| Wilbur Ross | ||||||
“We are not so much a vulture as a phoenix,” says Wilbur Ross, chairman of WL Ross& Co. “We are not liquidators, we are rehabilitators. There are a number of people who do what we do who are pure vultures. But we are interested in the ongoing business.”
Ross is one of the best-known people in the US in the world of bankruptcy and restructuring – Fortune magazine once dubbed him Wall Street’s “King of Bankruptcy” – but he is relatively new to distressed-debt investment.
He and his five-strong team set up WL Ross&Co in April 2000, having bought out the distressed-investing business of Rothschild Inc. Ross was previously the head of the bankruptcy practice at Rothschild, where he had worked since 1976.
In those 24 years he assisted in the restructuring of some $200 billion of liabilities – with a hand in several of the biggest bankruptcies and restructurings in US history, including Texaco, Trans World Airlines, Drexel Burnham Lambert and Trump Plaza.
WL Ross&Co is now the manager of the WLR Recovery Fund – the former Rothschild Recovery Partners, which he helped to set up in 1997 – and the Asia Recovery Fund and Asia Recovery Co-Investment Partners.
Last year the firm also launched a hedge fund, the Bermuda-based Absolute Recovery Hedge Fund, which raised $150 million in June 2001 and has recently reached its $200 million cut-off point.
The new fund can take naked short positions in the stocks of companies that the firm believes to be heading for default or bankruptcy. By contrast, the long-only private-equity funds will only take positions once a company is already either in default or in bankruptcy.
In a novel twist, the hedge fund also operates a short-equity, long-bond strategy. That strategy should pay off best in a situation where the equity goes to zero but the bondholders, who have a senior claim, recover something from the wreckage.
But the strategy is also designed as a hedge: the debt should appreciate substantially in any company where the equity suddenly recovers, thereby mitigating the potential loss.
In recent months the hedge fund has profited handsomely from a naked short position in Williams Communications, which the firm shorted at $3 and which traded down to 30 cents.
But the flaw in the strategy was seen when the fund went short in Enron stock and simultaneously long in Enron bonds. The profit made from Enron’s precipitous decline from $30 to 30 cents – the level at which Absolute Recovery sold out – was given back when the bonds also collapsed.
Ross says the firm broke even on the Enron trade. “The reason we closed out was that, although we still think there’s some value, it will all boil down to litigation. We don’t like to invest in things when the outcome is down to litigation. There may be people who think they can analyze and second-guess a situation like that but we are not among them.”
The hedge fund has been heavily subscribed by German and Japanese investors in particular, even more so than in the US. Its purpose, according to Ross, is “anticipatory distress”. He explains: “We spend a lot of our time working out who is going to go down 12 to 24 months forward. The hedge fund gives us the ability to use that research further out.”
According to Ross, many distressed investors will only start to become interested in a company once it has actually gone into default. “If we have been looking at something for a year, and someone else has just been looking for a fortnight, we should have an advantage,” he says.
He adds: “If one of the investment banks rings you up offering you bonds at 50, then your mind is automatically drawn to that figure as a basis for determining value. But if you have been doing your own research you have already arrived at your own valuation and so you have your own starting point.”
One rule is that the hedge fund never shorts anything in bankruptcy. “Once a company files for bankruptcy, the long fund can get involved. The long fund can only make money on the upside so it needs to buy paper at a much lower price – at or below liquidation value,” says Ross.
“It takes much bigger and much more concentrated positions and is basically arbitraging between liquidation value and going-concern value.” The hedge fund has a large number of short positions and will generally hold things for under a year – often less than six months. The long fund will hold much larger positions for at least 12 to 18 months, up to three years at most.
Ross is hopeful that the hedge fund will improve the firm’s overall performance – not least because analysts are required to talk at least once a week to the company in which they have invested. “These are, by their nature, under-managed companies and you don’t want to let them out of your sight for too long,” he says.
In terms of large investments, WL Ross is primarily active in Asia – notably Japan and Korea – and the US. In Japan, the firm and a group of co-investors bought the Osaka-based Kofuku Bank for ¥24 billion ($185 million) in February 2001.
Now renamed Kansai Sawayaka (“Fresh Start”) Bank, the bank is operating under new western-style management and, after substantial rationalization, is one of the lowest-cost financial services operations in Japan.
In partnership with Daiwa Securities, with which Ross has a joint venture, the firm has also bought control of auto parts company Nikko Electric.
In Korea, in a 50/50 deal with life insurance company Tong Yang, WL Ross bought Pacific Life from the Korean government. The deal was signed on April 1 2000 – the first day of Ross’s independence from Rothschild.
Two months later Pacific Life was merged with Tong Yang Life. WL Ross has a 20% stake in the combined company, which is the fourth most profitable life company in Korea.
In the US, Ross prefers to invest in smaller companies – with $200 million or less of debt. “That is the more imperfect segment of the market”, he says. “Most people focus on the big situations. We are interested in the little firms that fall between the cracks.”
But the firm has made three large investments in the US – most recently buying control of US steel producer LTV for around $300 million. LTV is in Chapter 11 for the second time, having spent four years in bankruptcy at the end of the 1980s.
The company was bought just before president George W Bush announced dramatic new measures to protect the US steel industry from foreign competitors – a move that Ross clearly anticipated. “Steel has been on our radar screen for a long time,” he says. “It was as clear as could be that something like this would happen. We didn’t actually know it was going to happen but we had good information and we weren’t surprised.”
Ross believes the next area to which the Bush administration might turn its increasingly protectionist stance is textiles. That would certainly be handy in the light of the major interest WL Ross has in US textiles producer Burlington Industries.
Burlington filed for bankruptcy last December. One of the early positions that the Absolute Recovery hedge fund had taken was to go short Burlington’s stock and long the bonds. When it filed for Chapter 11 bankruptcy, the long fund bought more bonds. The firm is now Burlington’s largest creditor and chairs the creditor committee. The bonds have already traded up from nine cents to 15 cents and Ross believes that there is plenty more value to come yet.
The company’s management is taking an axe to the cost structure of the business. It announced in February that it would lay off 5,000 of its 10,000 US employees and outsource much of its production to China. However it is also repositioning itself as a high-technology textile company, devoting much of its attention to product innovation.
A profitable exit from Burlington would be a second success for Ross in the textiles business following a rewarding investment in Fruit of the Loom – one of the world’s best-known brand names. Fruit had fallen on hard times as a result of a dramatic change in management strategy that backfired.
WL Ross had been tracking the company for about a year before it filed for bankruptcy. The debt had traded down to the low 40s and Ross bought at 42, also benefiting from a windfall when the bankruptcy court awarded interest on the basis of the bonds’ collateral.
Under new management, the company was successfully turned around within a year, with the bonds trading up to 70 – a 66.66% return. In a recent auction in which a number of bidders participated, Warren Buffett bought the business for $835 million.
So far, so good. But Ross and his team will have to keep coming up with deals like this to stay ahead.
