Happy Days in Distress
By ERIN ARVEDLUND, Barron’s Magazine
Hedge fund Litespeed Partners finds opportunities in bankruptcies like American Airlines, MF Global and Eastman Kodak. And what’s Tronox, and why is it so valuable?
As a sign of her competitiveness, Litespeed Partners founder Jamie Zimmerman named her hedge fund after her favorite model of racing bike. The fund has managed to maintain a pretty good pace of its own: It has averaged an 11.3% annual return since its founding in 2000 and has grown to just over $1.1 billion in assets.
Because of its event-driven style, Litespeed’s portfolio seems as current as today’s business pages, as it seeks out distressed debt and stocks, particularly companies that are filing for bankruptcy, undergoing restructuring or being targeted for possible acquisition or merger. “We’re value investors with an event overlay. Stocks can stay cheap, unless you buy something that monetizes of its own accord, say through a tender offer, a bond with a coupon in a takeout, or a distressed situation with a package of cash and bonds. To us, plain stock is the most questionable — you have to sell it to someone else for more, unless someone buys the company.”
Brad trent for Barron’s
Among its holdings, Litespeed owns distressed debt of AMR, the parent ofAmerican Airlines (AAMRQ.OTC) andEastman Kodak (EKDKQ.OTC), as well as bank debt of MF Global, the failed brokerage run by New Jersey’s former governor Jon Corzine. Litespeed is also a holder of preferred stock of Strategic Hotels & Resorts (BEE) and shares ofTronox (TROX.OTC), a former unit of Kerr-McGee that got saddled with much of its environmental liability.
Before founding Litespeed, Zimmerman was head of research for the risk-arbitrage situations portfolio at Toronto-Dominion Bank. Zimmerman received a B.A. from Amherst, where she played soccer, basketball and softball, and a J.D. from the University of Michigan Law School. She began her career as an attorney clerking for a federal bankruptcy-court judge in the Southern District of New York, but then jumped into finance as a Wall Street risk-arbitrage analyst. She ran an Oppenheimer proprietary account that invested in post-reorganization equities. She also was a member of a Dillon Read risk-arbitrage group responsible for distressed securities and research on merger-arbitrage opportunities. Today she oversees Litespeed’s 16-person staff in midtown Manhattan.
A marathoner and bicyclist who’s ridden across the country, Zimmerman still works out at 6:30 a.m. daily. A torn Achilles tendon has ended her basketball career, but she remains a big fan of the New York Knicks.
ZIMMERMAN’S FUND WILL TRADE some positions, though it holds others for years, waiting for a company’s fortunes to improve. For instance, once it comes out of bankruptcy, American Airlines, she believes, eventually will mimic carriers like Northwest, United and Delta, which emerged in much stronger financial shape. “They’ve all come out with labor costs significantly lower. Northwest’s labor costs were 33% of revenue, and after bankruptcy they were 21%. United Airlines was even higher; salaries as a percent of revenue were cut in half.”
American’s labor costs when it filed for Chapter 11 in November came to 30.9% of 2010 revenue. “We figure if they can take out enough to bring that number down to 22%, Ebitda [earnings before interest, taxes, depreciation and amortization] will fly, perhaps more than double,” says Zimmerman.
Litespeed bought unsecured bonds issued by American at 19 cents on the dollar, and they currently trade at 30 cents. American is also repositioning its plane fleet and could be bought or re-emerge from bankruptcy in a year and a half, she adds.
“It’s a pattern bankruptcy, in which they cut the pensions and renegotiate the collective bargaining agreement, etc.,” she explains. “You make the assumption that the airline saves $1.6 billion in costs per year and turns that into Ebitda,” Zimmerman says. When American emerges from bankruptcy, she expects Litespeed’s bonds to convert into more valuable equity in a new company. She anticipates more consolidation in the U.S. airline business once American completes its restructuring.
The pioneering camera and film maker Eastman Kodak filed for bankruptcy in January, and Litespeed invested in secured bonds at 71 cents on the dollar. “There’s enough value between the information technology and other Kodak businesses to make money. There’s over $2.3 billion of value to pay us off at par,” or 100 cents on the dollar.
Kodak has three business segments, some of whose elements are cash-flow positive, and some not. The Rochester, N.Y., outfit is shutting down its digital-photography business, while its online photo-printing unit, Kodak Gallery, and other components like ink-jet printers could be sold, Zimmerman believes. Kodak’s commercial-printing business makes money, while a scanner business could also be bought up by a competitor. However, “I don’t think Kodak emerges as a business again, like American Airlines. Lots of little pieces will be sold off,” she contends.
STRATEGIC HOTELS & RESORTS is a real-estate investment trust that owns and manages luxury hotels like the Four Seasons in Jackson Hole, Wyo., the Ritz-Carlton in Half Moon Bay, Calif., and the Fairmont Hotel in Chicago, among others. After the financial crisis of 2008, Strategic stopped paying dividends on its common and preferred shares, but Litespeed stepped in to scoop up the preferred about two years ago. They now trade at $29, up from $18.50 when the fund started buying.
This summer the company will pay hefty back dividends owed on the shares, Zimmerman adds. Unpaid dividends payable on June 29, 2012, will be $7.22 per share, which works out to about an 8% return for the firm. If the preferreds trade at par once dividends are reinstated, the shares will be worth $32.22, Zimmerman estimates.
There are companies even an expert distressed investor avoids. Zimmerman says a low interest-rate environment is protecting many weak companies with heavy bank debts like Harrah’s, Univision Communications, Clear Channel and Rite Aid (RAD). “They have heavy debt loads benefiting from low rates; when interest rates go up, the whole system goes.”
ZIMMERMAN, A WIDOW for more than a decade, devotes her time to her two high-school-age daughters and her firm. She’s considering opening a Litespeed office in Europe, depending upon the opportunities that emerge from the euro zone’s debt turmoil and possible defaults.
Litespeed bought some Bank of Ireland (IRE) bonds as the country’s real-estate problems worsened, but the investment underscored for her the risks of government ownership. “We the bondholders should have wound up with full equity; we got a fraction,” notes Zimmerman. The fund still holds the stock into which the bonds converted. The bank’s chief financial officer assured Litespeed that it was the best deal the government would allow. The Irish government still owns about 15% of the lender and therefore is expected to support it. Yet, “you don’t really know the outcome. The opportunity in the crisis in sovereign debt is tricky. It’s just a different risk; you can take it but you have to understand it’s a political calculus rather than just straight payoff.”
Zimmerman has more clarity on industrials like Tronox, the Kerr-McGee spinoff. The maker of titanium dioxide declared bankruptcy in 2009 to get clear of environmental problems its parent encountered in the former subsidiary. Litespeed purchased Tronox bonds, which then converted into stock at an average price of $47 a share.
Without the environmental liabilities, Tronox has a promising future. It’s the fifth-largest producer of the paint chemical. Zimmerman estimates 2012 Ebitda will more than double to $400 million. The market is dominated by a few players that reduced capacity during 2008 and 2009 and are now operating at nearly full bore. As demand recovers, Tronox and its rivals are raising prices, she says.