Posts Tagged ‘Hedge Fund’

Hedge Fund Pershing Square’s 1st Quarter 2012 Letter (Bill Ackman)

Monday, June 25th, 2012

Bill Ackman, legendary activist investor recently published its 1st quarter investment letter. The fund has performed strongly to date, with 9.3% returns and has large holdings in Canadian Pacific, General Growth Properties, Citigroup, and J.C. Penney. If he still owns them, the latter two companies may create some trouble for his firm in the future.

In this investor letter, Ackman discusses the idea of time arbitrage, which is taking advantage of forced sellers for the benefit of long term profit. This is because stocks are often more volatile than their underlying businesses, and few firms and individuals can stomach volatility.

He also discusses that private equity portfolio companies, because of their higher implied leverage, have much more volatile returns, but unfortunately, you do not see a mark-to-market as you do in publicly traded equities.

Enjoy the letter below:


Martin J. Whitman on Distressed Investing – A Legend and Founder of Third Avenue

Monday, June 6th, 2011

Over the past two years, I have become a staunch follower of Martin J. Whitman, a legend in deep value investing and founder of Third Avenue. I have read his book, Distress Investing twice now, and wanted to share some excerpts with you. Hopefully you will pick up a copy too!

According to Whitman, there have been three major trends that have shaped the credit markets since the innovation of the high yield (junk bond) in the late seventies through 2008:

1)      Financial Innovation

2)      New Laws & Regulations

3)      2007-2008 Financial Meltdown

1)      New credit instruments, capital structures, and financial institutions grossly inflated the size of the credit and derivatives markets from the 1980s to 2008.  The shadow banking system (SIVs, SPEs) and securities this system issued like CLOs were part of this trend.  Credit default swaps eventually allowed banks and hedge funds to make highly levered bets against issuers, directly influencing market perceptions about credit worthiness.

New primary and secondary markets improved liquidity for below investment grade issues in the late 80s and early 90s.  Leveraged loans that one would have paid 40 cents for in the 1980s, investors were paying 85-90 cents for in the early 90s through the 2007/2008 meltdown.  Almost 70% of leveraged loans were held by nonbank institutions like hedge funds, CDOs, CLOs, etc.

2)      After Gramm-Leach Bliley passed in 1999, commercial banks also began to act more like underwrites, completely eschewing credit risks, and collecting fees on originating loans, bonds, and ABS.  Securitization allowed for the transfer of risk off of bank balance sheets.

BACPA, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 imposed new time limits for filing a plan of reorganization (POR) and shortened the amount of time required for business bankruptcy filings.  It additionally shortened the time over which investors could decide to curtail payments on property and reject non-residential real estate losses.  Finally, it curtailed executive pay for firms under Ch. 11 and enhanced vendor rights, so trade vendors were pari passu with the unsecured creditors.

Many of these innovations drove litigation costs so high, that today most of the reorganizations done today are prepackaged or prenegotiated filings.


According to Whitman, since 1950, credit market debt has grown at 4.1% in real terms, while GDP grew at 2.7%.  In the 1970s, more of the below investment grade debt was classified as “fallen angel,” and was originally investment grade credit.  Originally issued high yield bonds, which were unsecured and had much less restrictive covenants than loans, were quite rare.  They took the form of Rule 144A securities (unregistered with the SEC).

Junk bonds were unsecured claims usually subordinate to senior loans and senior unsecured debt.  But by the 1980s, they were the preferred security for driving LBO and M&A transactions.  By 1989, high yield debt consisted of 20%+ of the non-financial bond universe. (to be ctnd…)

Cheers, Tom Rendon

Greenstone Value Opportunity Fund, LP 2010 Annual Letter (Distressed, Deep Value Fund)

Friday, February 25th, 2011

After closing three strong years of performance (2008 – 2.5%, 2009 – 36.5%, 2010 – 15.6%), Greenstone shares its outlook for 2011, as the year of “dividend chasing.”  2010 was certainly a year of “credit chasing,” where all funds searched for yield in high yield bonds, leveraged loans, and REITs.  About 80% of the Greenstone portfolio is investing in traditional deep value securities, and 20% is invested in “special situations.”  The last bullet point in Greenstone’s themes is that historically, “economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers.”

Here are Greenstone’s selected themes for 2011:

• We still like equities, particularly in the U.S. While they currently seem short-term overbought, and a technical correction is possible, we still see the most value in this area, especially when we consider the alternatives.

• In reviewing our letters from early last year, we talked about 2010 being the “Year of the Yield Chaser” in the credit space. We cut the majority of our credit exposure in Q1 and Q2 of 2010 because of what we thought was limited further upside appreciation potential. We can see 2011 being the “Year of the Dividend Chaser”.
• Offshore deepwater drilling is the last bastion for hydrocarbon discovery. We think a lot of “first time” emerging market demand characteristics and higher oil prices will lead to increased deepwater programs by the IOCs and NOCs. We have a handful of positions that give us exposure to this area.
• We would consider shorting natural gas companies because of the supply/demand dynamics and high valuations. We could see a scenario where the contrarian call is to go long physical natural gas because 1) it’s unloved and 2) the historical ratio between gas and oil prices is creating the perception that gas might be a buy. However, even with increasing demand for natural gas expected in the U.S. this year, we still have a tremendous overabundance of supply. We’re keeping an eye on high multiple natural gas companies and MLP’s that derive a generous amount of “other income” from hedging programs that are set to roll off.
• The M&A space is one that, for various reasons, we see doing well going forward. This primarily derives from the cash reserves on S&P 500 company balance sheets, which are at the highest level in ten years (currently over $1.2 trillion). This is almost 50% more than the $825 billion held in cash in September 2008. Information technology is the leading sector with cash reserves. With a near 0% interest rate environment, how long can companies hold so much cash? VC’s and Private Equity have not had a genuine chance to monetize their portfolios for 2-3 years now, and we believe they will search out the cash rich/public company exit option. We currently have 5+ names in the portfolio that we believe could benefit from such a trend.
• This year could finally be the year where companies have the ability to pass through their increased input costs to consumers. This would result in inflation showing up in the U.S., despite what the CPI is saying.
• Along with middle of the road valuations, allocation shifts could be a boom for the equity market in 2011. It is interesting to hear people like Byron Wein say that “Institutional portfolios have to have more of their money invested in places like China, India, and Latin America,” essentially saying that developing countries are generating a majority of the world’s growth, and institutional portfolios should have exposure to these markets. Mr. Wein recommends large conventional institutions substantially increase their allocations to hedge funds and emerging markets.
• European and municipal debt issues will once again provide buying opportunities when the markets turns south on these worries. With municipal budgets due in early June, expect more movement in and around this time frame. We have taken advantage of market gyrations that these events have previously offered, and would look to do so again.
• The dramatic equity rally from the lows at the end of June occurred almost entirely with net outflows from domestic equity funds, and net inflows into domestic fixed income funds. Late in the fourth quarter, this dynamic switched for the first time in a long while, with inflows into equities and outflows from bond funds. If this trend continues, which it appears that it might, even more fuel could be added to the recent stock market rally.
• Even in light of the money flows just mentioned, we don’t expect John Q. Public will come charging back into the market any time soon. We are wary, however, about the potential shift of pensions and endowments (who manage John Q. Public’s money) into equity markets. Essentially, there are way too many underperforming endowments (relative to their liabilities), and they may be forced to chase returns in order to meet their obligations.
• In contrast to the Byron Wein bullet point above, Elroy Dimson of the London Business School has decades of compelling data from 50+ countries to support the view that high economic growth in emerging markets doesn’t ensure high stock returns. His book, ‘Triumph of the Optimists: 101 Years of Global Investment Returns’, along with several other studies, have underlying evidence that economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers (who are trying to cool off overheated economies with monetary policy, etc), while developed markets are receiving tailwinds from policymakers (who are aggressively trying to lift the prices for risk assets). While many are clamoring for additional exposure to emerging markets, we believe the best risk/reward is to continue to find value in developed markets like the United States.

December 2010 (1) Letter from Distressed Debt Investing Blog

Viking Hedge Fund Loses Dris Upitis

Wednesday, February 9th, 2011

Viking Global Investors LP, the Greenwich, Connecticut based hedge fund faces another high level departure only 10 months after Chief Investment Officer David Ott resigned in April 2010. Dris Upitis, one of the four management committee members, recently announced his resignation from Viking. Since Ott stepped down in April, Upitis, along with his colleagues Tom Purcell, Dan Sundheim, and Jim Parsons, have overseen most of the hedge fund’s $10 billion capital. Upitis was promoted to senior portfolio manager last year after working as an analyst at Viking for six years.

Viking, founded in 1999 returned an average of 13% annually. The Viking Long Fund gained 14.5% in 2010, slightly under the S&P 500 Index of U.S. stock, which returned 15%, including dividends.

Dris Upitis, one of four management committee members at hedge fund Viking Global Investors LP, resigned, the second high-level departure in 10 months after Chief Investment Officer David Ott stepped down in April, according to two people with knowledge of the matter.

Upitis and colleagues Tom Purcell, Dan Sundheim and Jim Parsons have overseen most of Viking’s $10 billion in capital since Ott stepped down in April, said the people, who asked not to be identified because the information isn’t public. Clients were notified of Upitis’ resignation in a note last week, the people said.

Upitis was an analyst at Greenwich, Connecticut-based Viking Global for six years before being promoted to senior portfolio manager last year. The firm is run by Andreas Halvorsen, one of the “Tiger Cubs” who helped build Julian Robertson’s Tiger Management LLC into the world’s biggest hedge- fund group in the 1990s.

After losing 4 percent in the first six months of 2010, Viking Global Equities gained 10 percent in the second half of the year after the fund reshuffled the managers, the people said. The long-short fund rose 3.8 percent last year, investors were told in the letter. That trailed the 7 percent increase of the BAIF Hedge Fund Index.

Halvorsen didn’t respond to two telephone messages left with his office seeking comment. A person answering a number listed for Upitis said he no longer works at the firm.

13% a Year

Viking, which Halvorsen founded with Ott and Brian Olson in 1999, returned an average of 13 percent annually in the decade ended Dec. 31, one of the people said. Viking Global Equities lost 1.9 percent in 2008, when the Lehman Brothers Holdings Inc. bankruptcy triggered the global financial crisis, and the fund climbed 20 percent in 2009, the person said.

Halvorsen started a new fund two years ago to focus on buying stocks after selling them short, or betting on price declines, became more risky. The Viking Long Fund began trading in January 2009 after raising about $80 million, the firm said in a regulatory filing. The Viking Long Fund gained 14.5 percent in 2010, one of the people said. The Standard & Poor’s 500 Index of U.S. stocks returned 15 percent, including dividends.

Shumway Closes its Doors…from $70mm to $8bn in 8 Years…and Now it’s No More…

Monday, February 7th, 2011

Chris Shumway announced that in November that he would be stepping down as the chief investment officer of his eponymous fund, Shumway Capital Partners LLC. Shumway’s started his $8 billion hedge fund in 2002 with $70 million. The company has produced average annual returns of 17 percent before fees. Since it’s creation, Shumway’s funds’ average annual performance has beat the S&P 500 Index by 14 percentage points before fees. Shumway had initially planned to continue to oversee the hedge fund when he appointed Tom Wilcox as the sole portfolio manager last year. However, these changes did not rest well among investors, prompting them to ask for $3 billion in redemptions.  Shumway said in an interview that “A key to my investment success has been my ability to invest with a long-term focus,” which he said he’ll be freer to do if he isn’t managing client capital.  The fund will now focus on managing internal money only.

Chris Shumway, who announced he would step down as chief investment officer of his $8 billion Shumway Capital Partners LLC in November, said he’ll return client capital by March 31, according to a letter sent to investors.

Shumway, 45, who started the Greenwich, Connecticut, firm with $70 million in 2002 and has produced average annual returns of 17 percent before fees, will continue to manage money for himself and his employees.

Investors had asked to redeem $3 billion after Shumway told them of his plan to step down. Last year, Shumway appointed Tom Wilcox to be the sole portfolio manager, while saying he would continue to oversee the hedge fund as chief executive officer and chairman of the management committee. He named Wilcox and three other employees as partners at the firm.

“We changed our operating structure and it created a higher sense of risk for our investors and put greater significance on short-term performance of the fund,” Shumway said in an interview. “A key to my investment success has been my ability to invest with a long-term focus,” which he said he’ll be freer to do if he isn’t managing client capital.

Shumway, an alumnus of Julian Robertson’s Tiger Management LLC, trades stocks worldwide. Shumway’s three funds returned about 2 percent last year. Since inception, the funds’ average annual performance beat the Standard & Poor’s 500 Index by 14 percentage points, before fees, according to the letter. The funds returned 3 percent before fees from October 2007 to March 2009, when the S&P 500 fell about 57 percent, the firm said.

Shumway has 95 employees, including 25 investment professionals. A number of Shumway’s alumni have opened funds in recent years, and Shumway expects other employees to start their own investment firms.

A leveraged-buyout fund run by Goldman Sachs Group Inc. bought an 8 percent stake in Shumway in January 2010.

Harvard Days

Shumway started investing when he was in Harvard Business School, where he earned a master’s in business administration after getting an undergraduate degree from the University of Virginia.

“It was really fun finding the gems and doing the research,” including flying to visit corporate managements, he said.

As chief investment officer, Wilcox would have been responsible for day-to-day management of the portfolio, while Shumway had planned to become a “super analyst” who would focus on finding a few, highly profitable investment ideas each year. He had also planned to manage risk and analyze macroeconomic trends.

“That’s how I started in this business,” he said. “I’m going back to that.”

Paulson Proves He is Not “One Hit Wonder,” Pulls in $1.25 billion for 2010

Sunday, January 2nd, 2011


After being bashed by many hedge fund managers as a “one hit wonder,” Paulson closed well in 2010, putting another strong year under his belt.  The Paulson Advantage Fund was up 14% at the end of 2010 (after being down more than 10% earlier).  His largest stakes were in Hartford Financial Services, MGM, and Boston Scientific.  The Paulson Gold Fund also performed well, given the runup in physical commodities this year.  After outperforming many of his competitors, it is rumored that the hedge fund manager will earn $1.25 billion for himself this year.  It is also interesting to see the divergence in HF manager earnings in the U.S. versus the U.K…

According to Daily News UK, “multi-billionaire US hedge fund manager John Paulson, who pulled off one of the biggest coups in Wall Street history when he made £2.3bn by betting against the sub-prime housing market, is showing the Midas touch again writes Edward Helmore from New York. 

Initial reports suggest his firm, Paulson & Co, has made returns of nearly treble the industry average of 7 per cent in 2010, giving him a personal gain estimated at more than £800mm ($1.25 billion). 

That would eclipse even the biggest earners on the UK hedge fund scene, based in London’s swish Mayfair district.

Colm O’Shea of fund group Comac is reported to have made nearly £10mm last year as did Jonathan Ruffer, of the eponymous investment company. 

Crispin Odey, founder of Odey Asset Management took home £36.4mm. ”

According to Dealbook, “two years after Mr. Paulson pulled off one of the greatest trades in Wall Street history, with a winning bet against the overheated mortgage market, he has managed to salvage a poor year for his giant hedge fund with a remarkable come-from-behind showing.

Defying those who said his subprime success was an anomaly, Mr. Paulson appears to have scored big on bets he made on companies that would benefit from an economic rebound.

In less than three months, his flagship fund, the Paulson Advantage Fund, has turned a double-digit loss into a double-digit gain. At mid-December, the fund, which was worth $9 billion at the start of the year, was up about 14 percent, according to one investor in the fund who provided confidential figures on the condition of anonymity.

It is a remarkable turnabout for Mr. Paulson, whose winning gamble against the housing market plucked him from obscurity and transformed him into one of the most celebrated money managers in the business.

What precisely propelled the sharp rebound in Mr. Paulson’s hedge fund is unclear. A spokesman for Paulson & Company declined to comment, and regulatory filings of significant changes made to Mr. Paulson’s funds typically lag behind by several weeks.

But it is clear that several of Mr. Paulson’s largest stakes — in Hartford Financial Services, MGM Resorts and Boston Scientific — went on a tear in the final quarter of the year, with gains of 16 percent, 30 percent and 26 percent, respectively.

“Several of his general investment themes this year came to fruition,” the investor in the Paulson Advantage Fund said.

Mr. Paulson stands out in what may go down as a lukewarm year for many hedge fund managers. The average return for funds through the end of November was 7.1 percent after fees, according to a composite index tracked by Hedge Fund Research of Chicago. Investors would have done better buying a low-cost mutual fund that tracks the Standard & Poor’s 500-stock index, which rose 7.8 percent during that period.

With volatile markets creating uncertainty for hedge fund managers this year, some investors are surprised that these funds did even that well. But they expect the funds to continue to attract money from investors, particularly state pension funds seeking higher returns to offset their budget shortfalls.

“When investors look back at the year they’re going to be pretty happy,” said David T. Shukis, a managing director of hedge fund research and consulting at Cambridge Associates, which oversees $26 billion in hedge fund assets for clients.

But the lackluster performance has other people wondering: are hedge funds worthwhile? The high fees and muted returns — and a long-running federal investigation into insider trading in the industry — has cast a cloud over a business that long defined Wall Street wealth.

“A client told me the other day that paying these ridiculous fees for single-digit returns, then worrying about these investigations — it’s just not worth it,” said Bradley H. Alford, chief investment officer at Alpha Capital Management, which invests in hedge funds. “A lot of these things you can sweep under the rug when there are double-digit returns, but in this environment it’s tougher.”

This year, bets by hedge fund managers were whipsawed by the stock market “flash crash” in May; the European debt crisis; frustration with the Obama administration over what many in the business viewed as anti-Wall Street rhetoric; and the Federal Reserve’s unusual strategy of buying bonds in the open market to hold down interest rates.

“It was an interesting year where you had to have a couple of gut checks,” said David Tepper, founder of Appaloosa Management, whose Palomino fund, which invests largely in distressed debt, was up nearly 21 percent at the end of October, according to data from HSBC Private Bank.

“If you had those gut checks, looked around and made the right decisions, you could make some money,” Mr. Tepper added.

There are still many hurdles for the industry to clear, including the insider trading investigation, lingering difficulty in raising money, and the liquidity demands from investors still fuming over lockups in 2008 that denied them access to their cash.

Some hedge fund notables will probably remember 2010 as a year they would like to write off. For instance, Harbinger Capital, run by Philip A. Falcone, was down 13.8 percent at the end of November, according to HSBC’s data.

But the Third Point Offshore fund, run by Dan Loeb, was up 25 percent for the year through November after it made successful bets on one of Europe’s largest media operators, ProSieben, and Anadarko Petroleum, according to a report obtained from an investor in the fund.

Other big names also fared well. SAC Capital Advisors, run by Steven A. Cohen, was up about 13 percent in its flagship fund, one of his investors said.

A handful of other usual suspects turned out solid performances this year too, according to investors in their funds: David Einhorn notched a 10.5 percent return at his Greenlight Capital hedge fund through November, raising the fund’s total to $6.8 billion.

And after two consecutive years of losses, James Simons, the seer of quantitative hedge funds, was up 17 percent in his two public Renaissance funds, which now collectively manage $7 billion.

The figures reflect performance after fees through November, and do not take into account the strong market rally in the final month of the year, some investors noted.

For many, being in the right sectors of the market — distressed debt and emerging markets, for instance — paid off handsomely.

“If you look at how some of the distressed managers performed, you’re seeing some really good returns among a number of funds,” said David Bailin, global head of managed investments at Citi Private Bank.

Bets on distressed debt produced a return of more than 19 percent as of the end of October for the Monarch Debt Recovery Fund, overseen by a pair of former Lazard managers. Similarly, Pershing Square, a fund run by William A. Ackman, was up 27 percent after fees through the end of November.

Mr. Ackman’s big win was a bet on the debt of General Growth Properties, a developer that emerged from bankruptcy last month.

It was a bumpy year for Mr. Paulson who, besides making a huge bet on gold — which rose 30 percent — also took large stakes in several companies he believed would benefit from a sharp recovery in the economy, including banking and financial services companies.

But as the economic recovery sputtered along, Mr. Paulson’s portfolio sank, prompting some critics to claim that his funds had become too big to manage. Some of Mr. Paulson’s investors asked for their money back around midyear.

At one point this summer, in fact, other hedge fund managers were selling short stocks Mr. Paulson held in his funds, betting that redemption requests would flood in and that he would be forced to sell down some of his big positions, according to a hedge fund trader at another firm who declined to be named for fear of damaging business relationships. He said investors were making similar bets against stocks held by Mr. Falcone’s Harbinger fund.

As recently as the end of September, Mr. Paulson’s flagship Advantage Plus fund was down 11 percent. As of last week, the fund was up more than 14 percent for the year. (His clients are mostly institutions that invest a minimum of $10 million in the fund.)

Patience paid off for Mr. Paulson as many bets he made late last year and early this year finally shot higher in the last quarter.

This year, Mr. Paulson bought 43 million shares of the gambling company MGM, whose shares have soared more than 30 percent since the end of September. A bet of 40 million shares in the cable giant Comcast has risen 22 percent this quarter.

Shares of Boston Scientific, of which Mr. Paulson owns 80 million shares, have skyrocketed 26 percent, and his 44 million shares of Hartford Financial Services climbed 16 percent in the quarter.

One of Mr. Paulson’s newer positions, a stake in Anadarko Petroleum, moved up 20 percent in the quarter.

With the last-minute rally, Mr. Paulson saved himself from being the headliner among flat funds this year. Most were not so fortunate, with many hedging against their stakes late in the year, expecting that stocks would end the year down. That move, some say, probably limited their gains.

“Psychology is such a fragile thing,” said William C. Crerend, the chief executive of EACM Advisors, which oversees a $3.6 billion fund for Bank of New York Mellon.”

David Tepper Personally Earns $4 Billion for 2009 Performance

Sunday, December 26th, 2010

We thank Dan for his contribution to Leverage Academy, LLC and for writing this biography on David Tepper, of Appaloosa, who made $4 billion for himself last year.

David Tepper grew up in a middle class neighborhood in Pittsburgh, PA. He became interested in the stock market after observing his dad, an accountant, trade stocks during the day.  Following high school, he enrolled in the University of Pittsburgh, where he excelled. After Tepper graduated with a degree in economics, he found a job with Equibank as a credit analyst. He quickly became bored with the role and enrolled in the MBA program at Carnegie Mellon’s School of Business, now named after him. [1] Tepper’s experience at Carnegie Mellon helped him learn options theory at a time when there were no textbooks written on the subject. Kenn Dunn, the Dean of school of the school himself taught these option courses.[2]

After graduating, Tepper worked in the Treasury division at Republic Steel, once the third largest steel manufacturer in the U.S.  Soon after, Tepper moved onto Keystone Mutual Funds, and finally to Goldman Sachs.  At Goldman, Tepper focused on his original role as a credit analyst.  However, six months later, he became the head trader on the high yield bond desk!  Despite his successes, Tepper was not promoted to partner due to his disregard for office politics.  After eight years at Goldman, he left and started Appaloosa Management in 1992 with Jack Walton, another Goldman Sachs trader.

With his background in bankruptcies and special situations at Goldman, Tepper applied his skills and experience at the new hedge fund, and it worked out tremendously for him. Tepper is categorized as a distressed debt investor, but he really analyzes and invests in the entire capital structure of distressed companies, from senior secured debt to sub-debt and post-bankruptcy equity. His fund has averaged a 30% average return since 1993!  While that number is particularly high, Appaloosa has fairly volatile historical returns.  In 2008, Tepper’s fund was down around 25% for the year. For the investor that stuck with him, this certainly paid off with a 120% return after fees in 2009. [3] Tepper shies away from the typical glitz and glamour of the ostentatious hedge fund industry. Appaloosa is not based in New York, but in a small office in Chatham, NJ. It is only about 15 minutes from his house so he can spend more time with his family. The firm manages around $12 billion.

Tepper’s astronomical returns resulted from huge bets on the banking industry, specifically Bank of America (BAC) and Citibank (C). He bought BAC around $3.72 and Citi near $0.79. At year’s end, BAC ended at $15.06, a 305% return, and Citi ended at $3.31, a 319% return.  Appaloosa also has invested in other financial companies such as Wells Fargo (WFC), Suntrust (STI), and Royal Bank of Scotland (RBS). Other companies Tepper has investments in are Rite Aid (RAD) , Office Depot (ODP), Good Year Tire and Rubber (GT), OfficeMax (OMX), and Microsoft (MSFT).  He believes that valuations on stocks and bonds in the financial industry remain favorable, and he is now investing in commercial real estate, a place where many analysts expect huge losses.[4]

Tepper’s investment strategy involves finding value in these distressed companies and betting big. He is not very diversified in his holdings compared to most hedge funds. Investing in these distressed companies can be a very lonely business. David Tepper stated about his recent purchases of BAC and Citi, “I felt like I was alone. No one was even bidding.” While some don’t like being alone, Tepper’s contrarian approach helped him scoop up these companies at bargain prices. Tepper reminds himself that he needs a contrarian attitude every day when he walks into his office and sees a pair of brass balls on his desk, literally. “Mr. Tepper keeps a brass replica of a pair of testicles in a prominent spot on his desk, a present from former employees. He rubs the gift for luck during the trading day to get a laugh out of colleagues.”[5] While humorous, these brass balls represent his strategy of taking concentrated bets on these companies that the market does not see any value in.

David Tepper has not been without controversy. In his dealings with Delphi, an auto parts maker, his hedge fund along with other investors backed out of their exit financing agreement after Delphi sought additional funding from General Motors. His hedge fund believed accepting money from an automaker would hurt Delphi’s ability to win contracts with other automakers. The hedge fund also claimed that this funding arrangement broke their financing agreement. Delphi, in turn sued, declaring that the issue was a “story of betrayal and mistrust.” [6] It has since gone into Chapter 11 reorganization.

While most hedge fund managers who have made $4 billion in a year during one of the worst recessions since the 1930s would face scrutiny from the press, public, and government, Tepper has largely gone unscathed due to the lack of glitz and glamour of his lifestyle. Tepper lives in a New Jersey suburb in the same house that he bought in the early 1990s and coaches his kids’ sports teams. He is a family man is proud of raising three good children. He says, “It was much easier when they were younger. It’s harder now when they open the paper and see how much money I make.”[7]

Last year, Tepper told the business school magazine at Carnegie Mellon that money should be a secondary goal, while living an upstanding life and pursuing what you enjoy should be the top priority.[8] Tepper does not forget about his roots either. He regularly goes to Pittsburgh to visit his alma mater and to watch the Pittsburgh Steelers (of which he is now a part owner).  He also donates money to food pantries and other charities around Pittsburgh.[9] Tepper comes to Carnegie Mellon frequently to talk to students about what needs to be improved at the school. Students describe him as down to earth, friendly, and very candid. While he has been an extremely successful hedge fund manager, he does not lead an extravagant lifestyle and continues to deliver excellent results to investors. His philosophy is very simple: if you treat people right, run your business right, and run your life right, you will create a sustainable business.




[4] ibid






2010 Top 10 Highest Earning Hedge Fund Managers
Rank Name Firm Name 2009 Earnings
1 David Tepper Appaloosa Management $4 billion
2 George Soros Soros Fund Management $3.3 billion
3 James Simons Renaissance Technologies $2.5 billion
4 John Paulson Paulson & Co. $2.3 billion
5 Steve Cohen SAC Capital Advisors $1.4 billion
6 Carl Icahn Icahn Capital $1.3 billion
7 Edward Lampert ESL Investments $1.3 billion
8 Kenneth Griffin Citadel Investment Group $900 million
9 John Arnold Centaurus Advisors $900 million
10 Philip Falcone Harbinger Capital Partners $825 million


Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at] with your inquiries or call our corporate line.

Third Point Hedge Fund up 15.3% in First 3 Months of 2010 – Investor Letter Attached

Friday, April 2nd, 2010

According to Marketwatch, “Third Point LLC, a $3 billion hedge fund firm run by Dan Loeb, generated big gains during the first quarter, helping to recoup a lot of the losses suffered during the financial crisis of late 2008 and early 2009.

Third Point Offshore, the firm’s largest fund, was up 7.9% in March, leaving it with a 15.3% gain during the first three months of 2010, according to a recent update sent to investors. MarketWatch obtained a copy of the update.

Third Point Partners, a smaller fund, gained 8.8% in March and 16.6% in the first quarter.

Loeb, who started Third Point in 1995, is best known as an outspoken activist investor, taking big stakes in companies and pushing management to make strategic changes. Check out activist methods.

However, activist positions have never taken up a large portion of Third Point’s portfolio. The firm focuses on value investing and trading around corporate events like reorganizations and mergers and acquisitions.

Third Point Q4 Letter

When the financial crisis struck in 2008, Third Point was hit hard, ending the year down almost 33%. Between June 2008 and March 2009, the firm lost roughly 35%, its biggest drawdown ever. However, the firm rebounded strongly by the end of 2009, generating returns of 38.2%.

Some of Third Point’s gains have come from credit market bets, rather than equity investments. Indeed, by the end of the first quarter of 2010, credit positions made up 64% of the firm’s total exposure, while equity accounted for less than 50%. Hedge funds often have more than 100% exposure because they use leverage, or borrowed money, to magnify their bets.

Third Point’s top three positions at the end of March were in securities of car company Chrysler, auto-parts maker Delphi Corp. and lender CIT Group.

These companies emerged from major bankruptcy reorganizations last year. Such restructurings usually involve giving new equity to debt holders.

CIT emerged from bankruptcy in December and its new shareholders are a who’s-who of the hedge fund industry. Icahn Associates, run by activist investor Carl Icahn, Greenlight Capital, headed by David Einhorn, and Oaktree Capital, run by Howard Marks, are among the company’s top five owners.

Third Point is the 19th-largest CIT shareholder, behind other hedge-fund giants including Paulson & Co., run by John Paulson, Marc Lasry’s Avenue Capital and Eddie Lampert’s ESL Investments, according to FactSet data.

CIT shares jumped 41% in the first quarter of 2010.

Third Point’s other top positions are in securities of PHH Corp. /quotes/comstock/13*!phh/quotes/nls/phh (PHH 24.03, 0.00, 0.00%) , a fleet-management and leasing company, and Dana Holding /quotes/comstock/13*!dan/quotes/nls/dan (DAN 11.78, 0.00, 0.00%) , another auto-parts maker that emerged from bankruptcy in early 2008, according to the hedge fund firm’s recent investor update.

PHH shares soared 46% in the first quarter, while Dana shares climbed 10%.”

According to NYMAG, “Loeb (founder of ThirdPoint) is a focus guy. Each morning at 5:30, he makes his way from his West Village townhouse to a yoga center and puts his feet behind his neck, which Loeb maintains is good for concentration. Still, at the moment, Loeb seems distracted. His hair, which is starting to gray, sticks up in patches. He wears white corduroys. His shirt, with pink and purple stripes, is untucked. “Let’s put it in context,” he says. “It’s never fun to lose a lot of money.” But it’s only $20 million. “We lost a little over 1 percent of the fund,” he points out. He calls for a trash can for his tea bag.

By contrast, the Ross matter seems a bit of fun, a mood elevator. Loeb places the press release on the table. It seems that Loeb and Ross, who has his own private equity fund, find themselves in the same investment. Recently, Loeb purchased $37 million of bankrupt Horizon Natural Resources, a coal company. Ross heads the committee guiding the company through bankruptcy.

In this capacity, Loeb says, warming up, Ross has committed “an egregious example of greed and self-dealing.” From Loeb’s point of view, he overweights his compensation, a mistake Loeb suggests may be a reflex from “the many years you spent generating fees . . . ” Loeb accuses Ross of “double-dipping,” a charge that sent Loeb’s jittery lawyers running for cover. “He’s a bit of a blowhard,” says Loeb, who knew Ross wouldn’t sue. Blowhard, apparently, isn’t entirely pejorative. Loeb admires Ross’s success in the steel industry—“no disrespect,” says Loeb.

Disrespect, though, is kind of a Loeb sideline. Since 1995, Loeb has run Third Point Management, a hedge fund he started with $3.3 million from family and friends. He now has eight other investment personnel and $1.7 billion, which to Loeb’s mind isn’t particularly exceptional these days. At a hedge-fund charity event, he asked for a show of hands: Anyone here not run a $1 billion hedge fund? His fund has returned over 25 percent annually to investors.

Loeb is well known in Hedgeworld for his attacks on what he views as greedy execs who also happen to be depressing shareholder value. Of shares he owns. “The moral-indignation business,” Loeb sometimes calls it.

Hedge-fund guys love to read Loeb’s attacks—“he articulates what people feel,” says one. Usually, the letters accompany Loeb’s government filings. If you buy 5 percent of a public company, you must file with the SEC; Loeb once increased his holdings, at a cost of more than $4 million, just so he could file a letter.

Loeb is proud of his letters, which are thorough, well argued, and filled with clever turns of phrase. (He had a batch prepared for his high-school English teacher.) In a letter to the CEO of Warnaco, he referred to the CEO’s “imminent involuntary extraction.” To the CEO of Bindview Corp., a software company, he wrote of “your seemingly perpetual failure.” He’s gone after Intercept, Potlatch, Penn Virginia. There’s one where he calls the CEO “Chief Value Destroyer,” which he abbreviates CVD. “I’m surprised some CEO hasn’t had him shot,” says one manager.”

Flamand Leaves Goldman to Start Fund

Thursday, March 11th, 2010

Pierre-Henri Flamand, a 15 year veteran employee of Goldman Sachs recently left Goldman Sachs to start his own firm.   Mr. Flamand formerly ran  Goldman Principal Investments.  His new fund may raise as much as $1 billion.  Six years ago, another Goldman employee, Eric Mindich, raised $3 billion for his fund Eton Park Capital.

According to Mr. Cahill of Bloomberg,  Pierre-Henri Flamand, the head of Goldman Sachs Group Inc.’s largest internal hedge fund, is retiring from the world’s most profitable securities firm to start a hedge fund, according to three people with knowledge of his plans.

Flamand, 39, has worked at Goldman Sachs for 15 years and has run Goldman Sachs Principal Strategies from London since 2007. He didn’t respond to calls or e-mails seeking comment. A Goldman Sachs executive in London confirmed the departure and said the company supports Flamand’s plan.

Flamand is setting up his own fund as Wall Street pay and proprietary trading come under increased scrutiny from lawmakers. Goldman Sachs Investment Partners, founded by a former principal strategies team, was transformed into a hedge fund managing $7 billion in 2008 and became part of Goldman’s asset management unit.

“Goldman Sachs is the best money-making machine in the world but compensation is subject to public policy — if you go private it’s your own business,” said Jerome Lussan, chief executive officer of Laven Partners LLP, a London-based hedge fund consultancy. “You could have been the best prop trader in the world and you would have been paid less last year than you might have expected.”

Goldman Sachs Principal Strategies rebounded from losses in 2008 to fuel the firm’s 7 percent gain in equity revenues to $9.89 billion in 2009, according to its annual report. The business seeks to profit from discrepancies in relative values of financial instruments, convertible bonds and “various types of volatility trading,” according to the report.

“Results in principal strategies were positive compared with losses in 2008,” Goldman said in its 10-K filing with the U.S. Securities and Exchange Commission. That helped make up for a reduction in revenue in the rest of Goldman Sachs’s equities business last year, according to the filing.

Before 2007, Flamand was head of Goldman Sachs Principal Strategies in Europe from 2002. While his background at Goldman will help lure investors, he’ll face a more challenging fund- raising environment than his fellow Goldman Sachs veterans who set up their own firms, said Lussan.

Former Goldman Sachs partner Eric Mindich founded Eton Park Capital Management LP with $3 billion in 2004.

“There’s so much less appetite today, if he gets a billion to start today it’ll be a massive launch,” said Lussan. “The world has a lot less means than it used to.”

Famed Investor Eddie Lamperts’ Portfolio and Shareholder Letter

Monday, March 1st, 2010

Eddie Lampert, Chairman of Sears Holdings and founder of ESL Investments recently published his letter to investors.  It is a great read.  He focuses on the retail sector as a concentrated value investor.  Mr. Lambert graduated from Yale summa cum lade, and was part of Skull & Bones.  Here are Mr. Lampert’s top investments:

  • Sears Holdings (SHLD): 49.9%
  • Autozone (AZO): 28.9%
  • Autonation (AN): 13.8%
  • Capital One (COF): 3.3%
  • CIT Group (CIT): 1.1%
  • Citigroup (C): 0.9%
  • Genworth Financial (GNW): 0.9%
  • Wells Fargo (WFC): 0.4%
  • Acxiom (ACXM): 0.3%
  • SLM Corp (SLM): 0.3%
  • February 23, 2010

    To Our Shareholders:

    Today we announced our financial results for our 2009 fiscal year. I am pleased to report that we delivered both stability and progress, resulting in roughly $1.8 billion of Adjusted EBITDA, an improvement of more than $200 million over 2008. While this may be surprising to some, it isn’t to me. The dedication of our associates and leadership team led by Bruce Johnson and the diversity of the Sears Holdings business portfolio—Sears Full Line stores, Kmart stores, our Home Services business, Sears Auto Centers, Outlet Stores, Hometown Stores, the Kenmore, Craftsman, DieHard and Lands’ End brands, our majority interest in Sears Canada, and our online business properties including—have allowed us to successfully manage through the economic and financial crisis of the past two years.

    Today, the United States stands with an unemployment rate close to 10%, a housing market that appears to be stabilizing at depressed levels, and uncertainty over government policy and geopolitical events. Despite this, Sears Holdings continues to make progress against our strategic initiatives and our long-term financial goals. I recognize that our financial results, while substantially improved from 2008, remain well below where we would like them to be. At the same time, we have seen significant improvements in our focus on customers and the transformation of our culture.

    I would like to do several things in this letter. First, review 2009 at Sears Holdings. Second, look ahead to 2010 and beyond. Third, discuss some policy issues generally including job creation, and finally, address some consequences of ecommerce tax practices.

    2009 in Review

    In 2009, we kept expenses under control and stayed focused on our vision and strategic, operational, and financial goals. We were both prudent and opportunistic in spending money and in allocating capital at a time when many others had to make major adjustments.

    Early in the year we amended and extended our revolving credit facility through June 2012. In one of the most difficult financing markets in recent memory, we found significant support from numerous financial partners led by Bank of America, Wells Fargo and General Electric, and we executed one of the largest revolving credit facilities in the past couple of years. Our substantial asset base and our strong cash flow management were important factors in this successful deal. When people take a close and objective look at our company, our strengths are not difficult to see.

    Our customer satisfaction scores have continued to rise in both Kmart and Sears stores. While we know we still have room to improve, we are pleased that we are making progress against the five key pillars of our strategy that I outlined in last year’s letter.

    Creating lasting relationships with customers by empowering them to manage their lives: In 2009, we executed a number of initiatives to improve our relationships with customers. These initiatives focused on increasing the breadth and depth of our product offerings, improving our multichannel capabilities, creating platforms that engage with customers, and improving our ability to deliver customer services and solutions. Specific initiatives for 2009 included the introduction of Marketplace on, which dramatically increased our assortment by giving customers access to millions of products, and the launch of online shipping capability to 90 countries. We also introduced, expanding our site into an online destination that supplements by providing information that helps people get things done by themselves or with the help of others. We created or expanded marketing programs including ShopYourWay, “Life. Well spent.”, Sears Blue Appliance Crew, Sears Blue Electronics Crew, Sears Blue Tools Crew and “there’s smart, and there’s kmart smart.” We grew our online engagement platforms, and, allowing our customers to interact with each other and us and get advice before they buy. We launched the ShopYourWay Rewards program at Kmart and Sears that will provide even more value and opportunities for our customers. We also re-launched a Christmas Club program at Sears and Blue Light Specials at Kmart to offer more convenience, value, and excitement for our customers.

    Attaining best in class productivity and efficiency: In 2009, we focused throughout the year on delivering quality products and services to our customers in a more productive and efficient manner. We delivered better results by focusing on product sourcing, supply chain efficiencies, franchising, labor model optimization, and consolidation of functions. Year over year, our gross margin rate was up 60 basis points and we reduced our selling and administrative expenses by over $400 million.

    Building our brands: In 2009, we continued to improve and expand our brands. We are in the process of completely redesigning our entire Kenmore product line and introducing more innovation to Craftsman products. We created and launched the Lands’ End Canvas brand to target a new customer segment. We also launched or expanded new footwear brands, including Protégé, and introduced a complete product line for the home with the Cannon, Jaclyn Smith and Country Living brands. We also continue to look for ways to give more Americans more opportunities to purchase our brands, as evidenced by the recent announcement of the trademark license agreement with Schumacher Electric Corporation, which will enable DieHard branded power accessories to be sold to retailers in the United States, Puerto Rico and Mexico, as well as our agreement with Ace Hardware that will introduce a selected assortment of Craftsman products to customers who prefer to purchase in a smaller and different type of retail channel.

    Reinventing the company continuously through technology and innovation: We continued to improve convenience for our customers by investing in technology. We also focused on being more innovative across all business units. We improved our point of sale systems for faster check-outs, improved the customer experience on our websites, launched new mobile applications, including Sears2Go and Personal Shopper, and offered our customers multiple forms of payment both in-store and online, including express checkout, PayPal, eBillme, check electronification, and an expanded version of our successful Layaway program.

    Reinforcing “The SHC Way” by living our values every day: In 2009, we also strove to improve our work environment and our impact in the communities in which we live. We harnessed technology solutions to increase real-time feedback from our associates and customers, which has had a transformative impact on our culture and customer focus. We also made progress towards our commitment to environmental responsibility by launching a corporate environmental sustainability program and announcing a new sustainable paper procurement policy. Our community programs, such as Heroes at Home, the March of Dimes, and St. Jude’s Research Hospital, continue to grow.

    We are striving for more consistency, better customer service, increased transparency, and tighter integration of our stores, our service businesses, and our online experiences. Our early efforts in these areas are bearing fruit. Stay tuned for more ahead.

    On a less positive note, we regret the closing of roughly 60 stores in 2009. Most of those stores have underperformed for some time and, despite focused efforts to improve them, we felt that we could no longer afford to wait for those stores to turn around. With expiring leases, we have been able to reduce our money-losing stores while at the same time generating cash from the liquidation of inventory and the monetization of some of the stores that we closed. We continue to evaluate our store portfolio, over 2,200 Kmart and Sears Full Line stores combined, and experiment with new and different ways to serve our customers and avoid additional store closings. Like any retailer, we would expect that our store portfolio will require continuous evaluation and transformation as we strive to have every store contribute to the creation of future value.

    In the middle of last year, I responded to an errant published story that repeated unfounded claims from a Wall Street analyst regarding the cash impact of our store closings. As I explained, in most cases, when we close stores we generate cash, net of any cash required for severance and other store closing expenses. The GAAP accounting losses arise from the markdown of inventory, write-off of fixed asset balances, associate severance and any remaining payments on leases that expire in the future. Our ability to close stores is in no way hampered by any cash requirements. Instead, our preference is to operate stores profitably and to transform unprofitable or marginally profitable stores into money makers by evolving our formats to better meet the needs of the communities in which we operate. We know that when we operate our stores well, we have the ability to serve our customers well and to make money.

    The pace of expansion in retail generally and in big-box retail more specifically has slowed dramatically in the past year. I have written previously about what I believed was the reckless expansion of retail space leading to lower profitability for many retailers and to low or negative returns on the investment required to expand space. In other industries, consolidation rather than expansion has led to a more sensible competitive environment and better returns for shareholders. If you examine the level of capital expenditures over the past decade at many large retailers and compare that expenditure to value created, it would not paint a pretty picture. Additionally, the dramatic declines in capital expenditures over the past couple of years at most large retailers are strong evidence that the level of maintenance capital expenditures for a big box retailer is materially below what many analysts and experts previously believed. Most of the capital spent over the past decade has been largely for store expansion, with some lesser amount required for maintaining existing stores. For a company like Sears Holdings, with over 2,200 stores in the Kmart and Sears Full Line store formats, our need to expand our physical store footprint is much less than many of our competitors. At the same time, our need to improve the productivity of our space is much greater than many of our competitors. We are pursuing a number of alternative solutions in parallel to address this challenge.

    We have chosen to invest primarily in areas of our business that we believe will yield long-term growth and attractive returns. These areas include our online businesses, our service businesses, our Kenmore, Craftsman and Lands’ End brands, and some of our alternative formats like Hometown Stores and Outlet Stores. We will continue to experiment and explore ways to materially improve our Kmart and Sears Full Line store experience and competitiveness. To this end, we have made substantial investments in our online platform and in the in-store and mobile technology that enables multichannel experiences under our ShopYourWay banner. We believe that we are on the right track, with an acute customer focus internally, which should yield improved results for our customers and our shareholders externally.

    Despite perceptions, we have not hesitated to open new stores when the economics make sense, including opening new Sears Outlet and Sears Hometown stores in 2009. With roughly 100 Outlet stores and almost 1,000 Hometown stores, these alternative formats represent both sources of profit and sources of growth for Sears Holdings. While both are small relative to the Kmart and Sears Full Line store formats, they serve their customers well and provide a Sears presence in smaller spaces and less populated communities.

    While a number of our major competitors saw their EBITDA decline in the past year, we were pleased to report a meaningful improvement in Adjusted EBITDA from 2008 to 2009 and we aspire to repeat this improvement again in 2010. With unemployment near 10%, many of our current and potential customers have had to tighten their belts and have had their access to credit reduced and the associated costs increased, leading to a cut back in their spending, especially for big ticket items. This has impacted the Sears Full Line stores format to a greater extent than some of our other businesses. This change in customer behavior is not unique to Sears. You can see it reflected in our major mall-based competitors as well as Home Depot and Lowe’s in the home improvement categories.

    2009 Awards and Recognition

    Let’s look at some of the awards and recognition Sears Holdings businesses and associates received during 2009:

    • Sears Holdings was named one of the Top Customer Experience Web Sites for 2009 by e-Tailing Group’s Annual e-Commerce Customer Experience Index.
    • Sears Holdings was recognized by Retail Touchpoints as the winner of the 2009 Channel Integration Award in the Mass Merchant/Department category. The Channel Integration Award honors retailers who have achieved cross-channel integration and improved the shopping experience for their customers.
    • Sears placed third in Mobile Commerce Daily’s ranking of the 2009 Mobile Retailer of the Year.
    • Sears Holdings was named the Overall Best-in-Class Company and Best-in-Industry for the Department Stores/Mass Merchandise category for adaptation of mobile e-commerce initiatives by Acquity Group, a leading services firm focusing on digital solutions, in its mobile study of the 2008 Internet Retailer 500 list.
    • Three of Sears Holdings e-commerce Web sites ranked in the Top 25 on STORES Magazine’s list of 50 Favorite Online Retailers of 2009. ranked number 10, was number 15 and was number 23.
    • Sears Holdings online community was ranked the top retail-branded community site in North America and ranked number four out of the top five-branded communities in a study sponsored by the Word of Mouth Marketing Association.
    • Sears was listed in the The Vitrue 100: Top Social Brands of 2009. The Vitrue Social Media Index assigns brands and products a score based on overall buzz from status updates, videos, photos and blog posts. Sears moved up four places to 96 this year and was the number seven retailer.
    • Sears received Special Recognition in 2009 for Retail Commitment from the U. S. Environmental Protection Agency. Organizations recognized have achieved major energy savings and/or help consumers save money while also increasing energy efficiency and reducing carbon emissions by offering high-performance products, educating consumers or offering incentives for better ways to use energy.
    • Craftsman was voted the favorite hand tool brand by over 7,000 Popular Mechanics’ readers.
    • Lands’ End ranked number eight in the National Retail Foundation/American Express Customer’s Choice Survey for 2009. This is the fourth consecutive year that Lands’ End has been named in the top ten.
    • Sears Holdings was honored with the Stars of Madison Avenue Award presented by the ADVERTISING Club. Sears Holdings was recognized for our efforts with Heroes at Home and Rebuilding Together.
    • Sears Holdings was ranked by BusinessWeek as one of the Top 100 best places to launch a career in 2009.
    • Crain’s Chicago Business named Michelle Pearlman, SVP and President, Jewelry, one of their “40 under 40” to Watch in 2009. Crain’s “40 Under 40” highlights Chicago-area leaders under the age of forty who are considered to be among the best and the brightest in the Chicago business community.
    • US Banker magazine named Susan Ehrlich, SVP and President, Financial Services, to its annual list of The Top 25 Non-bank Women in Finance.
    • Sears Holdings was ranked by G.I. Jobs Magazine as number 25 on their Top 100 Military Friendly Employers list for 2009.
    • Sears Holdings Corporation was named by Black Engineering, Hispanic Engineering and Women of Color magazines, which are part of Career Communications Group, as one of the Most Admired Employers for minority professionals based on a survey regarding their impressions of diversity initiatives at top organizations.
    • Sears Holdings was listed as one of the Best Places to Work for GLBT Equality by the Human Rights Campaign and received a 100 percent score in the Corporate Equality Index (CEI) for a sixth consecutive year.
    • Sears Holdings won the Volunteer Leadership award from the March of Dimes for our on-going support in raising public awareness of maternal and baby health issues.
    • Sears Holdings was ranked as the number-two retailer and number 48 out of 100 by The Dave Thomas Foundation for Adoption in 2009.
    • Sears Holdings was ranked in the Top 100 for the Reputation Institute’s Most Reputable and Recommended U.S. Companies for 2009.

    We are proud of these accomplishments, in addition to the progress made on our financial and strategic priorities, and hope that those who may have doubted us in the past are willing to keep an open mind. For example, critics have cited our investment choices for our declining sales, while the economy has been cited for our competitors’ declining sales. Likewise, our reduction in debt is ignored while our competitors’ expansion in debt is not taken into account. While we continued to repurchase shares during the economic crisis because the value was attractive and because we had significantly lower leverage than others in our industry, many of our competitors suspended their repurchase programs to appease credit rating agencies only to resume them again after their share prices recovered significantly.

    We can understand rating agency caution surrounding economic events, the retail environment, and the potential for things to get worse. In our case, it turns out that our performance far exceeded many observers’ expectations and we hope to receive credit for this performance in the form of higher credit ratings and more balanced analysis.

    Rating agencies play an important role in how investors allocate capital by “qualifying” debt for certain investors. By overrating companies and securities, rating agencies can lead to systemic issues and investor losses. Similarly, by underrating companies they can lead to lower growth, less risk taking, and less job creation. Simplistic analyses, which automatically prefer capital investment to share repurchases as a use of cash that “benefits“ bondholders, ignore the fact that negative or below market returns on invested capital are as harmful to creditors as to shareholders.

    When we inquire why our ratings are not higher than some competitors with credit metrics that are weaker than ours, one factor cited is that some analysts prefer their business models. Meanwhile, we have a higher market capitalization and less debt than many of these competitors. We increased our earnings, while many others have seen their earnings decline. We have a diversified business portfolio and a significant revenue base and scale. Obviously, we don’t agree with all of the critical qualitative conclusions and the quantitative metrics speak for themselves.

    We do some things differently than others, and we have certain beliefs that differ from theirs. Our culture is owner-oriented, because we have owners who serve on the board that governs the company. We believe that ownership makes a difference, especially when owners have significant financial interests in the company and a long-term perspective. Instead of this raising concern, rating agencies should welcome and value owners with a demonstrated track record of long-term value creation and conservative capital policies, even when some of the capital allocation preferences differ from those that others believe lead to higher long-term credit performance.

    Looking Forward

    I expect us to continue our journey in 2010 to deliver improved customer experiences, new ideas, and better financial performance. It would be great to see a slight tailwind in our economy this year, though we will stay focused on the five pillars of our strategy and driving improved financial results regardless. We recently announced new and innovative products in our Kenmore laundry business as a result of our work towards a complete brand redesign that I mentioned earlier. We have an exciting Kenmore product line being delivered throughout 2010. In laundry, in refrigeration, and in cooking, we will demonstrate renewed innovation and reinvigorated leadership with heavy marketing and customer experience support. It has taken us some time, but we feel confident that we are on the right track, as the leader in the appliance business, to differentiate and extend our leadership and financial results in this important business.

    At Lands’ End, we expanded our business on three dimensions in 2009 and will continue building on these in 2010. First, we added Lands’ End shops to an additional 68 Sears stores. Second, we expanded internationally for the first time in over a decade, into France and Austria. Third, we introduced Lands’ End Canvas, an updated version of the classic Lands’ End styling, which has been very well received and which extends Lands’ End’s relevance to a new demographic. And, all of this comes with the exceptional and widely recognized customer service excellence that has always been, and which we expect will continue to be, a hallmark of the Lands’ End brand.

    Our Home and Auto Services businesses have identified new growth opportunities that we began to execute in 2009. As we progress through 2010, we expect to continue to innovate and update our service businesses, which extend our reach to our customers outside our stores and help them not only purchase products but install, maintain, and repair those products as well. Sears has a long tradition of building lifetime relationships with our customers, and the focus that we have on updating and improving our service businesses continues that tradition. Expect us to reinforce our services capabilities and presence in the pursuit of helping our customers manage and improve their lives.

    In 2010, we also plan to continue to expand our online and multichannel capabilities as well as our ShopYourWay Rewards program in order to help us build digital and personalized customer relationships. We aim to give our customers vastly more convenience and choice in terms of 1) what they buy (through our online Marketplace and expanded assortments), 2) where they shop (online, in stores or on their mobile devices), 3) when they receive what they want (including the popular option of same-day buy online, pick up in store which is “ready in 5 minutes–guaranteed”), and 4) how they choose what to buy (through improved access to content and feedback from our product and service experts as well as other customers). We think online social networking and social media have only just begun to have an impact on shopping, and it is a revolution we intend to harness going forward.

    Finally, we continue to develop our associates and leaders. We expect that Sears Holdings will become more widely recognized as a great place to begin one’s career as well as a company that develops great talent by providing them with a variety of challenges and opportunities. Opportunities to lead are widespread and numerous at Sears Holdings. The business unit structure that we put in place two years ago has created many more general management positions, and we will continue to break down our business units to create even more opportunities for our associates to demonstrate their leadership capabilities. At the same time, we expect our leaders to perform and deliver results. With the increased opportunities for responsibility comes more clearly defined accountability. Strong leaders will welcome this challenge, and it helps us identify better performers earlier in their careers.


    Making Sense of Business and Policy

    I just finished Thomas Sowell’s most recent book, Intellectuals and Society. For those not familiar with his writings, Thomas Sowell is one of the clearest and most insightful writers of our era. I look forward to every book and column he publishes. In this book, he discusses the “vision of the anointed” and how their views shape society regardless of their merit. He describes how often these views conflict with reality without altering these views and, paradoxically, sometimes strengthening them. I couldn’t help noticing the parallels between his comments and the “vision of the anointed” in the financial and business world over the past few years.

    Business leaders, regulators, public officials, and journalists have become an echo chamber of self-support and self-congratulation, whether on TV, in print or at numerous conferences. Their words and their actions are often self-serving (whether right or wrong), and they are typically regarded and reported on as if they were obvious and selfless. They get repeated as if there were no alternative views or possibility of error in their thinking. Dominant narratives develop and get defended primarily by repetition and secondarily by attacks on those who disagree with those narratives. When these favored people and views become endorsed in laws and regulations, some may benefit, but many get harmed.

    There are several examples of issues that have been smothered by dominant narratives. Accepting these narratives without critical evaluation can be a contributing factor to some of the negative unexpected consequences they produce. Did the seizure of Fannie Mae and Freddie Mac (the largest nationalization in our country and likely in history) calm or ignite fear in the financial markets and did those urging or supporting the seizure profit from it? Has raising minimum wage rates helped or harmed the individuals that those advocating such policy intended to help? Is there any link between a higher minimum wage and high unemployment? Has the consolidation in financial services helped or hurt depositors and borrowers? Why were some institutions saved and others seized, merged or left to fail? How does regulatory and policy uncertainty impact investment and risk-taking in society?

    I fear that Americans have been provided a false choice between a little more and a lot more regulation and taxes. We keep hearing more ideas to create jobs and generate growth that almost exclusively require more government spending. Jobs can come from government, but those jobs get paid for by taking money from the private sector, reducing the private sector’s ability to provide jobs. On the other hand, there are many who believe that less regulation, less government interference, less arbitrary regulation when it does exist, and lower government spending will generate more growth and more jobs. I agree with those views.

    As one of the largest private sector employers in the United States, Sears Holdings recognizes the challenges of finding good talent, developing good talent and keeping good talent. We have created not just new jobs, but new job categories and job descriptions as our industry changes and as new technology provides both new opportunities and new challenges.

    Some contend that there is an inherent conflict between labor and capital, yet they fail to appreciate that without investment there will be no growth and no jobs. For there to be investment there needs to be an expectation of profit, and, for there to be an expectation of profit, there needs to be hope and belief in the future and confidence in the rules of the game.

    The straw man frequently used to justify more regulation and to criticize free markets is to assert that the proponents of free markets blindly believe that they always work and that they always produce good results. Most free market advocates don’t actually make this claim, and they know that it is not true. Free markets respect individual rights and freedom, preserve choice and accountability, and produce superior results compared with non-free markets. When free markets experience problems and produce poor results, critics are fast to proclaim that things would have been better if only there was more, but better regulation. However, in most industries and societies where there is more regulation, there is typically lower growth, lower employment, and less innovation.

    Self-regulation is a better idea and it is a better choice, whether for an individual or a corporation. Any corporation can choose to limit or make investments, increase or decrease compensation, and manage risk at different levels. Companies can compete by promoting their “safety and soundness” or by their “willingness to take risks.” Investors, customers, and workers can choose which companies and their associated behaviors and philosophies appeal to them. Let the media and politicians explain, compare, criticize, and contrast the various policies, so there will be little doubt that success or failure is determined by choice and not by ignorance. Then, make sure that government doesn’t reward failure and punish success by interfering with outcomes based upon political contributions, undue influence, or the personal beliefs of the policymakers.

    Putting Americans to Work

    I have written in the past about the need for pension funding relief. The simple and appropriate relief that I mentioned in my letter to shareholders last year has not been enacted. It has gotten bogged down in Washington. We have closed several stores and may choose to close more in the future, in part so that we can liquidate inventory and reduce losses to invest capital in our pension plan. There is nothing about the relief we are advocating that makes it less likely that we can meet our pension obligations. Rather, the ability to spread our payments into the plan over an additional two years would have allowed us to keep some of those marginally performing stores open and retain the jobs that they require.

    Compare our situation to major financial firms and the deferrals they were granted practically overnight and with great subsidy to those firms. By allowing financial firms to issue FDIC guaranteed debt, the repayment of their short-term debt was effectively extended by up to three years. Despite this support, there was a significant reduction in jobs in the financial services industry and a significant reduction in lending and risk taking as well.

    At Sears Holdings, amending and extending our short term debt in 2009 required significant fees and more onerous terms than our previous facility. Providing an extension in funding our pension plan for two years costs the government nothing (in fact Congressional Budget Office scoring shows it to be a significant revenue generator), requires no subsidy, and will not reduce the benefits paid to pension recipients. Furthermore, it allows companies to invest and increase – or at least maintain – employment rather than reduce investment in order to meet accelerated pension contributions brought about by both the reduction in asset values and the reduction in interest rates that has accompanied many of the liquidity policies that have benefited the very same financial institutions.

    You would think that pension relief would have been quickly forthcoming and would have been completed a year ago. We are hopeful that reason will prevail and such relief will be forthcoming shortly. This is not about skirting responsibility for our pension plan (we have contributed more than $1 billion over the past 4 years). It is not about getting a single penny of subsidy from the government, and it is not about reducing a single penny of pension benefits that associates will receive. It is about creating the ability for us and others to focus on improving operations rather than closing operations.

    Sears Holdings shares the stated goal of many public officials of creating jobs. But, we don’t believe that we need large government programs to generate these jobs. Public officials often fail to recognize the obstacles they place in the way of job creation. For example, over the past year proposal after proposal has been put forward to reform health care, reform the financial system, increase taxes, and add regulations, all with the intention of making the United States a better and stronger country. Yet, as a business, trying to understand which of these proposals might become law, what their impact might be on business prospects and competition, and what additional costs they might impose creates a great deal of uncertainty. It has led our management team and board (and I am sure those managements and boards of other companies) to spend inordinate time trying to determine which investments we should make, defer, or cancel and which jobs to create, maintain, or eliminate. The removal of this uncertainty and the constant drumbeat of new threats against various businesses would go a long way to allowing American entrepreneurial energy to be unleashed.

    Our budget deficit has left many searching for ways to raise revenues through new taxes, rather than reducing spending and generating new revenues through growth and through the removal of the impediments to growth from existing regulations and threats of new regulations. Here are a few ideas, none original, that can contribute to reducing unemployment over the near term without additional government spending: reduce U.S. corporate tax rates (amongst the highest in the world), extend individual tax programs that are scheduled to expire or that are subject to debate (freeing up individual time and attention devoted to tax planning and strategies), deal with entitlements and don’t create additional ones (we can’t afford the ones we currently have), and stop providing selective benefits to individual companies or industries (it creates an uneven playing field).

    Capital can quickly reorganize and provide financing for businesses and projects that create value for our society, without the heavy hand of government planning and policy. I disagree with most people calling for a gigantic overhaul of our financial system led by new and “improved” regulations. Instead, begin the process of allowing more competition in financial services and begin the removal of implicit and explicit government guarantees that provide the perception that some are “too big to fail.” While there are those that claim that their institutions are not too big to fail, they surely recognize the significant competitive advantages that come from this perception. Of course they will accept regulations as long as these regulations do not permit additional competition from entities and institutions that do not take insured deposits, do not have access to Federal Reserve funding, and do not have government guarantees associated with their debt offerings. Regulatory capture comes when there is little competition allowed outside regulated entities and a “freezing” of competitors and innovation in an industry.

    We need innovation in our society, including financial innovation. Large institutions believe that they can innovate, create value, and create growth. But history has shown that regulations that provide a sense of certainty and stability by limiting risk, also lead to lower innovation, lower growth, and fewer jobs. Innovation is a messy process. Some efforts succeed, others fail. Those who desire to compete based upon limiting competition usually protest and criticize innovation (regardless of industry) and the companies and leaders leading that innovation. The intervention of regulators and politicians to slow down or prohibit new ideas and innovation, however well-intended it may be, inhibits growth, value, and job creation. and the E-Commerce Competitive Environment

    Sears has a long legacy in serving customers beyond physical stores. In many respects, The Sears Catalog was the 20th century model for selling products through the mail. To be successful, Sears had to earn the trust of its customers who purchased products sight unseen and who had to feel confident that they would receive what they purchased and, if they were not satisfied, they would be able to get their money back. “Satisfaction Guaranteed or Your Money Back.”

    The merger of Sears and Kmart in 2005 expanded the reach of each company, both in terms of physical stores and in terms of categories and customers served. With this increased reach comes the ability to serve more customers, more frequently — in our stores and in their homes and businesses. In order to do so effectively, we have invested significantly in building our technology and customer experience capabilities, with the goal of making it easy for customers to do business with Sears Holdings anywhere, anytime, and in many ways.

    We united our initiatives under the banner ShopYourWay and launched ShopYourWay Rewards in 2009 to further emphasize the value and capabilities we bring to our customers. We have been working intently to make it easy for customers to engage with us online through the numerous websites that we operate including,,,,,,, and It should be easy for a customer to access any of the myriad products, services, and information we make available online, regardless of which website they choose to begin their particular shopping mission.

    The two leaders in online commerce are and eBay. Despite operating no physical stores of their own, these two companies have built tremendous businesses over the last decade serving millions of customers every day in a broad number of categories. They have taken significant market share from traditional retailers by providing convenience, service, and competitive prices. One has to give each of these companies tremendous credit for their foresight, persistence, and execution through the collapse of the internet bubble, early skepticism, and competition against larger and more established retailers.

    There remains, however, one advantage that the major online retailers retain that is both unfair and problematic, for competition and for communities and jobs as well. For customers in many states, Amazon and other online retailers are not required to collect sales taxes on purchases made by their customers. Since the 1992 Quill Supreme Court decision, businesses without a local “nexus” have sold goods through the mail or online without being required to charge and collect the related sales or use tax. Amazon, in particular, has argued that when it doesn’t have a physical presence in a state or local jurisdiction, it is not benefiting from police, fire protection, and other local services and therefore shouldn’t be forced to pay for them. Analyses by others suggest that the real issue is competitive advantage, more than other explanations put forward in the past.1

    The real story here is that it is not the payment of taxes or the charging of taxes that is at issue. It is the collection of taxes on behalf of local governments from purchasers of goods and services from stores in a locality or for use in such locality. It is the latter fact that is often ignored. A person who buys products from is required by law to pay sales or use tax to their local jurisdiction. In practice, almost nobody does so. The cost and unpopularity of enforcing such laws has allowed customers to avoid paying sales or use taxes, even though they are required in many states and localities. If you buy a work of art or piece of jewelry in NYC, for example, and have it shipped to New Jersey or California, the seller does not collect sales tax on that purchase but the buyer would be required to pay sales or use tax on the purchase where they receive the merchandise and use the merchandise. So, a piece of jewelry shipped to California would require the buyer to pay California sales or use tax.

    Amazon’s domestic business has grown to $12.8 billion in revenues for the year just ended. If you were to apply a 6% sales tax to this revenue (reflecting a rough average of sales taxes across multiple jurisdictions), that would amount to almost $800 million in sales and use taxes owed to state and local governments that is likely not being paid. The good news is that it is $800 million that remains in the hands of the purchasers of products from Amazon, but at the cost of jobs and new fees and taxes required to make up for lost revenue. Having delayed a level playing field for as long as they have already, Amazon has been able to build relationships with many customers that give it an advantage, even playing under the same rules as those it competes against.

    I would propose that there be a leveling of the playing field for e-commerce merchants. Either we all collect taxes or nobody collects taxes. If state and local governments are going to require retailers like Sears and Kmart to collect sales taxes and not retailers like, they should recognize that over time their sales tax base will erode significantly and that they place companies who have chosen to locate stores locally at a competitive disadvantage. This will lead to a loss of revenues, the closing of local businesses, the loss of tax revenue, and ultimately to the increase in other types of taxes to compensate for the lost jobs and revenues. Alaska, Delaware, Montana, New Hampshire, and Oregon are states that currently charge no sales tax at all. Let me be clear, we have no issue with continuing our current practice of collecting tax on behalf of state and local governments. We just don’t believe that the current set of rules is sustainable without severe competitive and community damage over time.


    I look forward to seeing many of you on May 4, 2010, when we hold our annual shareholder meeting in Hoffman Estates. I hope to have updates on our progress and the numerous initiatives and opportunities that we are pursuing.

    As always, I want to thank all of our associates and leaders for staying focused and dedicated through difficult times and pursuing excellence in their jobs and in delivering outstanding customer experiences. I want to thank our customers for their tremendous feedback, both good and bad, that helps us to get better every day and to serve you better in the future. And, finally, I want to thank all of our shareholders for continuing to support us with your investment in the company. I know you appreciate what we are trying to do to create long-term value in a deliberate and logical fashion, while remaining cognizant of the risks and challenges that we face.


    Edward S. Lampert

    For more information, please visit Market Folly…