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Alternative Market Briefing

Australian manager seizes current middle-market credit opportunity

Tuesday, June 15, 2021

Mukhtader Mohammed
B. G., Opalesque Geneva for New Managers:

Second only to private equity, the global private credit asset class is expected to grow by 72% to US$1.5tln globally by 2025, according to Daniel Tamone from the SILC Group. In Australia, tougher bank regulatory requirements have led to a significant decline in traditional bank lending, paving the way for non-bank lenders and private credit funds to fill the funding gap left by the traditional banks. The financing shortfall is most apparent in the unlisted private sector, known as the "middle market", since the banks are focusing their efforts on the big institutions and the mums and dads, and not much in-between.

One Australian manager has seized this opportunity in a timely manner.

First deal

Arbitrium Capital Partners' brand new opportunistic credit and special situations fund has closed its first transaction; it is providing financing to allow M Group to purchase one of Sandvik AB's business unit.

Brisbane-based M Group of Companies and Sandvik AB signed agreement in October 2020 for M Group to acquire the global drill manufacturing business of Sandvik Mining and Construction Tools AB. Sandvik AB is a Swedish multinational engineering company.

The transaction was structured as a senior secured loan, and Arbitrium's investors can expect a net IRR (internal rate of return) of more than 20%.

Arbitrium's co-founder Mukhtader Mohammed said the deal highlighted the need for alternative credit providers. "Unorthodox and creative credit solutions like ours are a vital part of the debt landscape today," he said. "Where middle-market companies are unable to access traditional loans, we can step in to ensure that these businesses can continue to provide valuable employment, products and services to Australian people and businesses."

Mr. Mohammed will present in next week's webinar Small Managers - Big Alpha, Episode 2 (22nd June at 10:30 am ET).

The transaction highlighted the ability of funds like Arbitrium to deliver private-equity style returns with strong downside protection via significant asset cover, according to managing director Blake Ammit. This transaction will allow Arbitrium to move on to its pipeline of over A$500m (US$385m) of other potential deals.

Arbitrium Capital Partners is a specialist fund manager based in Sydney and Melbourne that invests in event-driven special situations transactions. It was established in 2020 when the founders saw a gap in the market providing flexible financing solutions to complex situations for middle-market companies. The managers structure the funding solution to assist borrowers first to stabilise and turnaround and then grow the business.

The Arbitrium Credit Partners Fund, launched in March 2021, is Arbitrium's sole fund so far. It seeks to outperform the Reserve Bank Overnight Cash Rate by 600 basis points per annum. It primarily invests in senior secured loans but may consider subordinated positions. It does not invest in unsecured loans.

"Arbitrium provides senior secured loans in the range of A$20m to A$80m to mid-market Australian corporates with a maturity of 3-5 years," Mr. Mohammed explains. "All loans are structured as senior secured loans with equity warrants. We offer our investors 10%-13% p.a. yield with an overall IRR of 17% - 20% p.a. net of fees after including the equity warrants."

Opportunity set in mid-market Australian corporates

Arbitrium sees a unique opportunity in mid-market Australian corporates with non-investment grade secured loans of $20m to $100m, which are currently underserviced by banks. This lending space is also underserviced by onshore funds that lack the expertise in complex opportunistic credit, and offshore funds that currently have the expertise but are physically limited due to COVID-19.

According to Arbitrium, Australia is recovering from the effects of Covid-19, which has led to its first recession in nearly 30 years. Its GDP shrank by 7% in Q2-2020 (after a fall of 0.3% in Q1), the worst economic growth in 61 years.

This means that about $100bn in loans to mid-market companies may be at risk of default in the next six months despite the federal and state government fiscal measures. Companies that were previously sound financially and able to service their debt may post COVID, experience financial hardship and need to secure new sources of capital to see them through recovery.

When asked about corporate loan defaults so far this year, Mr. Mohammed told Opalesque: "It is early to say given majority of corporates were artificially supported by the government fiscal stimulus packages. There has been a significant rise in small business insolvencies, however, this is not the market that Arbitrium participates in. We believe that the next three to six months will provide better guidance on corporate loan defaults."

Furthermore, major banks limit their funding at 2.5x debt to EBITDA while non-bank financiers limit their funding at 4x debt to EBITDA. There are few to none in the mid-market space that are prepared to lend at up to 6x debt to EBITDA - which is what Arbitrium does.

Distressed debt net IRR has outperformed private debt during times of economic crashes and the recovery post crises, as evident from the performance of vintages 2001-2003 (Dotcom crash) and 2008-2011 (GFC). According to Arbitrium, similar outperformance is expected during the post-COVID recovery of the economy.

Related article:
14.Dec.2020 Arbitrium Capital adds two veteran fund and debt experts

Upcoming webinar:

Small Managers - Big Alpha - Episode 2

With larger quantities of capital chasing the same alpha strategies and continuing to erode alpha, savvy investors are turning to smaller and/or emerging managers as they look for alternative sources of return. Opalesque presents a carefully screened panel of such investment managers.

Robert Zuccaro, Target QR Strategies
Mukhtader Mohammed, Arbitrium Capital Partners
Craig Reebes, Prestige Funds
Mark O. Witten, Portal Asset Management

• When: Tuesday, June 22nd at 10:30 ET
• Free registration:

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