A new type of investor smells opportunity in the struggling auto-supply industry, one willing to put money at risk but expecting quick and high returns: hedge funds.
Not only are these funds buying and selling publicly traded debt, they're making investments, such as angling for ownership of supplier Intermet Corp., which has filed for Chapter 11 bankruptcy protection.
According to published reports, a few hedge funds - including Soros Fund Management LLC and Davidson Kempner Advisors Inc. - hold second-tier secured debt for supplier Meridian Automotive Systems Inc. of Dearborn, Mich., which is in Chapter 11 reorganization. New Venture Holdings LLC of Fraser, Mich., the post-Chapter 11 version of Venture Holdings Co. LLC, has a hedge fund included in its ownership group of about a dozen financial institutions.
Hedge funds often buy positions in the company's debt and look to cash out if the debt trades higher or if the company is sold. In the event of a bankruptcy, these funds sometimes look to acquire ownership by pumping money into the company.
Although hedge funds have been growing for several years - there's an estimated $1 trillion in hedge fund assets, according to Hedge Fund Research of Chicago - they are relatively new players in the auto industry, bankers say.
But they see auto suppliers at the bottom of a cycle, and sources of traditional loans are drying up, says Dave Eberly, senior managing director of investment banking firm Beringea LLC in Farmington Hills, Mich. Hedge funds strike when they think the value of a company's traded debt has bottomed out but could rebound, he says.
But the auto industry has more complex supplier relationships, and what worked for steel and airlines won't necessarily work for suppliers, he says.
While some argue that hedge funds provide money to a stressed industry, others say their short-term outlook could harm relations with automakers who look for stability when awarding long-term contracts. Hedge funds look to cash in on their investment faster than private-equity funds.
Private equity typically has a five- to 10-year plan. Hedge funds seek a turnaround of two years or less, Eberly says. Hedge funds also are aggressive in collecting accounts receivables and pressuring customers on price, he says.
"Is that the kind of relationship you want coming out of bankruptcy?" Eberly asks. "If hedge funds step in, the automakers are not going to award suppliers new programs. The uncertainty will disqualify them from plum platforms."
Others say that though that's a concern, hedge funds can be a big help.
"It's a bit of a dichotomy," says Kimberly Rodriguez, managing director at Stout Risius Ross Inc. in Farmington Hills and a turnaround consultant who works with suppliers. "They can be a good thing. They can support difficult changes in direction. They can be a welcome force.
"On the other hand, hedge funds can be very short-term focused. They can artificially make a firm financially buoyant. The long-term survival of the entity isn't necessarily their key concern."
Rodriguez calls their inexperience in the auto industry "troubling."
General Motors and Ford Motor Co. wouldn't comment on hedge fund activity in their supply base. Markus Mainka, manager of procurement communications for the Chrysler group, says the trend is "no significant issue."
The fight over Intermet's reorganization is a prime example of both arguments. Two hedge funds, Stanfield Capital Partners LLC and R2 Investments, proposed a $75 million investment in Intermet of Troy, Mich., in return for a majority of its new stock. Both funds own about
$79.5 million of Intermet's $175 million of bond debt. The deal would have put money into Intermet without adding to its debt.
U.S. Bankruptcy Judge Marci McIvor denied the proposal, primarily on procedural grounds, but Intermet can file an amended motion.
The fees proposed to the hedge funds were part of the objections, as was the amount of ownership they would take for the price. The proposal called for commitment fees and breakup fees that could have totaled $5 million. Under the proposal, the debtors would have owed the hedge funds $1 million the day after a deal was approved by the court.
No hedge fund contacted would comment, including Stanfield Capital Partners of New York. R2 Investment's parent, Q Investments AG of Zurich, Switzerland, couldn't be reached for comment.