HF & PE Cases

Was ESL's decision to take over Kmart and merge it with Sears the best option for the bankrupt retailer?

- The merger was the least risky for K mart based on the value of sears - However, K-mart could have reinvested and recreated its brand to a more niche offering more risk but higher return

1. Describe the role of credit rating agencies in the CDO market?

- The rating agencies analyze the tranches of the CDOs. - Helped bring liquidity to the CDO market as they determined a value. - Lacked manpower to gauge risk, and lack of historic CDOs made it difficult. - received blame for giving investment grade ratings on subprime loans

1. Summarize the industry dynamics, including the major issues and potential catalysts for improvement?

- Toy market decreased driven by traditional toy segment. - Competition increase (Walmart and Target) - Video game segment growing

1. Summarize the debt in the transaction?

- Transaction value 7.7b - Net leverage was 5.4bn

1. Why did TCI and 3G enter into a total return swaps on CSX stock?

- Wanted changes in management and seperate CEO and chairman role. - Wanted to add 5 independent directors on the board to link management compensation with company performance. - Liked total return swaps as they received ownership without obtaining the risk of ownership, didn't have to put up large sums of cash, and needed to be stealth

Evaluate Lampert's strategy and the benefits for Sears's shareholders.

- Expedite location roll out strategy to compete with walmart and target. - Holders could decide if they wanted a share or cash payout he elected 100% stock - received 55% of the combined shares - cost and revenue synergies

Evaluate Ackman's strategy with Wendy's and McDonald's. Ackman's position in both was largely amassed through derivatives. Since his downside risk was lower than that of other McDonald's shareholders, should management have devoted time to his concerns?

- Ackman pitched to sell off Tim Hortons donut chain which accounted for 50% of profits. Wendy's didn't take this seriously - Similar offering to take MCdonalds real estat public and raise 14.7b debt and refinance the debt and then buy back shares. - He should have had time devouted to him cause of his holding amount and it wold have improved EBITDA margins

Describe the positive and negative impacts of hedge fund activism on corporate governance.

- Bad: Shift corporate focus to fighting the activist instead of driving SH value - Good: Provide different perspective on the operations of the business. Highlight issues that shareholders don't know about (toys). Helps improve overall efficiency of the business.

1. According to Biggs what makes an investor a superstar investor?

- Believes that they have a special way of understanding the markets and have magic to intuitively do the right things during market movements. - Doesn't beleive it is luck

1. Summarize what happened to Cerberus investments in GMAC and Chrysler since this case was written (Using outside sources)

- Cerberus investment into Chrysler and GMAC have changed. The Fed made GM and Cerberus to provide additional capital into GMAC to become a bank holding company. - GMAC re-branded to Ally Financial Bank - improved profitabiltiy, driven by the re-bound in the automotive industry. - Cerberus eventually surrendered ownership of chrysler operation to us treasury.

1. Describe the characteristics of great investment managers?

- Cut losses and hold onto winners - Admit mistakes - Digest information in multiple forms - Analyze multiple points and create decision

1. Describe the process through which Yale's endowment became one of the best performing investment funds in the world?

- David Swensen and Dean Takasai believed in 5 principals 1. Equities 2. diversified portfolio 3. Generate returns in the private market 4. Use outside managers outside of major indexes 5. conflict of interest with mutual fund compensatoin

1. What are the risk and merits of the transaction? TOYS R US

- Decrease in market value and increase in competition as Walmart and Target began offering toys especially video games - Consortium strategy: multiple private equity funds come together, large amounts of capital, strong expertise, - KKR, BAIN, and Vornado

1. What were the potential positives and negatives of this transaction for GM? For GMAC?

- GM positive: Additional capital to be reinvested into operations - GM Negative: Selling their top-performing line of business. (50% of EBITDA) - GMAC Positive: Receive their own stand-alone credit rating - GMAC negative: Cross-selling with GM, hasn't demonstrated success as a stand-alone, Cerberus had voting rights

1. Why does groupthink stink? Why is solothink Dangerous?

- Groupthink: The bigger the group the more prone they are to making a mistake. Group rationalization, Negative stereotypes (Don't believe data), suppression of personal doubts, group leadership influence, lack of conversation focus, group pressure (or being friendly) - Solothink: More dangerous than groupthink and can lead to authoritarian, and tyrannical decisions. Cause people to not provide insight resulting in lower critical thinking. Increase employee turnover

1. Describe growth, value, and agnostic investment strategies?

- Growth: higher multiples increase earnings and have strong management teams, high margins - Value: Cheap and find undervalued assets - Agnostic: Don't believe in value or growth theories. Everything is temporary and will trade off between the two strategies

1. What are the potential exit alternatives for this investment?

- IPO - Acquisition - Alternate consortium - Divesture - Dividend recap

1. Recommend whether or not to join the Consortium?

- Joining the consortium would be beneficial because of the capital and experience. I don't like the investment.

1. Which investors take the view that absolute return in not relevant and why? Contrast this with chasing alpha?

- Large pension funds, focus on asset allocation - Chasing alpha are firms that seek to outperform the market while maintaining the same volatility. Funds survive and grow assets like this

1. What is Biggs description of a macro global investor? What is meant by the quote "Diversification is an enemy of performance" and what is the argument behind this statement?

- Macro investor looks for investments in all countries across a variety of asset classes. - Diversity is an enemy because if you are confident then you have the confidene to invest everything

1. Summarize the CDO strategy deployed by Magnetar during 2007. How was this different from Paulson's strategy?

- Magnetar: recognized that equity tranches of CDOS and CDO derivatives were inaccurately priced. Bought CDO equity and credit default swaps on tranches that were less riskly - Paulson took a bearish position on the entire market - Magnetar: focused finding anomalies that would profit regardless

What forces drive hedge fund activism? Are these legitimate concerns?

- Main force is when the stock price is lower than the value of the company (book value) - Large sums of cash - Spend cash on non critical assets (Toys)

1. What were the implications of GM's call option on GMAC's auto finance business?

- Main implication GMs call option GMAC was time, condition and overall valuation metrics. - Term of the call options was 10 years following the close with a credit condition higher than GMAC's investment grade - The valuation was set to be greater than fair market which included GM would have to pay 9.5x ev/ NI multiple

1. Should total return swaps be disclosed? Should investment banks act as a counterparty to such swaps? Explain your answer.

- Makes it difficult for a firm to protect themselves against a takeover. Firms should have visibility when investors begin to acquire large amounts of ownership. Having an investment bank as a middle man makes it even more blindsiding

Assess the merits of McDonald's response to Ackman's demands. Was McDonald's simply a large bureaucracy unwilling to consider changes that might benefit it?

- Many advisors agreed with his views around the valuation of the business but not the suggestions for capital. - Had real concerns with future strategic positioning. - Rejected proposal but made changes that benefited the company

1. Why did Volkswagen's share price increase by 5 times after Porsche's disclosure regarding cash-settled options on Volkswagen stock?

- Many hedge funds had a short position on VEM - Porsche announced they had a 74.1% ownership and that the government had a 20% stake leaving only 5% of shares for HF to hedge their bet. - increased 5x and was included in the DAX index

Describe the business model of McDonald's (franchise, real estate and company-owned stores). What were the advantages of its diversified strategy?

- Mcdonalds was one of few resturants to have large real estate portfolio - Maintained steady cash flows, and used assets to get cheaper debt

1. Should Cerberus's status as a financial investor as opposed to a strategic investor, impact the rating agencies analysis of GMAC?

- No, GMAc should be valued based off the the substance of their portfolio and the probability of future cash flows. - Financial buyers have more knowledge around financial engineering, but shouldn't be take into account

1. Explain pairs trading and the "bet" hedge funds were making when they entered into two different pairs trades that involved Volkswagen stock?

- Pair trading is where investors match a long position with a short position in stocks that are highly correlated. - Long VEM preferred, and short common - Long Porsche and short VEM

1. Describe Peloton's liquidity Crisis, including UBS's role?

- Peltoton was a top performing fund, as they shorted the U.S housing market before subprime crisis. - Felt that the prices for morgage securites were being unfairly punished so they took a long position on AAA rated securities. Levered up 9x - UBS disclosed that the bank owned 21.2Bn high rated A securities and the market specualted that they would have to sell. decrease by 10-15% - Tried to raise more cash and delay margin calls but banks were unwilling to delay the margin call, and ran out of cash -

Detail recent developments in hedge fund activism and discuss the more prominent managers. Highlight the differences between activist hedge funds and the corporate raiders of the 1980s

- Performed well until 2007 - Persuaded companies to do share repurchase 1.7t and pushed companies back to private markets. - Kerkoria, Car Icahn, William Ackman - Differences: Position (Corp raiders Large position) Strategy: Corp raiders use Greenmail, where activist push stock repurchases or going private Control: Acitivist used external users to drive pressure, corp raiders had large position and didn't need external

1. Why were stronger credit ratings important to GMAC?

- Played strong role as it helped bundle loans and re-sell loans for liquidity. Lower rates means more risk which makes it difficult to to liquidate because it shows the qulaity of the individual loans

Describe recent trends in the hedge fund and private equity industry and the growing overlap between the two.

- Recent trend is the number of funds and the total capital being raised - PE firms are moving towards publicly traded companies - Bankruptcy is another place where PE and HF overlap

1. What are the potential conflicts of interest that arise from second lien-lending?

- Second lien loans offer hedge funds greater security than other forms of debt with only slightly lower returns. - Second in line within the capital stack, and have security similar to first lien but have returns of mezzaine debt. - conflict of interest because HF brought funding to the industry but introduced incomparable products to suppliers than traditional lenders.

1. What is meant by "Size is the enemy of performance?" What other Impediments to success are managing hedge funds cited by Biggs?

- Size is the enemy of performance, the larger the fund the more difficult it is to generate returns - Thinks that success and wealth impact performance - retirement or huburis

1. Did Porsche's CEO make a smart calculation by entering into derivatives transactions on Volkswagen stock? Did CEO involvement in derivatives trades make sense? Explain your answer.

- Yes, the benefits outweighed the costs of the transaction. - Porsche faced pressure from german regulators, but didn't act in favor of them as they bought cash settle options. - Werent' required to disclose - If germany had punished them it would have been 200K in fines and 1M for mandatory bid rule which were largely outweghed

Why Did Biggs Short Oil? How to create a short position

- both real and nominal oil had reached their highest price level. Believed that demand for oil would decrease and capacity had reached its peak - buying short through futures - don't fight a long position if it doesn't show a profit

Discuss the causal events facilitating the acquisition of Sears. Could Sears have succeeded as a standalone retailer?

- casual event was proximity to customers as Sears was being outperformed by Target and Walmart and Sears Grand product - Sears grand was to use Kmarts real estate and make it sear stores. - Could have survived as a stand alone and EPS grew, but strategically were in a tough spot