Saturday, March 23, 2013

Politics, the Double-Edged Sword: Yucaipa

Politics, the Double-Edged Sword: Yucaipa

In 2008, Yucaipa Companies and Magic Johnson approached a group of public pension plans about raising a fund to invest in inner city deals.    They managed to raise $450 million mainly from a select group of large public pensions.  The fund has done poorly, and the investors have convinced Ron Burkle, the founder of Yucaipa, to waive the management fee.  According to The New York Times[1], Mr. Burkle has released the investors from ponying up the remaining $50 million in commitments and promised to return capital to investors before Yucaipa recovers its own investment.  The concessions come as Yucaipa prepares to raise a new fund.  Undoubtedly, Yucaipa needs to mollify its investors before trying to attract new capital.

Pre Launch Fantasy (2010)

In a previous post, I explored Yucaipa’s political connections to the Democratic Party (“Private Equity Democratic Style [November 21, 2012]”) and my involvement in conducting due diligence on the firm.  There’s little doubt that Mr. Burkle’s role as a major Democratic Party contributor at the national level and in California helped him build relationships with several public pension plans.  Moreover, Mr. Burkle shrewdly contributed to Republican Arnold Schwarzenegger when he ran for Governor, despite having been a major supporter of Grey Davis, who was removed from the statehouse after being recalled.

While the poor performance of Yucaipa Corporate Initiatives II has created challenges for Mr. Burkle, he’s earned plenty of management fees in the last decade in California alone.  For example, CALPERS has paid Yucaipa over $55 million between 2003 and 2011 on five different funds.  The California Teachers, New York State, and New York City pension plans among others, are also investors in one or more of Yucaipa’s funds.

When a handful of pension plans have a large commitment to a manager, it is easier to exert influence over the manager, especially when something goes wrong.  In Yucaipa’s case, it only required two or three phone calls among the investors to put together a super-majority of the capital to force the firm to accept concessions.  Yucaipa would have had far more leverage over the investors if their investment capital had been spread over a diverse group of institutions.  In the typical fund, the investor base is so broad that it’s difficult to build a solid coalition to oppose the manager. 

The Times notes that the other funds managed by Yucaipa appear to be in decent shape based on data posted by CALPERS.  Two of Yucaipa’s funds have positive returns.  Their original fund started in 2002 has a 7.9% return, and their second large fund launched in 2008 has generated a 17.4% return.  In my view, the 2002 fund has produced pretty mediocre results, and the 2008 fund only looks attractive on the surface. If I were an investor with Yucaipa, I would be very concerned because they’ve returned relatively little capital to their investors over the years.

CALPERS has committed $950 million to Yucaipa across five funds and has only received back $284 million.  This means that the vast majority of CALPERS returns are based on estimated values, rather than concrete results.  Even the 2002 fund remains largely unrealized.  CALPERS committed $200 million to that fund and has only received $124 million back.  This means that $143 million of the fund’s value is based on unrealized estimates.  After 11 years, you’d expect a manager to have made much more progress in selling investments.

Yucaipa demonstrates the opportunities and pitfalls of mixing politics into the investment process.  Politics certainly helped Yucaipa gain its client base.  However, when a fund with a political history fails to perform, the scrutiny can be intense.


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