Pressure from Hedge Funds

You know hedge funds aren’t popular when they get blamed for things they didn’t even do. Consider this passage from Forbes on Cendant (CD):

Spinoffs these days are being driven by the growing influence of hedge funds, where impatient managers buy up shares of a company and pressure managers to sell off parts of a business to spur quick market gains, many experts say. Why wait to grow profit when management can sell to make a quick buck?
“Hedge funds take an activist approach, poking management with sticks,” said Joseph W. Cornell of Spinoff Advisors of Chicago.
There’s no indication that Cendant’s Silverman, who worked in private equity earlier in his career, was verbally prodded by any hedge fund managers, but he seems to have adopted their approach.
Hedge fund returns have eased as the industry has grown to $1 trillion in assets across more than 7,000 funds, spurring managers to take a more activist approach toward seeking gains. The Barclays CTA index of hedge funds shows they’ve returned 7.8% so far this year, down from the consistent double-digit gains to which managers had grown accustomed. And investors have shown they require more return in exchange for the extra risk–new inflows into hedge funds are down almost 50% from the first three months of the year, according to Tremont Capital Management.

To quote Hoover from Animal House: “They confiscated everything, even the stuff we didn’t steal!” Wasn’t it also Silverman’s approach to be part of a lousy merger to begin with? That wasn’t the fault of any hedge fund.
The reason Cendant failed was because the business model didn’t make any sense. They tossed a bunch of mediocre businesses together and figured it would make one really good business. It didn’t work. The stock went down and now they’re breaking it up. I’m sorry but I just don’t see a sinister plot at work here.
The article’s implication, of course, is that these hedge funds are really Gordon Gekko for the new millennium. I’m not quite sure how Cendant is Bluestar, but it’s not my analogy. For the record, Cendant is being broken up to create shareholder value. This isn’t an 80s style LBO deal. They’re undoing a deal that never should have been done. It’s hard to ignore the fact that Cendant’s spin-offs have been doing quite well.
But hedge fund pressure doesn’t end with “no indication” at Cendant, there’s real live actual indication at OfficeMax (OMX).

Hedge fund K Capital Partners, the largest shareholder in OfficeMax Inc., put more pressure on the office-supplies retailer to consider selling itself and called for corporate-governance changes that would make a takeover of the company easier.
K Capital has been critical of OfficeMax, which is based in Itasca, Ill., for the better part of a year and has repeatedly suggested a sale. This spring, the hedge fund mounted a proxy contest; it was called off after the company agreed to appoint another independent director.
In an open letter sent yesterday to the company’s board, Brian Steck, K Capital’s managing director, said a “detailed turnaround plan,” complete with performance benchmarks, is overdue from OfficeMax Chief Executive Sam Duncan. Mr. Duncan was hired in April. Mr. Steck wrote that “financial and operating performance has been dismal.” Mr. Steck also asked the board to remove a poison-pill provision and declassify the election of directors.
K Capital holds 8.6% of OfficeMax shares, making it the largest investor according to the most recent securities filings.

Think of it! They’re actually demanding accountability from the company they own. If you’re keeping score, Staples and Office Depot are doing very well, while OfficeMax has had three straight lousy quarters. There was also the small matter of the accounting fraud, the financial restatements and the CEO getting canned. So now, Mr. Steck is demanding to see a strategy from the management. I think he’s being very generous. I would have sold out a long time ago.
Don’t look now. They’re at it again. Even the mighty McDonald’s (MCD) is getting pressure from a hedge fund.

A New York hedge fund wants McDonald’s to spin off its company-owned restaurants, but analysts said the company was unlikely to be persuaded and could be headed for a standoff with investors.
McDonald’s management has already rejected the call from Pershing Square Capital Management, which will present its plan to the investment community at the Value Investing Congress in New York on Tuesday. The fund holds a 4.9 percent stake in the fast-food company.

OK, this one probably isn’t a good idea, but at least it’s something. There’s also the story of the frenetic market for credit derivatives. This is a fascinating development on Wall Street. I hope to write more on this later.
If you’re not familiar with credit derivatives, I’ll skip the details by saying that it’s basically a way to buy insurance on a loan. This market isn’t just growing, it’s exploding. If a company is about to go under, this is a quick way to make (or lose) a lot of money. In other words, the hedge funds are all over it.
This past week, the betting on GM filing for bankruptcy has soared. Personally, I think the market is getting a bit ahead of itself, but Wall Street may soon face a crisis. How will the fairly-new credit derivatives market, and their hedge fund accomplishes, respond to its first major test? No one really knows. We had a dry run with Delphi that seemed to go well. Although Enron, or what’s left of Enron, is still being fought over in the courts.
Lastly, I see that when it comes to Eddie Lampert and Sears, all the hedge funds are on the same team.

Some of the biggest stars in the hedge-fund and money-management worlds are pulling hard for Sears Chairman Edward Lampert — who also runs ESL Investments Inc., a hedge fund with about $10 billion in assets — to turn around the retail chain. They have been betting on Sears shares, and some funds have added to their positions or established new ones in recent months, even as the stock has tumbled in value.
“To some extent, it’s a faith bet on Lampert, I’ll admit that,” says Whitney Tilson, who runs New York hedge fund T2 Partners LLC, a $110 million firm that has been buying Sears shares. “Hedge funds worship Eddie.”

Ironically, after yesterday’s close, the big story was that Amazon.com (AMZN) is being added to the S&P 500. This is Wall Street’s equivalent of becoming a “made man.” Salute! This is especially impressive when you remember that Amazon doesn’t make that much money. Maybe they’ll start getting more pressure form hedge funds. Oh wait, isn’t that what Jeff Bezos used to do?

Posted by on November 15th, 2005 at 11:26 am


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