Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Howard Marks became a billionaire for a reason.

He swoops into difficult corporate situations, often with more cash and power than anyone else involved. And his firm, Oaktree Capital Management, usually emerges with big profits. That’s good news for him, less good for ordinary bondholders who feel they get steamrolled when the companies go south.

Pool of Pain
The volume of company bonds that are considered distressed is growing.
Source: The BofA Merrill Lynch US Distressed High Yield Index

A good example of this can be found in the case of Molycorp, a rare earths miner that has filed for Chapter 11 bankruptcy protection. This company was so desperate for cash in 2014 that it promised Oaktree a huge premium to borrow more money so that it could finish upgrades on its mine in Mountain Pass, Calif.

The deal included Molycorp's borrowing $250 million on paper but receiving only $198.7 million of the cash. In addition, the miner would have to fork over about $374 million -- almost twice the amount of money it received -- if it sought to repay the debt before it matured in five years. 

But wait, there’s more! Oaktree also stood to get paid back in full, including that extra penalty for prepayment, before any other bondholders saw a dime in the event that the company filed for bankruptcy, which is exactly what happened.

Mined Out
Molycorp's debt plunged as the company collapsed into bankruptcy.
Source: Bloomberg, Finra's Trace

The deal was so beneficial to Oaktree -- and detrimental to other bondholders -- that they’re hashing it out in court, as Bloomberg reporter Steven Church has been tracking here, here, here and here. It seems unlikely that Molycorp’s creditors will prevent Oaktree from profiting handsomely from this situation, even if they manage to reduce some of its ultimate returns.

After all, Molycorp struck this deal with Oaktree willingly after getting into a dire situation. U.S. Bankruptcy Judge Christopher Sontchi said last year that the company didn’t have time to choose among possible lenders that wanted to provide short-term financing.

And let’s face it: It’s risky to invest in a miner amid a popping commodity bubble. Rare earths -- which sound like something you’d find in a science fiction show rather than elements used in commonplace electronic devices -- aren’t such an obvious investment. Investors like to be compensated for the risk they take, especially a seasoned, respected, distressed-debt investor such as Marks.

Of course, the other bondholders are screaming that Oaktree is placing claims on more of the miner’s assets than it deserves. The more money that goes to Oaktree, the less that is left over for them.

While Molycorp is bankrupt, there’s still quite a bit of money on the table to fight over. The miner received bids for assets that exceeded even the company’s own estimate of its value, with one company offering to pay more than $700 million for its non-U.S. assets, Bloomberg’s Jodi Xu Klein reported last week.

There’s a lesson here: Investors can still wring value out of some of the most beaten-down, heavily indebted companies. But it’s a matter of timing and skill, and it helps to have a multimillion-dollar war chest. There will be big losers as the credit cycle continues to sour, but there will be some big winners as well. There just won’t be as many.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net