside of Europe too?
It’s not as extreme as ’08, but we have seen prices crash globally in the last six months: High-yield bonds are at the same level as during the Asian crisis in 1998. With distressed debt, we think the price moves are so steep that it’s down to 2002 levels. While Europe is really interesting, the game in the United States has also changed.
Where are you buying in the U.S.?
We’re looking at infrastructure, the business of ports and toll roads. We’ve invested in distressed debt in the Port of Newark and the Port of Baltimore. And at Boston Logan Airport, we bought a significant amount of debt. These are quasi-monopolistic assets with somewhat predictable cash flows over long periods. We like old-economy businesses with a lot of hard assets. Infrastructure is clearly one of those businesses; power is a second one. A third sector has just emerged, and that is airplanes and airlines. We don’t particularly like airlines, but we like airplanes, and withAmerican Airlines now in bankruptcy, we think there’s a very interesting opportunity to buy distressed debt on airplanes or on the slots at the gates at airports.