Mark Fetting, chief executive officer of Legg Mason Inc. (LM:US), was out of time.
His biggest investor, Nelson Peltz, had watched for three years as Fetting struggled to increase profit at the Baltimore- based money manager and halt $135 billion in fund redemptions (LM:US).
At Peltz’s behest, Fetting cut costs by as much as $150 million a year and bought back (LM:US) at least $1 billion in stock. Still, the shares hadn’t gained much since Peltz’s hedge fund bought its stake in mid-2009. With a standstill agreement set to end in November, allowing Peltz to raise his holdings or propose a slate of directors, Fetting quit.
“Patience was clearly running out,” Jeff Hopson, an analyst at Stifel Nicolaus & Co. Inc. in St. Louis, said in a telephone interview. “The odds of a dramatic corporate change have increased at Legg Mason.”
Legg Mason is typical of the investments made by Peltz and partners Peter May and Ed Garden, who target underperforming companies including H.J. Heinz Co. (HNZ:US) and Wendy’s Co. (WEN:US) and nudge them to cut costs, spin off businesses or add new products. The approach is proving popular, according to investors, with Peltz’s Trian Fund Management LP set to wrap up $1 billion in new commitments from big institutions betting he’ll outperform other stock pickers in a market where many equities are moving in lock-step with each other.
Yet Legg Mason’s lackluster (LM:US) performance shows the challenges for activists like Peltz, who can no longer rely on a market rally to help lift assets. Trian’s $2.2 billion Master Fund, its original hedge fund, is unchanged this year through August, according to investors, as the Standard & Poor’s 500 Index (SPX) returned 14 percent including reinvested dividends.
“Our timing isn’t always perfect, sometimes it takes longer to create value, but if the companies generate more earnings, the stocks will ultimately reflect that,” Peltz said in an interview this month with his two partners in their Park Avenue offices in Manhattan. Peltz declined to comment on Legg Mason or Fetting’s resignation, which was announced Sept. 11.
Peltz, 70, a billionaire and father of 10 children ranging in age from 9 to 49, made his first fortune in the 1980s, doing leveraged buyouts financed by high-yield bonds sold by Michael Milken. Now Trian takes minority stakes in companies with no borrowed money, counting on the partners' experience running companies and their relationships with institutional investors to get management to listen. Sometimes they take a board seat.
“You don’t need to take a company private to fix it,” said May, 69, who has worked with Peltz since 1972.
The strategy has attracted investors at a time when few hedge funds are able to raise money. Last year, the California State Teachers’ Retirement System committed $300 million to Trian, agreeing to lock the money up for at least three years.
“We hire activist managers who go in and improve companies over the long run,” said Aeisha Mastagni, investment officer for the $152 billion fund’s corporate-governance unit. “We own those securities in our passive index, and so we look for managers who will make them better companies” even after they move on. The fund has $3 billion with eight activist managers.
In the past year, state retirement funds in Virginia, New Jersey and New York have invested $600 million with the $6.5 billion Cevian Capital AB, an activist fund run by Christer Gardell that targets northern European companies.
New York invested another $200 million in a Trian fund started in 2010 that doesn’t bet against stocks, draws down capital as needed for investments, and doesn’t let investors exit for at least six years. A second such fund will have its initial close in October with about half the $2 billion it’s seeking, according to three investors who asked not to be named because the fund is private.
Peltz and his partners declined to comment on the new fund.
Trian’s Master Fund has returned an annualized 5.2 percent since November 2005, according to investors. That compares with 3.4 percent for Bloomberg’s stock hedge fund index and about 4.5 percent for the Standard & Poor’s 500 Index.
Trian’s performance this year has lagged behind that of other activists. Cevian, whose holdings include German builder Bilfinger Berger SE and Danish bank Danske Bank A/S, climbed 16 percent this year through August, investors said. Bill Ackman’s $11 billion Pershing Square Capital Management LP, the firm behind the makeover of discount retailer J.C. Penney Co. Inc., returned 6.9 percent. He’s posted an annualized return of 20.4 percent since starting in 2004.
Former corporate raider Carl Icahn, who like Peltz was a Milken client, posted average annual returns of 11 percent before expenses from November 2004 through the end of 2010. He returned outside investor money in his funds in early 2011.
Unlike Ackman, whose portfolio includes shares he expects to climb as well as bets against companies he reckons will tumble, Peltz’s main fund only shorts as a hedge against a widespread tumble in the stock market, which can limit returns when benchmark indexes are on the rise. Gardell doesn’t short at all.
That Peltz would become a billionaire might have seemed unlikely back in 1962 when he dropped out of the University of Pennsylvania’s Wharton School to become a ski-racing instructor in Oregon. To earn money for the drive across the country, Peltz, who’d grown up in Brooklyn and later on Manhattan’s Park Avenue, got a job driving delivery trucks for the frozen-food distribution company founded by his grandfather. He planned to stay two weeks.
The business intrigued him and he gave up on Oregon to help expand A. Peltz & Sons. Over the next 10 years, Peltz bought up several food companies, and in 1972, he and his brother took their company, then called Flagstaff Corp., public. May, who had been the company’s outside accountant, joined as chief financial officer. After Flagstaff was sold in 1978, Peltz and May went searching for new acquisitions.
In April 1983, the two bought a stake in vending-machine and wire company Triangle Industries Inc. with the idea of using it to make acquisitions. Two years later, with bonds sold by Milken’s Drexel Burnham Lambert Inc., the smaller Triangle, with sales of around $300 million, bought National Can Corp., with revenue of $1.9 billion. At 11 times leverage, it was the most heavily indebted deal completed by Drexel at that time.
A year later, again using Milken’s junk bonds, Peltz and May bought American Can Co.’s packaging unit. In December 1988, they sold Triangle to Pechiney SA. The two made more than $800 million on the deal.
With money flowing in, Peltz’s acquisitive eye turned to real estate. In 1986, he and his third wife, former model Claudia Heffner, spent $6 million on High Winds, a 27-room French Norman-style stone castle in Bedford, New York. He traveled the 40 miles by helicopter from the estate, formerly owned by Reader’s Digest co-founder DeWitt Wallace, to his Manhattan office until he was sued by the town for violating zoning laws.
A year later he bought Montsorrel, an ocean-front mansion in Palm Beach for $18.9 million. The estate, once owned by Anita Young, widow to railroad baron Robert Young, included a 44,000- square-foot main house and a 16,000-square-foot guest house. Peltz later listed the property for $75 million. He never sold it.
Peltz’s and May’s next big money maker came in May 1997, when they bought Snapple from Quaker Oats Co. for $300 million. Three years later, after adding new products and reinvigorating the advertising campaign, they sold it to Cadbury Schweppes Plc for $1.45 billion in cash. Peltz wasn’t the only investor to make a killing on Snapple. Thomas H. Lee Partners LP made $900 million when the buyout firm sold the beverage company to Quaker Oats in 1994.
In 2003, the two partners were joined by Peltz’s son-in-law Garden, now 51. A former investment banker at Credit Suisse First Boston, he helped Trian start its first hedge fund. The three partners decided they needed outside capital if they were going to target large companies, which they thought offered the best investment opportunities.
Trian runs a lean operation, with an investment staff of about 15, including Peltz’s 29-year-old son Matt. Trian currently owns stakes in 10 companies and has board seats on six of them. The targets tend to have well-known brands and strong cash flows, yet shares that are trading cheaply.
Before they make an investment, the Trian team writes a 30- to-40 page white paper that examines the company’s problems and outlines Trian’s solutions. The suggestions tend to be very detailed and the partners’ involvement can be very hands on.
At Heinz, the white paper suggested introducing “peel and dip” ketchup containers, rather than the hard-to-open packets, to encourage consumers to use more of its product. The stock has risen (HNZ:US) to $56.49 a share, from around $37 on Feb. 21, 2006, when it first became known that Trian was targeting Heinz.
For Wendy’s, where Peltz, May and Garden all sit on the board, they’ve met with architects to discuss remodeling the restaurants to include features like fireplaces and big screen televisions. They helped design the new Dave’s Hot’N Juicy cheeseburgers with thicker patties served on a toasted and buttered buns, two pieces of cheese instead of one, and crinkle- cut pickles. Trian’s investment in Wendy’s is about flat, according to investors.
At Legg Mason, the route to profitability is less clear because the firm has already done a lot of the cost reductions and balance sheet improvement at the holding company level, Robert Lee, an analyst at Keefe, Bruyette & Woods Inc., wrote in a Sept. 11 report.
Legg Mason’s announcement that Fetting would step down sent shares up by 5.4 percent on Sept. 11, as investors bet that the management shakeup would precede bigger changes, such as breaking up the money manager or spinning off its investment units.
Legg Mason has said it will press ahead with its current strategy while searching for a successor.
“Our affiliates operate with substantial autonomy and derive benefits from being part of a financially strong parent company,” Mary Athridge, a spokeswoman for the firm, said in an e-mailed statement. “The company remains committed to the affiliate model and will continue to build its products and capabilities to meet the current and future needs of institutional and individual investors.”
Still, says Daniel Fannon, an analyst with Jefferies & Co., Fetting’s recent cost-cutting measures have eliminated all but the most complex options for a new management team.
“Legg Mason may try to exit some of the smaller affiliates,” Fannon said. “A lot of the options have been exhausted, so what remains is something dramatic, whether it is positive or negative.”
As Fetting learned, the next chief executive better pay attention to what its biggest investor says.
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