Vitesse: The Tennenbaum Factor

Dec.12.06 | About: Vitesse Semiconductor (VTSS)

The WSJ profiles Tennenbaum Capital Partners in a Page One article today. I harbor no illusions about the risk inherent in my Vitesse Semiconductor (NASDAQ:VTSS) investment. The worst case scenario for the company is a liquidity crunch, which would leave it in the hands of creditors. The creditor most likely to benefit is Tennenbaum, and their track record should rightfully concern Vitesse investors:

In mid-2005, Radnor Holdings Corp., a supplier of foam cups to restaurants, was losing money and struggling under a pile of debt. When plans for an initial public offering fizzled, it began searching for $50 million in fresh capital.

To the rescue came Tennenbaum Capital Partners LLC, a fast-growing investment firm. After two months analyzing the Philadelphia cup maker, Tennenbaum invested $25 million in Radnor’s equity and lent the company a further $95 million at interest rates of more than 11%.

But Radnor didn’t get fixed, at least not initially. Its business deteriorated further and it filed for bankruptcy protection. Tennenbaum, however, had a fallback position. Most of its investment was backed by Radnor’s assets. After battling other creditors in court, Tennenbaum became Radnor’s new owner a couple of weeks ago. It renamed the company and installed a new chief executive.

The primary challenge for Vitesse is to be operationally cash flow positive without entering a position that would require them to sell assets mortgaged to Tennenbaum. I believe Vitesse will do this.

Alternative means of raising cash include the sale of their fab in Colorado Springs and the potential sale of business units (see my Vitesse Investment Thesis). The major catch is that any such asset sale must be approved by Tennenbaum, as documented in their loan covenants. Nothing prevents Tennenbaum from acting in a malicious way, simply blocking the sale of these assets in order to force the company into insolvency. Such behavior, while reprehensible, is entirely possible:

Critics say firms like Tennenbaum are “vulture lenders,” preying on weak companies by charging high interest rates and swooping in when they fail to repay.

Because the stakes are so high, bankruptcy proceedings are often becoming slugfests. In the case of Radnor, the other creditors — led by money managers, banks and other holders of its unsecured bonds — accused Tennenbaum in court of deliberately pushing the company into bankruptcy in order to wrest control.