In the matter of distressed municipal revenue bonds, it's safe to say that Laurence Gottlieb, founder of Fundamental Advisors LP, has entrenched himself in a messy, quirky and decidedly unglamorous market. A one-time bankruptcy lawyer and bond trader, Gottlieb now devotes his energies to buying risky securities essentially abandoned by equity, with the goal of taking control of an underlying asset in the long term.
In that way, says the 43-year-old former head of Citigroup Inc.'s municipal distressed trading desk, "we have a seat at the table in a turnaround of the asset."
Not that it's a crowded place. Many investors view municipal revenue bonds as hostile terrain fraught with headline risk -- anything from politics to union issues, tax liabilities, restrictions on land or other regulatory hurdles could be a red flag. Often, Gottlieb says, it's not a single deterrent but a combination of factors, all of which relate to the unique features of the assets and the involvement of state or other government agencies.
That leaves the New York-based investment group with few competitors. "We not only have a seat at the table," he says, "but often there aren't many there" -- which, he adds half in jest, is the story of his life.
Five years since its inception in 2007, Fundamental Advisors believes that it's sufficiently validated its investment premise to raise a second fund to replace a $350 million maiden vehicle. The first fund had the blessings of Pete Briger's Fortress Investment Group LLC, which bankrolled it with $100 million. Fund II, which registered to raise up to $750 million, is targeting $500 million. (The firm declines to comment on the funds and fundraising, citing regulatory restrictions.)
A revenue bond, typically issued by a quasi-municipal agency, is a type of municipal bond repaid solely through revenue generated by the issuing public-purpose asset. Unlike general obligation municipal bonds, which can tap tax funds as collateral, only revenue from the asset, essentially the asset itself, may be used as collateral.
Given the complexities around these tax-exempt bonds and management of specific assets that need fixing, barriers to entry are high. To begin with, there's no central repository for who owns the bonds and who will sell them, and under what circumstances. Owners of securities are typically large retail-based municipal bond funds that are holders to maturity. So trolling for deals requires tenacious legwork and perspicacious conversations with lawyers, bankers, bond trustees, consultants, regulators or other professionals dealing with distressed muni bonds.
Exactly how large the distressed segment of the estimated $3.7 trillion municipal bond market is depends on who you ask. Prognosticators, including economist Nouriel Roubini and analyst Meredith Whitney, have posed doomsday scenarios predicting meganumbers. Some maintain the distressed, high-yield sub-investment-grade muni market is tiny, though clearly the number of defaults and municipal bankruptcies has accelerated in recent months -- in California, Pennsylvania and Jefferson County, Ala. A recent analysis by the Federal Reserve Bank of New York points out that the low default listings tracked by ratings agencies cover only rated municipal bonds. It says defaults by unrated municipal bonds occur much more frequently than the ratings agencies' data might suggest, especially since revenue bonds have composed about 60% to 70% of new issuance from 1996 on.
Gottlieb, who co-founded Fundamental Advisors with Dana Fusaris, former head of Madison Capital Management LLC's defaulted tax-exempt bond investment practice, subscribes to the rule of thumb that even 1% of the total universe is a "very, very big world."
Fundamental is unique in that, unlike hedge funds focused on corporate investments, its municipal investing involves a broad array of public-works projects. "Unlike traditional investors in municipal bonds, Fundamental brings in new capital to invest in the project and has more tools in their toolbox," says Ann-Ellen Hornidge, a member at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC.
So far it has sunk money into about 50 assets across two funds. The majority of these are control investments, and some are toehold positions that may lead to control. About a third of portfolio holdings are in housing; another third are in healthcare; and the rest are in other infrastructure such as parking lots, stadium, sewer, hospitality and the like. A captive asset management business helps with operations.
Valuing the assets is more of an art than a science. The firm weighs the book value against comparable bonds trading in the market, the operating business and historical performance, as well as how the firm's involvement can improve operations. There may be attendant circumstances such as the regulatory or political environment that can affect efficiencies and costs. For instance, bankrupt Las Vegas Monorail Co., which issued some $650 million worth of bonds to build the world's first driverless public monorail system, may have an attractive submarket, but the asset itself is flawed.
The son of a Montreal businessman who moved his family to South Florida in 1976, Gottlieb went to Boston University and the Benjamin N. Cardozo School of Law. He clerked with a bankruptcy court judge in Los Angeles before landing in 2000 at Citigroup in New York, where he spent the better part of his career on turnarounds and distressed investing in muni bonds.
His experience dealing with the aftermath of Hurricane Rita in Baton Rouge, La., helped crystallize a moment of self-realization. Citi owned a 1,100-unit affordable housing property on Lake Charles that was battered by the 2005 hurricane. Arriving at the site just hours after, Gottlieb recalls, "we had to repair the assets quickly, navigate insurance issues and work with nonprofits and political figures on the ground until we could deliver much better facilities to the community."
Citi's investment ultimately worked out well, says Gottlieb. But it also gave him a chance to see the benefits of his work beyond the commercial returns. Indeed, the social element to the firm's investment premise appeals to institutional backers.
"What we like about Laurence's business niche is that they are able to provide a meaningful influence on the outcome of a given asset," says Leslee Cowen, a managing director and partner at Fortress. The firm "doesn't have to be a megafund to make a difference. Obviously, the bigger you are, the better, but for the distressed muni bond market, Laurence fills a gap."
The firm, with nine investment professionals, relies on traditional private equity techniques minus leverage, at least to start. Investments are "rarely" levered, Gottlieb says, and bite sizes are generally small.
In September 2010, the firm took ownership of a 1,214-bed student housing structure, now known as Westmar Student Lofts, in Atlanta. The facility, built in 2005 for an estimated $100 million, was mismanaged and fell into disrepair. Occupancy dropped to 20% while losses amounted to roughly $750,000 a year.
When the lender foreclosed on it, Fundamental went in, partnering with Cardinal Group Investments LLC of Denver. The investors acquired the property, which came with luxury amenities including a resort-style swimming pool, for about $36 million, and modernized the facilities. Initially affiliated with the Art Institute of Atlanta, it was repositioned to cater to nearby Georgia Institute of Technology. Westmar is now fully occupied, according to the firm, and Fundamental's investment is worth nearly double the purchase price.
Business partners like the firm's attention to detail. "They have a rare combination of the financial sophistication of a private equity investor and a deep understanding of operations," says Jason Luker, a principal at Cardinal Group, who also gives Gottlieb credit for his ability to "sift through the rubble to find diamonds."
A similar effort went into senior-care housing -- Sedgebrook Inc. in Lincolnshire, Ill., and Monarch Landing in Naperville, Ill. The parent, Erickson Retirement Communities LLC, a Baltimore developer and manager of retirement communities, filed for Chapter 11 in 2010; the affiliates filed separately soon after. The affiliates cited a substantial decline in sales and occupancy and the weakened economy. Fundamental came in with a $40 million winning bid in Section 363 sales.
The firm later parlayed its experience with Sedgebrook and Monarch into the purchase of another asset, the 53-story Clare at Water Tower in downtown Chicago, which landed in bankruptcy court in November. The facility, owned by Loyola University of Chicago and managed by the Franciscan Sisters of Chicago Service Corp., provided accommodations and healthcare services for upper-middle-class seniors. It owed about $229 million in municipal bonds and needed rescuing after coming to market in 2007.
"Besides management issues, the market was challenging," explains Gottlieb. "It was located in an urban environment and catered to very wealthy, sophisticated clients with plenty of options for senior care."
Fundamental tapped Life Care Cos. LLC, now known as Life Care Services LLC, and Senior Care Development LLC as partners, the same joint venture involved in the Sedgebrook and Monarch restructuring. In April they paid $53.5 million for Clare, though additional capital expenditures are expected to top $60 million.
Taking over a troubled asset is no small feat, though Gottlieb says he has learned to be patient. The transfer of Clare's finances, for example, was complex because these historically included a restrictive land lease with Loyola University. The asset is now debt free.
Marketing was a big part of the rehabilitation process, says Gottlieb, but the property "is off to a rockin' start," and attracting interest from seniors.
For another sample transaction, Gottlieb points to the AutoZone Park, a baseball stadium in downtown Memphis. The 12,500-seat stadium opened in 2000, with the Memphis Redbirds Baseball Foundation, which owns the team, issuing $72 million in bonds. Attendance declined over the years, and the foundation defaulted on a payment in 2009. Fundamental purchased $57.4 million of the outstanding bonds for $24 million. Fundamental's collateral consisted of an interest in the stadium and the Redbirds.
From the sponsor's view, the stadium's bench-style seating was inappropriate for how visitors typically used the facilities. It reconfigured a portion of the stadium for picnic tables to accommodate corporate parties, church groups or other big gatherings. The work takes Gottlieb to Memphis frequently, not as much for games, he says, as to attend to a "needy" asset.
Or, it could just be his strong sense of mission. Coming into these situations means the onus is on Fundamental to act as responsible stewards of public assets. "When we come in and inject new life to these assets, it's actually a welcome activity," says Gottlieb.
Gottlieb won't discuss fund performance, other than to say Fundamental has had "many" successful exits. It's gained enough traction on the control-style investments that investors also became interested in noncontrol, less liquid investment strategies, leading to the launch in June of an opportunistic credit hedge fund, with Gottlieb and Hector Negroni, former head of municipal trading at Goldman, Sachs & Co., as co-heads.
Hornidge, who has worked on numerous transactions with Fundamental, says it has done well "in helping to stabilize and preserve projects for communities while delivering positive returns to its investors."
At least one investor isn't quibbling about results. "If you look at his investments, he's doing a really good job of focusing on his picks," says Fortress' Cowen. "Combining his expertise, willingness and desire to be involved is a big deal; that's the reason why he has succeeded and will continue to succeed."