How I Invest with David Weisburd
E139: How HIG Went from $75 Million to $67 Billion AUM
Tue, 18 Feb 2025
In this episode of How I Invest, I engage with Jackson Craig, Managing Director and Co-Head of H.I.G. Bayside's U.S. Special Situations and Distressed Debt Strategy. With over 20 years of experience in private equity investing, Jackson shares his expertise on navigating distressed debt markets, building resilient portfolios, and uncovering hidden opportunities in complex financial situations. From sourcing distressed assets to managing risk, Jackson offers a masterclass on investing in challenging environments.
Chapter 1: How did HIG grow from $75 million to $67 billion in AUM?
You've been at HIG for 16 years and the firm has really grown through your tenure. Tell me about how HIG has grown over the 16 years that you've been there.
HIG is a platform. Starting in 1993, 75 million first fund, very strong performance. Fast forward to today, 67 billion in assets under management, 19 offices, over 500 investment professionals. And in addition to private equity, a fully developed alternative credit platform with both the stress debt and direct lending, a real estate effort, an infrastructure effort, and a growth equity effort.
And all of those in US, Europe, and Latin America.
HIG has really grown from a small private equity fund decades ago to the $68 billion behemoth today. How did HIG grow?
First and foremost, performance. And so very strong performance, especially in the flagship equity product, top decile for a number of years, really, really strong investor demand that allowed the firm to say, okay, we can raise more capital. Investors are asking us to manage more money, but we don't want to lose our discipline. We don't want to grow out of our space. How do we accomplish that?
We need to grow geographically. We need to grow into adjacencies. And so that's what they did. They really grew, grew laterally into these strategies. and then geographically first into Europe and then second into Latin America.
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Chapter 2: What is distressed debt and how is it defined?
So you're co-head of HIG's distress strategy. What is distress debt?
Good question. The traditional definition of distress debt is debt with a yield 1,000 basis points or more greater than the reference treasury. So what do I mean by that? For a five-year corporate bond, if the five-year U.S. treasury is yielding 4%,
that corporate bond would need to have a yield of 14%, 10 percentage points, 1,000 basis points greater than the treasury in order to be considered distressed. That's the benchmark that people use to distinguish between that debt's the distressed and that's not. That's where people draw the line, which might ask you to beg the question, why would debt have such a high yield?
It's really in yields that start to approach what you would expect to see for total returns on equity securities. The reason for that is, a perception of the probability of default and an impairment of recovery. So is this debt going to pay interest for the full life of it? Maybe, maybe not. The borrower's a little shaky.
Is value going to be sufficient to cause this debt to be repaid and pull at par in cash on or before the maturity date? Maybe, maybe not. The borrower's a little shaky. And so that increased perception of risk, that increased probability of default is what causes debt to trade at these very high yields.
I'm very intrigued. You said the perception of risk on an HIG portfolio. How much of the portfolio are you expecting to go to zero? How much to pay back? And tell me about how you construct a portfolio around that.
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Chapter 3: How does HIG construct a resilient portfolio?
Yeah, it's a good question. We have a pretty specific and distinct approach to investing. And so our hit rate is very high. And when we do take losses, they tend to be fairly light. Very rarely, maybe once or twice in my 16 years here, maybe less, have we lost all our money. We focus on first lien debt, so top of the capital structure, first in line in the waterfall to get paid off.
We focus on debt that we think is maybe outside of debt capacity, but inside the total enterprise value of the borrower. And so while there's some equity risk to it, we think the totality of the enterprise value is sufficient to cover our debt. Our model is much more focused on the safest, least risky top of the capital structure and try to buy things inside of enterprise value.
Just to simplify that, you might have a company that's worth $500 million and has $100 million in debt. You're nowhere near the $500 million in equity value. So even if the company goes down equity value, you're still going to get paid back.
Exactly right. And so prototypical capital structure, if it's a healthy, stable business, debt capacity might be 60% to 70% of total enterprise value. Well, if the face amount of the first lien debt that we're looking to buy constitutes 90% of the enterprise value. We've got a 10% equity cushion beyond the face amount of the debt, and we're purchasing it for something significantly less than that.
But if we're buying it at, say, 80 cents, a portion of our cost and certainly a portion of our claim is in the equity part of the capital structure, that junior tranche.
And being first lien debt, who's senior to you and who is subordinated to you?
In almost every case, no one will be senior to you. You're top of the capital structure. You're first in line.
Even bank.
The bank is typically that first lien debt. And so bank debt is where we focus. Then you're going to have most times junior debt being a second lien piece of paper, an unsecured piece of paper. Maybe it's converts. Maybe it's MES, what have you. And then the equity tranche.
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Chapter 4: What strategies does HIG use to source distressed debt opportunities?
And then when we find an opportunity, we'll work with those teams to really understand it at a granular kind of ground level, talking to an operating team that oftentimes is in that industry. And so the HIG platform, the portfolio, and all the expertise and experience that we have is the third area we focus on for sourcing and probably the most important.
Let's say that you talk to the management teams at HIG and they've highlighted a couple companies. What do you do next?
From there, we're going to go look at the lender base. We're going to get information either from the lenders or other sources, understand the financial picture. And what we look for is either the existence or the expectation of a dynamic to develop. that we would expect to cause lenders to sell debt to us, ultimately at a discount. That's key. Ultimately, we buy debt at a discount.
In order to do that, someone has to be willing to sell it to us. And so you have to find those situations and circumstances where those conditions exist, or you can reasonably expect them to exist. And so we spend a lot of time on that. That's heavy modeling and heavy diligence. Because the companies aren't a party to the transaction, We can't just call up the CFO and ask him 100 questions.
They don't have a data room available for us. There's a real element of detective work or investigative journalism to what we do to build a body of facts to be able to derive an investment decision from, an investment thesis.
Once we've done that, we'll either reach out to lenders, usually through an intermediary, or if we're right in the way the situation's developing, frankly, they're reaching out to us, and then we'll start to negotiate to purchase debt.
You have this almost paradoxical situation where you're trying to build relationships through distressed sales. It's almost a paradox, right? You think of distressed sales as very zero sum situations, but you've built this ecosystem of relationships, of repeat business. How do you manage the needs of the immediate transaction with the overall relationships?
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Chapter 5: How does HIG manage relationships in distressed sales?
That's our discipline to prevent ourselves from kind of recasting the thesis as subsequent events unfold.
You've been in this asset class for 27 years, 16 of those at HIG. What are the characteristics that make somebody great at distressed debt?
Good question. I'd say two things. One is, and this is going to sound counterintuitive maybe, you need to be a little bit of an optimist. Every distressed situation is bad, right? It's not called everything's great. It's called distressed for a reason. There's going to be some problems.
And you have to be kind of in a level-headed way able to look at those problems, acknowledge them, but also see beyond them to the potential or see beyond them to other pockets of value. And so it takes a certain level of positivity. It's very easy to look at a bad situation and say, that's bad. I don't want to touch it and move on. But no one gets paid to be a professional deal assassin, right?
No one's interested in someone who only kills deals. We're hired to invest our LPs money. And so we need to find opportunities. invest. And that takes a certain level of creativity, takes a certain level of optimism. And then the second characteristic I would point to that I think is pretty important, besides the basics of kind of intellect and rigor and discipline and all that, is curiosity.
And so you have to be curious as to, okay, why is this business the way it is? And why did they do that thing that turned out to be not so good? And what is the reason that this happened? And so just that desire to just that niggling itch to go figure something out. Like, why is it this way? And it might appear obvious, but maybe it's not obvious. And I don't quite understand this.
So I got to keep pressing because it's bugging me. People outside the industry or maybe new to the industry will say, well, I'm looking for good businesses with bad balance sheets. Okay, that's a myth. Like that debt was put there for a reason. And it was incurred based on a set of representations and promises that weren't met. And so why did that happen, right? Why was someone wrong here? It's
Too much debt just doesn't magically appear on an otherwise good and stable and growing business. It's there for a reason. Understand why. And now you're on your path to making a good debt investment.
It's a mix of right brain and left brain thinking.
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Chapter 6: What is the impact of tax efficiency on HIG's LP base?
What's maybe not as obvious, but I think important, and especially in our asset class, is diversification by causal factor. And so maybe I'll, by example, in 2015 and 16, the energy sector, the oil patch in the U.S. rolled over. Supply-demand imbalance, energy prices fell, profitability of energy-related firms fell. Sponsors have been very active in that.
Energy is a good place to borrow money and have been a good place to lend money for a long time. And so in 2016 in particular, the addressable universe of distressed debt opportunities was disproportionately weighted towards energy. And so when you look at energy companies, they fall into broadly four buckets. You've got upstream, which is natural resources, stuff in the ground.
You've got downstream, which is refining in pipelines. You've got service businesses that can be fracking businesses. It can be water businesses. It can be staffing businesses that help support both the construction of wells and then getting the product out of the ground. And then you've got manufacturing businesses where perhaps a disproportion of their end markets are energy related.
And so in 2016, you've got four different quote unquote industries there. Well, if you made six to eight investments in each of those four industries amongst companies that were active in that space and distressed at that time, you would say, okay, I've got 24 companies and they're diversified across four different industries. That's a pretty diversified portfolio. I feel decent about my risk.
And then if natural gas went to a dollar, every single one of those companies would be in trouble. And you'd find out that while you had, you know, on paper diversification, you had a concentration of 100% to this one causal factor. which is the price of the natural resource and a correlation of risk in your portfolio that you really are unhappy about at that point.
And so that's something that we look at pretty closely and try to make sure. The reason it's important for our asset class is because of something I touched on earlier, where distress tends to rotate from sector to sector.
And so if you're deploying capital outside of a credit crisis, maybe two or three industries are having a hard time at any given moment because some macroeconomic factors out of whack or something else happened. And so because of that dynamic, it's easy to find that causal factor concentration because that's what caused these companies to become distressed in the first place.
And so you have to work pretty hard to avoid it. And so that's something that we really spend some time thinking about and making sure we don't have excess exposure to. Energy prices is an easy one. Interest rates is maybe even an easier one. But things like wage inflation are a little more pernicious, home building rates, mortgage rates, what have you.
there's a number that cut across where you say, okay, I don't want too much exposure to that dynamic, to that causal factor.
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Chapter 7: How does HIG ensure investment thesis discipline?
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I'm not sure that I didn't know it, but I probably believe it more strongly now. Just a laser-like focus on the quality of the business. I probably attach more importance to the quality and stability of a management team than I did 16 years ago when evaluating a company. I've just found that that's an important factor.
There's no line for it in your spreadsheet, in your financial model, but it's something that... And so if you're looking at a distressed company, one of the first questions I'm going to ask is, what's been the recent turnover in the management team? And if the CEO has exited in the last four months, that business isn't doing well. I don't care what's going on.
You don't swap out your CEO unless you're in somewhat desperate straits. That's an incredibly disruptive move. It puts you back on your timeline as a private equity sponsor at least 12 to 18 months, if not longer. It's something you do when you absolutely have to, not if you want to.
And so if you see a company that's undergoing CEO or CFO turnover, you need to be fairly cautious in approaching that because things are not good. And so that's a factor I probably didn't give enough weight to earlier in my career that I pay more attention to now. And really just a laser-like focus on the fundamentals. What are the unit economics? What's going on in the industry?
What is the competitive position? What is the capital efficiency? I mean, some of the basics that everyone kind of espouses, but they're very, very important.
What's something that you thought was important 16 years ago that's not that important today?
Some of the tricks and traps of the bankruptcy process. If you're a clever, distressed investor, you can do some neat kind of clever maneuvers inside a bankruptcy court to maybe position your debt a little more favorably or try to squeeze out some other holders or slip a term in there or apply some capital at just the right moment to create an edge. And that feels good.
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Chapter 8: What makes someone great at investing in distressed debt?
Another thing that's compounded, and really we've piggybacked off the growth of the firm, there's real scale benefits involved. to being part of a larger alternatives firm. We just have access to a much deeper and wider information net, data set than we would if we were independent. And so as the firm has grown, that advantage has grown. So that's something that's scaled.
We are getting better and better every year at taking full advantage of it. We're a pretty networked firm and a very collaborative firm, but we're also a big firm. And so getting to every single person who knows every single thing that you want to know can sometimes be a challenge. And we're getting better at that. So those are two things I'd say that have scaled.
One thing that hasn't scaled is sourcing. I mean, going and finding deals, every day is a new day, every day is a new challenge. Finding deals is frankly not that hard in our space. Finding good deals and good value really is.
What would you like our audience to know about you, about HIG or anything else you'd like to share?
I think we have a pretty distinct identity as one of, if not the preeminent, alternative firms in the small and mid-cap space. We've got a long-standing culture of value orientation and cash flow-centric investing. We gravitate towards complexity. That goes hand-in-hand with being a value investor. And we have a pretty distinct approach and culture.
At the end of 2023, and we got a large number of our LPs together, it was very well attended, it was a great event, a lot of fun, and at that, each strategy presented to our LPs, you know, here's who we are, here's what we're doing, Here's what's going on in our market, and here are some representative transactions to give you a flavor.
And then we had a number of our portfolio companies come present as well. And it was very well received by our investors, but we did get a piece of constructive criticism, which is, as each strategy presented, they kept saying the same thing over and over again in terms of how they approached investing, what they gravitated to.
small and mid-cap, value-oriented, cash flow-centric, seek out complexity. And by the end of the second day, the LPs are like, guys, time out. We got it. You don't need to say this for the 12th time. And it wasn't something that we did with forethought.
It's just a natural result of each fund and strategy putting together its own presentation and having this commonality of approach and culture across strategies and geographies that made it a little more redundant than maybe we wanted to So it was kind of funny, but also it was a little affirming that as the firm has grown, we've been able to keep that culture pretty constant.
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