Tracking the Vultures

 | Oct 24, 2011 | 3:00 PM EDT
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We are still looking for a deal to fix Europe's debt problems and, again, we are told one is close. I hope so, but I'll believe it when I see it. The U.S. economy is faring a little better, but it's still a long way from good. In short, it's a very cloudy picture for the economy and the financial markets. At times like these, the vultures tend to eat very well and it makes sense to pay attention to what they are doing. So over the weekend, in between completing the honey-do list and watching college football and the World Series, I spent some time reviewing the holdings of the more effective distressed investors. Here's what I found.

One of the better firms is MatlinPatterson. Founded in 2002, it scored big with companies like Worldcom in the aftermath of the tech blow-up. Since the credit crisis began it has made a few missteps, including losing $450 million in the Thornburg Mortgage bankruptcy. Now MatlinPatterson has invested $1 billion in Flagstar Bancorp (FBC) and seen the value of that investment plummet by about 80%.

I own Flagstar and I like it as a call option on the banking system and real estate markets. Although the stock has fallen since MatlinPatterson made its initial investment, I still believe that this bank could pull it out as conditions improve. MatlinPatterson also acquired 45% of homebuilder Standard Pacific (SPF) in 2008. The firm recently took advantage of an insider trading scandal to acquire the Strategic Credit Fund from FrontPoint Partners on what appear to be favorable terms. An economic recovery that improves real estate markets over the next few years could easily return MatlinPatterson to rock-star status among vulture investors.

Another vulture that I have followed over the years is Whippoorwill Associates. The firm is led by long-time veteran of the distressed-securities market Shelley Greenhaus, who started in distressed securities in 1978 and opened his firm in 1990. The firm maintains a pretty low profile, but its filings make for interesting reading. It also appears to be positioned for spectacular gains in an economic recovery.

Whippoorwill has a decent-sized position in Packaging Corp. of America (PKG), picking up 268,000 shares of the containerboard and corrugated products maker in the second quarter. The company is already seeing signs of steady improvement. Although higher costs led to earnings falling from the year-earlier results, revenue and volume were higher on a year-over-year basis. Their mill and box plants set records for both production and sales. Management also said that it expects fourth-quarter earnings to be higher than Wall Street estimates. Whippoorwill is apparently very bullish on boxes and paper products as it also purchased shares of Rock-Tenn Co. (RKT) and International Paper (IP) this year.

The firm apparently shares my enthusiasm for Mueller Water Products (MWA). The water-infrastructure company should see revenue and profit soar when the economy recovers enough for municipal spending to begin anew. Much-needed upgrades and repairs to the nation's water-supply systems have been delayed, but the money has to be spent eventually. According to a 2009 report by the American Society of Civil Engineers, the U.S. water system faces an $11 billion annual spending deficit to repair aging facilities. A lot of this money is going to be spent on products for Mueller, which is either first or second in most of its markets. This bodes well for the company on a long-term basis.

Paying attention to what the distressed-investment community is doing during difficult times can lead to huge rewards when the economy and financial markets improve.

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