What it means
Tepper began his career in finance in the 1980s, including a spell in the debt trading area at Goldman Sachs, where he worked on the securities of companies in financial difficulty. He founded Appaloosa in the early 1990s.
The firm specialises in distressed and special situation investing, plus a broad range of other strategies. Distressed investing means buying the bonds, loans or shares of companies that are bankrupt, near bankruptcy or out of favour with investors.
Prices of such assets often fall below the value that careful analysis suggests, because sellers are forced to sell or are simply afraid. Investors who can analyse the legal position, the cash flows and the likely recovery can profit if the company recovers or its assets are worth more than the price paid.
He is widely remembered for his reasoning during the 2008 financial crisis, when he bought shares and bonds of large banks at deeply depressed prices, betting that government support would stop the system from collapsing. When the banks recovered, Appaloosa made large gains.
The episode is often used to teach how fear can push prices well below reasonable value. The lessons for business readers are about risk and timing.
Buying when others are fearful requires cash, patience and a high tolerance for volatility, and it can go badly wrong if the analysis is flawed. Few people have the capital or the nerve to apply the approach, and even experts find it hard to judge the bottom.
The nuance is that the popular story focuses on winners. Distressed investing involves many failures along the way, positions can take years to resolve, and fund performance varies from year to year.
Learn from the method of analysis and the discipline about risk, not simply from the headline success. Position sizing is a recurring theme in this style of investing.
Because any single distressed holding can fail completely, managers spread capital across several positions and keep enough cash to survive losses. The same thinking applies to a business owner deciding how much to commit to one risky project.
In practice
Real-world examples.
Example
A credit analyst at a fund reviews a bond that trades at 40 cents on the dollar after the issuer files for bankruptcy. She estimates that creditors are likely to recover 65 cents on the dollar through the restructuring. She presents the investment committee with the evidence and recommends a small initial position.
Example
A business school case compares two investors during a market panic, one who sells to avoid losses and one who buys quality assets at a discount. Students discuss time horizon, access to cash and the danger of buying too early. The class debates how to judge when fear has pushed prices too low.
Example
A family business owner learns that a competitor in financial trouble is selling assets cheaply. He applies a similar approach to the one associated with Tepper by studying the competitor's liabilities, estimating what the assets are worth to his own company and bidding below the asking price. He secures a warehouse at a deep discount.
Case study
Seen in the real world.
Redstone Credit Partners is an illustrative, fictional fund that invests in distressed debt. During a downturn, the bonds of a regional retailer fell to 30 cents on the dollar as investors feared bankruptcy.
The fund's team built a model of the retailer's stores, leases and inventory and concluded that the business was weak but that its property and brand were worth far more than the price of the bonds. They bought $10,000,000 of face value at 30 cents, paying $3,000,000.
The retailer went through a restructuring, and the bondholders received new shares and cash worth about 65 cents on the dollar, or $6,500,000. In this illustrative story, the fund made $3,500,000 on the position, but the partners reminded investors that two other positions that year lost money.
Watch out
Common mistakes.
- Assuming that buying cheap assets in a crisis is easy, when it requires deep analysis, patience and cash that does not have to be sold at the wrong time.
- Concentrating on the stories of success while ignoring distressed positions that were lost, which gives a distorted impression of the strategy.
- Treating a low price as proof of value, when a falling price can reflect real problems that justify the discount.
Questions
People also ask.
Who is David Tepper?
He is the founder of Appaloosa Management, a hedge fund known for distressed and special situation investing, and he bought the Carolina Panthers football team.
What is distressed debt?
It is debt issued by a company in financial difficulty or bankruptcy, which usually trades at a discount to face value because of the risk that it will not be repaid in full.
Can individuals invest like this?
It is difficult, because it needs large amounts of capital, legal expertise and a high risk tolerance, so individuals usually gain exposure through specialist funds.
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