A Vulture’s Full Plate

Howard Marks spent two decades trying to get all the things he really wanted in his career. When he had had it with the pace of his native New York, he got permission from his boss to move to Los Angeles. Souring on working for a bank, he quit to join a money management firm. Tired of being an employee, he started his own business. Now, with the market for his services booming for the first time since he began Oaktree Capital Management LLC seven years ago, he would seem to have it all.

“Things are great,” Mr. Marks, one of the biggest vulture investors, says of the bankruptcy explosion. He especially likes the bargain-basement prices that have come with the supply surge — and he’s been buying. Indeed, he claims to be the largest holder of bad bank loans, which make up $2 billion of his nearly $7 billion distressed-debt portfolio.

But it may be too much of a good thing. Vultures in this bankruptcy cycle, which features among others Enron Corp., Finova Group Inc., and Sunbeam Corp. — Oaktree has investments in all three — face unusually difficult obstacles to making money, and Mr. Marks, a quick-turnaround expert, could be stuck with a lot of bad debt. Oaktree then might be limited in the amount of additional bad debt that it could buy from lenders.

“We have a disagreement with Howard” on what it takes to succeed in the current environment, says Wilbur Ross, the chairman of New York-based Wilbur Ross & Co., another vulture firm, which used its debt holdings in LTV Corp. to acquire the bankrupt steelmaker two weeks ago. “You have to be really prepared to get in and change the company. They have not tried to get inside. They mostly try to fix the balance sheet.”

From his perch in his immaculate white-marble office high above downtown Los Angeles, the 56-year-old Mr. Marks differs with the doubters and says that not even the Enron case gives him pause.

“Wilbur invests in troubled companies which require more management than the companies we invest in,” Mr. Marks said. “The money management approach we’ve used is highly accurate and I don’t see any need to change.”

Still, he acknowledges that some recent undertakings, most notably Enron, will involve more time than some of his prior projects.

“Enron undoubtedly will take longer than most,” says Mr. Marks, whose firm has a seat on the crucial 15-member Enron creditors committee along with Citigroup Inc. and J.P. Morgan Chase & Co. “It’s a complex situation. We anticipated that it would take longer.”

But though the pickings are bountiful and cheap, and he’s prepared to wait while companies rehabilitate, Mr. Marks and his firm will be put to the test.

“There are just not enough targets they can turn over quickly,” says Henry Miller, vice chairman in charge of restructuring at Dresdner Kleinwort Wasserstein. Forced to go after ample but tougher targets, Mr. Marks and his firm “just don’t have enough bodies to stay on top of all those transactions,” Mr. Miller says.

Mr. Marks disputes that assertion too, and points to recent hires in the distressed debt group to buttress the point.

But at the least, Oaktree will be challenged to produce the double-digit gains it is shooting for and has hit in simpler, if leaner, bankruptcy cycles.

To be sure, no one could have anticipated the carnage and controversy that began in early 2001, when half of the last two decades’ 10 biggest bankruptcies took place, according to Bankruptcy.com. But the quintet’s pre-Chapter 11 assets of $140 billion is only part of the story. Last year $680 billion of distressed and defaulted debt traded hands, according to Edward Altman, a finance professor at New York University, compared with $650 billion in 2000, and it’s widely expected that the peak won’t be reached until later this year.

Vulture funds operators have built their war chests to $45 billion — from $25 billion two years ago — and many have a more attacking style than Mr. Marks. So while distressed-debt prices are down — 60 cents on the dollar last year — because of the ample supply, they might not be as low as they would be if there were fewer bidders.

Tougher competition can also hurt once Oaktree is on the inside as creditors fight for their share of the assets. The legal roadblocks and illusory valuations that dog Enron and other big meltdowns add to the concern that even the senior debt that Mr. Marks favors will be worth much less this time around. All these factors put pressure on his profit margins.

Still, Mr. Marks is a force in the graveyard of capitalism. He has beefed up Oaktree’s staff in the last couple of years to more than 200, including 17 professionals in distressed debt. And he has increased its portfolio — which also includes junk bonds and even active equity stakes in some companies on life support — to more than $22 billion. Perhaps more important is that he has gotten the job done many times before.

Growing up in middle-class Forest Hills in the New York borough of Queens, Mr. Marks knew all about debits and credits and risk. The son of an accountant, he was a regular cardplayer from the time he was in junior high school. He majored in accounting at the University of Pennsylvania’s Wharton School and minored, unofficially, in bridge, casino, cribbage, gin, poker and whist.

“Those years were very busy,” he says.

Two years after his 1967 graduation from Wharton, he earned an MBA from the University of Chicago and became an equity analyst at Citibank. He settled into his career and life, rising to director of equity research and marrying, before taking a big leap into something new in 1978.

“Around September, the bank was approached about running a high-yield bond mutual fund,” he says. “Remember, this was 24 years ago, and nobody had heard of the junk bond world — then only $2.5 billion of the total. They said to me, ‘There’s something called high-yield bonds, and the leading figure is some guy named Milken at a small brokerage firm in Los Angeles. Would you take it on?’ Of course I did, and that was a lucky moment for me.”

Becoming one of Michael Milken’s customers led to trips to Los Angeles. Mr. Marks grew to like the life there and thought it would be good to work on the West Coast.

“Many times we view New York as being preoccupied with what’s going on in the financial markets at the moment, making it easy to not see the whole picture,” he says. “In California, we’re stepped back a bit, and I believe that gives us more perspective.”

In 1980 he persuaded his boss to let him move to California and still head Citibank’s junk bond operation, which remained in New York. It was not unlike Mr. Milken’s transfer of Drexel Burnham Lambert’s junk bond staff two years earlier from New York to his native Los Angeles.

In 1985 Mr. Marks was ready to take the next step. Divorced from his first wife, he married a divorcee and mother whom he had known in college, and he left Citibank.

“You reach a point where you’re making huge amounts of money for the institution, but you’re not getting much of it,” he says.

His new home was TCW Group, a Los Angeles institutional money manager. Mr. Marks headed its junk bond department, which included distressed debt among its holdings, and was named the chief investment officer for debt and the president of TCW Asset Management Co.

But his experience with TCW wasn’t much different from his years with Citibank, and he left to start his own firm in 1995.

“He told me that for every dollar his group brought in, they were only allowed to keep 20 cents, because they were subsidizing the nonprofitable business at TCW,” says a fellow vulture investor. “Howard was in line to be president of TCW, but he left and took everyone in his group with him, because he wanted more control over his destiny.”

Mr. Marks denies that he complained about how TCW managed his group’s profits. But he acknowledged that autonomy was an issue.

“It’s natural to want to run your own show,” he says.

Defectors from TCW to Oaktree Capital Management included Bruce Karash, Sheldon M. Stone, and Richard Masson. They are, respectively, the firm’s president, head of junk bonds, and head of distressed debt.

More than 30 clients had switched $1.5 billion in assets from TCW to Oaktree just three months after it had opened for business, including the Pennsylvania State Employees Retirement System.

“It was the team with whom we were investing,” said Peter Gilbert, the retirement system’s chief investment officer, who signed on with Marks in the early 1990s. “Howard has the ability to make money from specialized market niches and he knows how to attract and retain very good people.”

To prevent a complete runoff, TCW — while publicly bitter about the defections — contracted with Oaktree to manage and ultimately liquidate about $2.6 billion of TCW’s “special credit funds” that had been handpicked by Mr. Karash and Mr. Masson.

Oaktree has spread its operations to New York, Tokyo, London, and Singapore. It has also expanded significantly in areas including distressed real estate, convertible securities, and corporate workouts. Its backers include corporate and public pension funds, insurance companies, endowments, and foundations.

Mr. Marks says his strategy in distressed debt is simple. He stays away from companies that require a lot of hands-on management. Those businesses he usually set his sights on have tangible assets — like manufacturers, retailers and truckers — that have solid business plans, but have taken on too much debt after overpaying for an acquisition using borrowed money or expanding too fast, outstripping demand. When the originators of that debt start looking for a way out, even if it means only getting pennies on the dollar, Mr. Marks starts looking for a way in.

“These are things other people have had problems with and they regret,” he says.

The trick, then, is to move in quietly.

“Stealthiness is very important,” Mr. Marks says. “These are illiquid investments where there is a finite amount trading in a small community. So if someone gets an idea that a major player is doing this or that, it can have a market impact. We have to assemble our position gradually over time, but we don’t want to be doing it at steadily increasing prices by our own doing, as would happen if everybody sees what we’re doing. If you have good discipline when you’re trading, if you have good relationships with the traders, you can accomplish.”

Often, his aim is to buy enough debt to get Oaktree a seat either at the negotiating table or on an eventual bankruptcy committee so as to have as much control as possible over what happens to the company. One out for him is to swap the debt for a piece of the company’s equity — in an effort to turn the company around and sell Oaktree’s stake at a premium.

Mr. Marks and Oaktree, in separate partnerships with the Denver billionaire Phillip Anschutz and the Canadian buyout firm Onex Corp., have bought up the debt of several major bankrupt movie-theater chains, including Edwards Theaters Circuit Inc., Regal Cinemas Inc., United Artists Theatre Circuits, and Loews Cineplex Entertainment Corp. After restructuring, they have wound up either owning a piece or controlling the companies.

“Some of these megaplexes were very profitable,” Mr. Marks says, “but then they borrowed too much money and built too many theaters. There just were not enough bodies to fill the seats.”

Not all debt positions are transformed so easily into equity, and this debt cycle has its share of corporate messes that can’t be easily mopped up.

Mr. Marks quietly started building his position in the energy giant months before Enron went bankrupt, acquiring enough debt (he won’t say how much) to win Oaktree a seat on the creditors committee. Any resemblance to a typical Oaktree investment, however, ends there. His firm has an unusual fight on his hands over assets of increasingly dubious value. Particularly noteworthy is the competition from a separate creditors committee established by the bankruptcy court for Enron personnel who lost money in their 401(k) plan.

The appointment of that committee “was probably a blow to Oaktree’s position,” Lynn LoPucki, a professor at the University of California at Los Angeles Law School. “This gives the employees more leverage, and that makes them a major player, whereas they are a minor player in most cases.”

Mr. Marks, though, says Oaktree will plow ahead no matter what obstacles are thrown in its way. This tenacity has worked in the past and he expects it will continue to work. Last year, returns for his distressed debt and junk bond portfolios, which together account for about two-thirds of Oaktree’s assets under management, were about 14% and 7% respectively. That’s not in the same league as private investment funds that stick to equity, but Mr. Gilbert, who has $400 million in Pennsylvania dollars in Oaktree, isn’t complaining.

“They may not be the highest returns, but they’re consistent,” he says.

Mr. Marks attributes Oaktree’s consistent returns so far to a cautious investment strategy — even though it specializes in very risky instruments — that goes beyond senior debt in distressed situations. He invests no more than 5% of Oaktree’s funds in any one company. On the high-yield bond side, Oaktree avoids the lowest-ranked junk, so Mr. Marks has only had to deal with a handful of defaults.

“Others try to go for home runs and get blown up,” he says.

Mr. Marks insists that the perception that today’s barrel has too many rotten apples is distorted.

“There are more good companies with bad balance sheets than people think,” he says. “There’s no sea change going on.”

He includes in that category Conseco Inc., the insurance and consumer finance firm, and Finova Group Inc., two of his current positions.

Timothy J. Gramatovich, the president and chief investment officer of Peritus Asset Management Inc. in Santa Barbara, Calif., agrees that Mr. Marks and his team have the tools to get what they need from their positions.

“Their business is not only finance, but it’s also an understanding of bankruptcy law and bankruptcy codes, which can get pretty arcane,” Mr. Gramatovich says. “It’s also an understanding of operations at a much deeper level.” This understanding enables Mr. Marks to price accordingly at the outset and then clean up balance sheets if the companies survive.

Mr. Marks, a fastidious sort known for bringing his own wheat germ to breakfast with colleagues in restaurants, has never personally sat on bankruptcy committees or finagled his way into negotiating rooms. Still, Mr. Gramatovich says, his influence is apparent in the work of his staff.

“I find Howard to be among the smartest people in the business,” he says. “He has a depth of knowledge that only experience can bring. Guys who have been in that business for more than 20 years have scars, and scars bring wisdom.”

But Mr. Marks admits that this latest downtick in the economy brings challenges he hasn’t seen before in the distressed-debt world.

“I think the arena is better and more thoroughly populated today versus 12 years ago,” he said. “You’d like to have a seller to yourself, but the room is becoming increasingly crowded and more of the participants are sophisticated. So the probability of finding bargains goes down.”