(Bloomberg) — Since 2009, when Jason Mudrick set up his fund Mudrick Capital Management, the world of distressed debt investing has seen three major changes: private equity plays a larger role in the economy, low rates have encouraged highly leveraged capital structures across sectors and there’s weaker financial documentation.  

Traditionally, distressed debt opportunities have emerged when the economy wobbles or specific industries face challenges. But the hike in interest rates in 2022 following a boom in leveraged buyouts stressed companies across sectors, as a majority of firms did not correctly hedge rate risk, Mudrick said on Bloomberg Intelligence’s Credit Edge podcast. 

“The beauty of this is it impacts all borrowers, not one industry,” said Mudrick, the chief investment officer of Mudrick Capital. “So we have a very diverse opportunity set, which is very unique to this cycle.”

The rush of LBOs came with weak debt documentation, which have allowed companies to move around assets and to pit creditors against each other in an effort to raise more liquidity or reorganize their capital structure outside of bankruptcy court, a maneuver known as a liability management exercise. 

These type of transactions have elongated the distressed cycle, according to Mudrick, as they often involve distressed debt exchanges, which ratings firms consider a default. That then pushes other investors to sell their holdings.

Previously, “the success or non-success of your investment would ultimately determine on whether you got the valuation right,” said Mudrick. “Today it’s more complicated. You have to value the business, you have to understand the capital structure today, but you also have to understand how that structure may evolve.’

The conditions that determine whether a restructuring will give creditors equal treatment or not has also changed. 

“We used to think it was really driven by the sponsor. Some sponsors were more aggressive, others were known as being more friendly,” said Mudrick. “That’s not the case anymore. It’s so normal to do non-pro rata transactions that I think almost every sponsor out there will consider them.”

As an example, Mudrick mentioned Tropicana, which is majority owned by PAI Partners. The private equity firm has a reputation of being a friendly sponsor and yet did a non-pro rata restructuring earlier this year, he said. On the other hand, Cision has done a consensual deal, though it’s owned by Platinum Equity, which historically has had a very aggressive reputation in the space, he said.

“You have to evaluate what does the company need, how important is the discount capture, and how important are other things like liquidity needs or maturity extension,” according to Mudrick. 

Once a company has gone through a liability management exercise, it’s unlikely that it conducts a second one, he said. Creditors often times rework covenants as part of the negotiations, which can limit potential options for the company if it struggles again. That makes the post-LME opportunity “particularly compelling,” Mudrick said. 

Click here to listen to the full conversation with Jason Mudrick at Mudrick Capital Management. 

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