AVCJ: Bain Capital refills special situations reserves, prepares to go against grain

AVCJ by Mergermarket

• Global special situations fund close rounds off USD 9bn pool including Asia, Europe vehicles
• Strategy is based on occupying areas beyond private equity, credit, real assets, public markets
• India, Korea, Japan angles underline importance of pivoting between opportunities, geographies

Link: https://mergermarket.ionanalytics.com/content/1004140592

Bain Capital’s special situations team has utilised most of its tools in India over the past six years: from distressed and rescue financing following the country’s bankruptcy reforms to opportunistic lending during the non-banking financial company (NBFC) liquidity crisis to structured solutions for real estate developers caught short during COVID-19. Now, though, the economy is strong, and everyone knows it.

Pursuing value in a notoriously expansive market has taken the firm to some unorthodox places, perhaps none more so than music and movie rights.

Working in partnership with a team from a local TV production house – Bain is preferred in the capital structure but also shares in the upside to drive alignment – it is picking up assets that can be leased to domestic and foreign streaming services. The investment is predicated on the fragmented nature of the content landscape, the size of the Indian market, and the large untapped streaming user base.

“We are often able to lease back at a price where we return our principal plus a profit almost immediately. The lessors get it for 4-5 years and we own the residual, which we think will see significant appreciation given the demographic trends in India,” said Barnaby Lyons, a partner and global head of special situations at Bain.

“We are benefiting from long-term consumer tailwinds, but it’s off the run and non-competitive.”

The approach to India, where Bain is also involved in the previously overlooked co-living accommodation segment, reflects an ability to pivot. Guided by three core strategies – capital solutions, hard assets, and opportunistic distressed – the special situations team flips between debt-like instruments and structured equity, corporate restructurings and data centres, public and private markets.

The pivot applies geographically as well. Bain’s special situations business was born in Asia when Lyons and David Gross, now the firm’s global managing partner, sat down and mapped out what it should look like in a market where immature capital markets were creating opportunities that sat in between traditional interpretations of private equity and private credit.

However, it was always envisaged as a global platform. Within 12 months of closing a debut Asia special situations fund on USD 1bn in 2018, dedicated European and global vehicles were raised. Capital commitments for the entire vintage – including various separately managed accounts – amounted to USD 7.4bn. The global vehicle participates in deals alongside the relevant regional fund.

Bain has now concluded fundraising for the second vintage following the close of a global vehicle on USD 5.7bn, against a target of USD 4bn. The overall total is USD 9bn, including previously closed funds focused on Asia and Europe. This capital will be deployed by a 140-strong team across 20 offices, confirming Bain’s status as one of few platforms to achieve scale in special situations globally.

“The strategy resonates with LPs because people understand the relevance of a GP that can provide companies with much of the same strategic value add as private equity – we have a 35-person portfolio group – but can do it in a structured non-control format, in a way that can be more flexible,” said Lyons.

“This approach also allows us to create deals that have both downside protection and upside – a unique combination.”

Global to local

Asia accounts for about 40% of Bain’s special situations investments since 2018, closely followed by North America and then Europe. However, some of the most interesting recent deal flow encompasses multiple geographies. IMS Nanofabrication – owned by US-based Intel Corporation [NASDAQ:INTC], run by a management team in Austria, and largely serving an Asian customer base – is a case in point.

Intel reached out to Bain’s private equity team last year to gauge appetite for a 20% stake in the semiconductor supply chain business, which it was thinking about spinning out. While the company appealed, the deal structure did not. The target valuation of USD 4.3bn seemed high for a situation with no governance control and a business that would be hard to finance because of its lumpy earnings.

The private equity team referred the opportunity to their colleagues in special situations who proposed an approximately USD 1bn deal whereby Bain would buy 20% but sit ahead of Intel in the capital structure with a guaranteed low-double-digit return and some equity upside. It also offered strategic support through operations professionals in Europe and customer coverage in Asia.

“We have great risk-reward: a strong underlying company in a growing sector, an investment-grade parent in a junior position to us, a floor return, and a target return that represents a multiple of money,” Lyons explained. “It’s neither a natural private equity deal nor a natural credit deal, but it has elements of both. We were able to get this because of the partnership approach.”

Though unusually large, the transaction bears two familiar characteristics. First, Bain’s desire to operate beyond the reach of private equity, private credit, real assets, and public markets, albeit by providing solutions that may feature aspects of each one. Second, investment opportunities seldom arise from inbound enquiries. Rather, they are referred by other strategies or directly originated.

For example, the special situations team reached out to Canada’s CI Financial [TSE:SIX] on seeing an IPO filing for one of its subsidiaries, registered investment advisor (RIA) platform Corient Private Wealth. On learning that CI wanted to raise capital to support Corient’s M&A-driven expansion, Bain suggested an alternative to listing in suboptimal conditions: issuing USD 1bn in convertible notes.

This was effectively a private credit replacement that appealed to CI because the instrument has no maturity, so it wouldn’t have to be recognised as debt, and the premium attached to the conversion price would play well with public market investors. For Bain, the deal offered a minimum contracted return tied to a business carrying limited bank debt and the prospect of equity upside upon conversion.

“We are seeing more non-sponsor transactions globally, and increasingly they involve large, investment-grade corporates that want scale capital and partnership,” added Lyons. “This has taken time, and education. Macro drivers have led people to engage more, but the acceleration in the last 4-5 years is also the result of people being educated as to the value of what we do.”

Grasping Asian nuance

While vertical expertise drawn from the entire Bain platform is the primary calling card for special situations in North America, in Asia scale remains the key differentiator. With local teams across the region, the firm is not beholden to any one geography or deal type. Australia, like India, is relevant to all three core strategies. In South Korea and Southeast Asia, it is capital solutions. In Japan, it is hard assets.

The respective dynamics in Korea and Japan – corporate restructuring is the key opportunity in both markets – speak to the nuances that interest Bain. In Korea, the firm is providing structured solutions for chaebols that need capital and operational support for growth initiatives at home or overseas. In Japan, it wants to help conglomerates realise value by reorganising their real estate portfolios.

Four years ago, Bain’s private equity team acquired Showa Aircraft Industries, a Japanese manufacturer of aircraft interiors that had expanded substantially into real estate. There was no local special situations presence at the time, so various Bain talents contributed to a gradual divestment of these assets, locking in a sizeable return separate to what might be achieved with the core manufacturing business.

Now staffed up in Japan, the special situations unit is keen to participate, either working alongside their private equity colleagues – this happens relatively infrequently globally given the differing risk-return profiles, but it can lead to outsize returns on the special situations side – or acting independently.

“In Japan, corporates own a lot of real estate directly and it is often undermanaged and undervalued. This creates an interesting opportunity for partnerships between our private equity and special situations teams,” said Lyons.

“Even if there isn’t a corporate angle – for example if the company is under activist pressure – one way they can release value is by selling down non-core real estate. Some of these books are enormous and they have many different asset types, so it plays into the special situations skillset and mindset.”

Broader market conditions are arguably making this mindset more relevant, but special situations opportunities are the product of structural as well as cyclical factors. Bain went heavy on European data centres when other investors were looking at the US; it also bailed out aviation companies during COVID-19. And to Lyons, the “human capital footprint” is of paramount importance in origination.

“Capital solutions is a structural opportunity but also one that has been accentuated by the current capital markets pullback and the rate environment,” he added.

“Distress is more of a cyclical opportunity, and it isn’t really our focus right now. Hard assets is somewhere in the middle: in some areas people are struggling; in others – from European data centres to India co-living – we see strong fundamentals.”