Saturday, December 22, 2012

Cerberus and Guns: Follow Up

Cerberus and Guns: Follow Up

Today, Joe Nocera, columnist for the New York Times, wrote a great commentary on the role of private equity in the gun business (“Guns and Their Makers”,  It is sad, indeed, as Mr. Nocera points out, that Cerberus has built a business designed to profit on the mass proliferation of weapons.  In Mr. Nocera’s column he references this blog, and my analysis (Divesting Gun Ownership: Public Funds Deserves No Credit).

There’s no doubt in my mind that Cerberus will sell Freedom Group at healthy profit, and as Mr. Nocera points out, there’s already a potential buyer.  In fact, potential buyers will be excited by the new opportunity afforded by the NRA’s suggestion for dealing with the Newtown tragedy: putting armed guards into schools.  The NRA opens up a whole new set of business opportunities for Freedom Group.  There are approximately 90,000 public schools in the United States, so the deployment of armed guards along with their service revolvers and assault weapons should translate into at least half a million more guns, plus the requisite ammunition.   

The Consultant (1995)

The NRA’s recommendation needs to be carried forward to other vulnerable venues, because mass shootings take place at all sorts of other venues.  For example, based on the tragedy at Aurora, we ‘ll need armed personnel at movie theatres.  With about 40,000 screens in the US, movie theaters offer another nice market.  Perhaps we can train projectionists, ushers, and ticket takers to pack heat. 

Churches are an even bigger potential market.  There are some 300,000 churches in the US.  By the time we arm pastors, choir directors, and ushers we’re looking at the sale of another million guns.  And, of course, churches will want to deploy silencers, so as not to disturb services.  Freedom Group has a company to meet that need.  One of its company’s manufactures clothing for hunters.  I can envision a special set of vestments for concealing weapons and caching extra rounds of ammunition.

We need to stand up to this madness.

Friday, December 21, 2012

Christmas Cookies and Managing Money

Christmas Cookies and Managing Money

At the close of trading on December 23, 1992, I stopped managing institutional money as a portfolio manager.  That year is not very memorable in stock market history.  After a bunch of ups and downs, the market posted a 7.6% gain.  Although the market eked out a small return for the final month of the year, my portfolios, representing about $3.5 billion in client assets, gyrated wildly.  As we entered the final month of the year, I’d built a lead over the S&P 500 in a year where institutional managers were struggling to beat the market.  Around Thanksgiving, I think I had about a 2.5% lead over the index. 

Ambushed (1997)

My computer had a small box in the upper left corner that continually compared my performance to the S&P 500.  I hated that box, and it produced endless bouts of stress.  In August, IBM had driven me out of the office when it announced that mainframe sales had gone flat.  The stock plummeted and my lead over the S&P 500 vanished.  The managing directors at my firm kept walking into my office asking me what I was going to do about IBM.  They offered conflicting opinions.  I bolted, driving the back roads around Westchester Airport and walking the trail along the Byrum Gorge to calm my nerves.  I’d do anything to get away from that little box on my computer screen.

By December, I had my lead back as well as a conviction that I needed to stop managing money.  However, I figured I was going to get through the remainder of the year, and I might actually beat the market.  Around the middle of the month several key holdings started to falter.  There were rumblings that lawyers were about to have a breakthrough in a series of lawsuits against the makers of gel breast implants.  Corning Glass and Dow Chemical jointly owned Dow Corning, one of the manufacturers, and Bristol Myer also had a subsidiary that made implants.  Their stocks began trading lower and my advantage shrank.

My analyst, Cathy Moore, got on the phone with the companies and various Wall Street analysts.  It was hard to gauge the outcome of the litigation.  The managing directors camped out in my office pressing me for answers.  They especially wanted to know if I was going to beat the S&P 500, because they’d been telling clients we were ahead of the market.  One of the managing directors was a chartist, and kept telling me that one stock chart or another “looked horrible” or “had bounced off an important support level [I think that’s supposed to be good].”  My trader was telling me the markets were very illiquid, and I wouldn’t be able to buy or sell any of these securities without disturbing the market.

On December 23rd, a jury awarded Pamela Jean Johnson $25 million from Medical Engineering Corp, a subsidiary of Bristol Myers.  She’d sought $63 million.  With Wall Street preparing for the holidays, there weren’t too many investors or traders around, and the selling precipitated by the decision turned into a rout.  Suddenly the market was convinced that the hundreds of other pending lawsuits might, in fact, succeed.  My lead was gone, and so was I.

At the close of trading, I wished everyone a Merry Christmas, and went home for the remainder of the year.  There was no sense in trying to move the portfolio around and trade my way out of my growing deficit against the S&P 500.  I joined my wife and kids in baking cookies and ignored the stock market.

I spent the week after Christmas with family and friends, and avoided the little box on my computer screen.  On January 2nd, I returned to the office to discover that my portfolios had rallied and we’d eked out a 70 BP (0.70%) margin over the market.  In the end, baking cookies with the kids was far more rewarding than beating the market.

Unless something really big happens in the next 10 days, I’m done posting for the year.  I don’t think we’ll be baking, but the kids will be home.

Wednesday, December 19, 2012

Revised 12/22 Divesting Gun Ownership: Public Funds Deserves No Credit

Divesting Gun Ownership: Public Funds Deserves No Credit

Cerberus, a private equity firm, has announced plans to sell its stake in the gun manufacturer, Freedom Group.  The press is reporting this decision as a dramatic reaction to the shootings in Newtown, Connecticut.  Apparently, Cerberus was feeling pressure from some of its large institutional investors, such as CALPERs, CALSTERs, and the New York Common Retirement Fund.  

Rather than being lauded for their efforts, the trustees and politicians should be lambasted.  They haven’t done anything to advance their stated objective of fostering gun control.  They’ve just ducked the issue and asked Cerberus to pass the problem on to a new group investors.  Meanwhile, they’ll pocket a nice return on the sale of guns, bullets, and silencers.  Cerberus looks like it is being responsive and doing something difficult and may be even financially painful.  I doubt it.

Let’s take a quick look at Freedom Group.  The company is the largest manufacturer of guns and ammunition in the world and operates under a number of brands, including Remington and Bushmaster.  Cerberus built the company by making a series of acquisitions beginning in 2006.  According to filings with the SEC, it appears that Cerberus paid about $158 million in consideration for its various purchases.[1]  Cerberus received $248 million via the retirement of preferred stock in 2010 and 2011[2].  So it appears that Cerberus and its investors already have a profit.  Meanwhile, Cerberus has also pulled out $5.3 million in management fees through the end of 2011[3]

A back of the envelope calculation suggests that Cerberus and their investors stand to make a bunch more money on the sale of the company, unless Freedom Group can’t sell guns and ammunition anymore (LOL).  In round figures, Freedom Group should generate about $160 million in Adjusted EBITDA in 2012[4][5].  If the company is sold for 6 times EBITDA, a below average multiple, investors would earn about $225 million ($960 million in proceeds less $650[6] million in long-term debt and $75 million in other liabilities, and 95% ownership) on top of the $220 million they’ve already earned.  If my math is right, the gross investment multiple will be about 3 times.  Even if Cerberus invested more than the $158 million it reported in the SEC filings and receives a lower price on the sale, the decision to sell is still easy and profitable.

Getting your money manager to sell a profitable investment doesn’t demonstrate courage of any kind.  In 2006 when Cerberus started building its gun platform, I doubt any of the public funds said a word.  A month after 32 people died at Virginia Tech, Cerberus acquired Remington.  Investors were quiet.  After all, the weapons were a Glock 19 and Walther P22, not Remington products.  In 2009, thirteen people died in Binghamton and another thirteen perished at Ft. Hood Texas.  Meanwhile, Cerberus was adding Dakota Arms (rifles), Barnes Bullets, and Advanced Armaments (silencers, legal in 39 states according to the company); again, the investors were probably silent.  Earlier, this year, at Aurora, Colorado, James Holmes used a Remington 810, among other weapons.  Silence.

We’d be better served if the public pension plans held onto their gun investments and forced Cerberus to take an active stand on gun and ammunition control.  The Public Pension Plans have washed their hands, but they haven’t removed the dirt.

[1] Form S-1 Registration Statement, Amendment #4, May 17, 2010, p 146
[2] Freedom Group Annual Report 2011, p 115, 3rd Quarter 2012, p 14
[3] Freedom Group Annual Report 2011, p 115; Freedom Group Annual Report 2010, p 110.
[4] Through the end of the 3rd Quarter of 2012, the company had $118 million in adjusted EBITDA, and appears to generating better that $40 million per quarter.  Quarterly Report for Period ended September 30, 2012, pp.31-32
[5] EBITDA is earnings before interest, taxes, depreciation, and amortization.  The adjustment appears to remove other non-recurring items.  EBITDA is a common measure of profitability in Private Equity
[6] According to the Quarterly Report, the company had $647 million in long-term debt, p 1

The Battle for Public Pension Plan Compensation North Carolina Style

The Battle for Public Pension Plan Compensation

When I became the Chief Investment Officer for the State of North Carolina in 2001, the job paid $90,000.  Aside from managing some $65 billion in investments, my goal was reform.  My biggest priority was improving the compensation for the existing employees.  I should have known that this was going to be a problem because the State Treasurer Richard Moore had already been attacked for proposing a few new positions and higher salaries for the Investment Division.

For about eight months, I battled the State Department of Administration to get salary increases for the staff, including my position.  As I mentioned in a previous post, some of my employees had to take second jobs in order to make ends meet, and we were at great risk of losing key members of our tiny team.  I vividly remember a meeting during the summer of 2002 with a group of folks from the Department of Administration.  After once again making my case, one of the senior officers said, “I’m not trying to be mean, but you’ll be long gone before there are any major changes in the staff or compensation.  It just ain’t going to happen.”

Splitting Shares (1999)

The Treasurer still wanted to do something to help the staff and send a signal to the General Assembly and Department of Administration that we were serious about funding staff positions.  So we decided to abolish the position of Chief Investment Officer in the fall of 2002, and use the funds from that position (known as lapsed salary) to slightly increase the pay of the rest of the staff.  It was a nice little trick and paved the way for me to receive higher compensation.  I signed a new contract with the State Treasurer and became the Chief Investment Advisor at a rate of $170,000 per year with a potential 30% bonus.

Within days my contract was leaked to the press, and the State Treasurer was forced to defend paying me more than he was paid.  The substance of the articles was nearly identical to the Bloomberg report I wrote about yesterday.  I didn’t enjoy the publicity or some of the letters to the editor in the local paper.  On the day of the press reports, I went to lunch with Jeremy Coller, the founder of Coller Capital, a London-based private equity secondaries manager.[1]  We dined at the Armadillo Grill, and after consuming a beef burrito and Diet Dr. Pepper, Jeremy gave me a ride back to the Albemarle Building.  When I walked into the reception area outside my office, Dana Rosenberg, the head of private equity, was anxiously waiting.  Without taking a breath he said,

“Andy, you need to call the State Treasurer right away.  He saw you getting out of the car.  He’s royally pissed.  He wants to know how you could ride in a chauffeured limo in front of hundreds of state employees on the same day that your contract was on the front page of the newspaper.  He’s really disappointed in your lack of judgment.  He sounds really upset.”

I ran into my office, quickly rehearsing my apology to the State Treasurer.  I dialed his number, and as it started to ring, I heard Dana and couple of other staff members laughing.  Just as Stephanie Scott, the Treasurer’s assistant picked up, I realized I was the victim of a prank.  I told Stephanie to ignore the call, and hung up.  By the time Dana walked into my office, I was cracking up (and plotting to get even with Dana).  I told Jeremy the story a few days later, and he had a cartoon made of me stepping out of his car amidst the press and state employees. 

We submitted our salary data to the National Association of State Investment Officers (NASIO).  The database was used to help gauge how people should be paid as analysts, directors, and CIOs.  A week later, I got a call the woman managing the database.  She said that a number of CIOs wanted me to withdraw North Carolina’s data because it dramatically pulled down the averages.  We were, in just about every job category, the lowest data point by a huge margin.  I pulled our data.

The woman from the Department of Administration turned out to be right.  I resigned before there was any material improvement in the salaries of the Investment Division.  In fact, I resigned in order to get the salaries and positions straightened-out.  This time there wasn’t a leak.  I wrote to the newspapers about my decision, and the lack of proper funding.  I am pleased to report that progress has been made over the year.  Our merry band of 13 employees earning the princely and collective sum of $850,000 is now much larger and far better compensated.  Unfortunately, the changes didn’t come soon enough, and the State lost the talents and humor of Dana Rosenberg to an endowment.

[1] Coller Capital is in the business of buying existing private equity interests from investors, hence the term “secondaries.”  Private equity investments are illiquid, and some investors suddenly find that they need to sell their investments.  Coller Capital and a number of other firms are in the business of buying up these interests (at a discount).