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What's Bigger Than Cisco, Coke, Or McDonald's?


Editor's Note: On May 14, 2007, DaimlerChrysler and the private equity firm Cerberus Capital Management announced that Cerberus would buy a controlling stake in Chrysler, ending the troubled eight-year merger of the two automakers. This BusinessWeek cover story, originally published in 2005, was one of the first in-depth profiles of the secretive Cerberus and stands as one of the only stories ever published that provides detailed perspective into how the firm operates.

Shares of Albertson's Inc. (ABS) were soaring in mid-September on rumors of an impending bid for the Boise (Idaho) grocery chain. A pair of private-equity funds -- giant pools of capital just waiting to pounce on takeover targets -- had been circling, preparing offers that were said to top $16 billion. But then a new player showed up: hedge-fund group Cerberus. The Albertson's drama is still playing out. But even as Cerberus Capital Management LP pursues the grocer, it has been quietly discussing an offer for Morgan Stanley's (MWD) aircraft-leasing business for up to $2 billion and negotiating for a big stake in Israel's second-largest bank, Bank Leumi. And it's still digesting a $2.3 billion purchase in May of Meadwestvaco Corp.'s (MWV) paper businesses -- a deal that included 900,000 acres of forest.

Cerberus has been shopping up a storm for a year now, seemingly coming out of nowhere to build a corporate empire. With more than $16 billion of investors' assets on its books -- almost double what it had in 2003 -- it has bought 28 companies and snapped up stakes of at least 15% in an additional 15 over the past decade. According to BusinessWeek estimates, Cerberus controls companies that ring up at least a combined $30 billion in annual sales, more than McDonald's, 3M (AXP), Coca-Cola (KO), or Cisco Systems (CSCO). With more than 106,000 employees, Cerberus companies have a bigger payroll than Exxon Mobil Corp. (XOM). Its trophies include 226 Burger King restaurants, the National and Alamo car-rental chains, building-products maker Formica Corp., and the old Warner Hollywood Studios, where blockbusters such as Basic Instinct were made. Its companies connect BlackBerrys, provide medical therapy, and set up military-base camps in Iraq.

PICKUP TRUCKS AND BUD

The mind-boggling rise of Cerberus -- from a fringe vulture fund started with a grubstake of about $10 million in 1992 to a Wall Street powerhouse -- has been driven by its enigmatic boss, Stephen A. Feinberg, 45. Like other hedge-fund managers and buyout kings, Feinberg has a penchant for secrecy, although his is more developed than most. While co-founder William L. Richter deals with investors, and lieutenants such as former Vice-President Dan Quayle jet around the globe to seal deals, the mustached Feinberg keeps very much to himself in a nondescript office on the 22nd floor of a high-rise on Manhattan's Park Avenue. The walls are bare save for a lone photograph of a motorbike that is propped up against his window; a black kid-size motorbike with training wheels -- a gift from an outside adviser -- is parked next to his desk.

The son of a steel salesman, Feinberg was born in the working-class town of Spring Valley, N.Y. He still describes himself as "blue-collar," even though he's a Princeton grad and took home about $50 million last year. "While other hedge-fund managers are collecting fine French wines and flying around in private planes, he drives a Ford truck and drinks Budweiser," says college roommate Jonathan Gallen, who runs his own hedge fund. Cerberus doesn't even have a Web site -- and it doesn't reveal exactly which companies it owns. Feinberg declined to be interviewed or photographed for this story, but dozens of current and former Cerberus executives, investors, and associates spoke with BusinessWeek, many not for attribution.

However six-pack his origins, Feinberg now moves in rarefied circles. Defense Secretary Donald H. Rumsfeld was an investor in 2001, according to government ethics disclosures. Hedge-fund legend Michael Steinhardt is a shareholder and director in Cerberus' lending arm, Ableco LLC. Michael Dell's private-investment firm has joined with Cerberus and home-builder Lennar Corp. to develop upscale residential communities on the former El Toro Marine Corps Air Station in Irvine, Calif. His roster of investors also includes public pension funds such as TIAA-CREF and the California State Teachers' Retirement System.

Feinberg likes to dream big. If he ends up buying Albertson's, he'll pull off the biggest deal by an investment firm since the storied Kohlberg Kravis Roberts & Co. purchase of RJR Nabisco (MO) Inc. for $31 billion in 1989. But to win, he'll have to beat out investor groups led by KKR and another buyout legend, Thomas H. Lee Partners, say bankers close to the deal.

This is a long way from traditional hedge-fund or even vulture-fund investing. In fact, Feinberg is breaking important new ground in the hedge-fund business. While many funds stick to a single, sharply focused strategy, Feinberg casts a wide net. Not content simply to trade securities the way other funds do or to assemble assorted companies for resale in the same way as many buyout firms, he's forging what looks more like an integrated industrial conglomerate than an investment firm. His secret weapon: a deep bench of 80 seasoned executives who troll the world for investment opportunities and stand ready to parachute in and run the companies he buys. Put all the elements together, says David M. Rubenstein, Carlyle Group co-founder and managing director, and "Feinberg may have perfected a new business model."

The Feinberg Way, like the methods of superfueled hedge-fund financiers such as Eddie Lampert and Wilbur Ross, has the potential to remake the corporate landscape as profoundly as the leveraged-buyout mavens, corporate raiders, and conglomerateurs did in earlier generations. With their access to huge amounts of cheap capital and ability to operate largely outside traditional markets -- and the view of regulators -- Feinberg and his cohorts could soon set their sights on even the biggest companies caught in a downdraft or struggling with change.

As befits a new kind of organization, Feinberg aspires to run the place more like General Electric Co. (GE) than a trading operation set up to turn a quick buck. In his search for best practices and economies of scale, Feinberg convenes as many as 100 of his investment pros and top managers at regular Monday meetings. They trade ideas, discuss ways to boost cooperation, and comb through each outfit's strategy. Among the regular attendees are such highfliers as Timothy F. Price, a former president of MCI Communications, and George E. Hamilton, who was an executive at Newell Rubbermaid (NWL) and now runs several of Newell's old consumer-goods divisions that Cerberus bought and retitled Global Home Products. They also combine forces to win cheaper rates on everything from overnight deliveries to ink-jet cartridges by putting group-wide supply contracts up for bidding online.

This elite corps of managers examines potential deals, performs due diligence on loans that Cerberus makes, and sits on Cerberus company boards. Feinberg also expects his CEOs to bring him ideas for deals. Their incentive: a chance to run a company and get a chunk of equity. "With their operating experience, they help us identify both opportunities and problems we might not see," says Cerberus Chief Operating Officer Mark A. Neporent.

A NOVEL APPROACH

None of his rivals have attempted integration on such a wide scale before. Other firms sometimes hire CEOs to run companies they buy, but never so many. Nor do they have them work so closely together or with the investment pros back at headquarters. Executives who run companies owned by KKR, for example, rarely, if ever, meet formally.

Feinberg has been equally innovative when it comes to financing. In 1996 he started Cerberus' own finance company, and in 2003 added a bank in Japan, Aozora Bank, making him a sizable lender to his own companies, as well as others. That means he can brandish his checkbook to clinch deals, while even well-heeled rivals often must scramble to line up financing.

Certainly, Feinberg's novel approach is producing healthy returns. Last year his biggest fund, Cerberus International, earned 15% after fees, having gained 22% in 2003, according to hedge-fund trade magazine Alpha. Because of the complex strategies he follows, the 12 funds Feinberg runs defy conventional categorization: Each is a heady cocktail of loans, real estate, debt instruments, and other investments. Some allow investors to take money out with just six months' notice, while others have lock-up periods of up to 12 years. Likewise, some are priced every month based on the market value of their investments; others are repriced just twice a year. All are now closed to new money.

Skeptics question whether a firm that long specialized in the debt of troubled companies brings the right management skills to outfits that make everything from picture frames and car seats to enterprise software and sports apparel. "Acquiring assets in all industries and selecting good managers, without any background at all in running companies, is insanely ambitious," says Bruce C.N. Greenwald, a finance professor at Columbia Business School. "When Warren Buffett goes into industries he doesn't know well, his record is substantially less successful for him. And these guys are not Buffett."

True enough, Cerberus has had some big disappointments. Of the four companies it has taken public while retaining control, two have stumbled. Building-materials wholesaler BlueLinx Holdings Inc. (BXC) has gone nowhere from its initial public offering price in December, despite the housing boom. Far more embarrassing, Anchor Glass Container Corp., which makes bottles for Budweiser (BUD) beer, filed for bankruptcy protection in August after being hit by a combination of accounting mishaps, rising natural-gas prices, and slumping bottled-beer sales. Now, Cerberus is facing a class action from Anchor shareholders alleging it hid the loss of a contract from one of Anchor's biggest customers just before its 2003 IPO. Cerberus filed to dismiss the suit, denying the allegations and arguing that it didn't oversee Anchor's day-to-day business. Cerberus' financing strategy sometimes means that it is doubly exposed when a business doesn't pan out: Anchor has a substantial revolving-credit agreement with Cerberus' Madeleine LLC lending arm. Feinberg has taken each of these flops personally. "He is brutal on himself," according to a person close to him.

But Feinberg also hits a lot of homers. The stock of SSA Global, the software outfit that Cerberus built through acquisitions, has soared 41% since it went public in May and now boasts a market cap of $1 billion. In July, Cerberus nearly doubled its money when it sold a 66% stake in communication-services provider Teleglobe International Holdings Ltd. (TLGB) to a division of India's Tata Group for $116 million. Executives at Vanguard Car Rental USA, the umbrella for National Car Rental and Alamo Rent A Car that Feinberg bought out of bankruptcy two years ago for $400 million, told investors this summer that they may eventually take the company public. Chicago-based researcher Spin-Off Advisors LLC estimates that if that happens, Vanguard could fetch $2 billion. In August the news that Cerberus was merely eyeing $2.6 billion retailer Saks Inc. sent the stock up 10%; the shares sank when word spread that Feinberg was pulling out. Such clout wins him the esteem of hard-nosed observers. "I find him to be quite intelligent," says legendary tough-guy financier Carl C. Icahn.

Feinberg will need all the respect he can muster for the battle shaping up over Albertson's. Flush buyout firms and drug-store chains such as CVS and Walgreens are swarming around the deal, undeterred by the grocery business' razor-thin margins. They like the chain's stable business, its substantial real estate holdings, or the opportunity to invest a big chunk of their funds in one shot. In the end, buyout firms might team up with corporate buyers to make bids, but battle lines will remain blurry as the firms pore over Albertson's books for the next several weeks before deciding how much to offer. For now, Cerberus has joined with real estate investment trust Kimco Realty Corp.

Feinberg may be weighing megadeals, but at least by the standards of Masters of the Universe, his tastes are unpretentious. He lives with his wife and three daughters in an apartment on the Upper East Side of Manhattan that cost less than $4 million in 1997. He also owns a 2,500-square-foot home in Stamford, Conn., that he bought in 1991 for around $500,000. To relax, he goes hunting, usually for pheasants and partridges on weekend trips to upstate New York with money-manager buddy T.K. Duggan. But last fall he raised the stakes by traveling to Colorado and scaling an 11,000-foot mountain in pursuit of bull elk. He felled the first one he saw with one shot, says Duggan.

When Feinberg was at Princeton it was far from obvious that he'd become a business mogul. He was brainy enough to beat classmates in games of chess but nervy enough to sign up for the Reserve Officers Training Corps, making jumps out of airplanes as part of his training in the Army's 82nd Airborne Division. By senior year, Feinberg was the captain of the tennis team, but not because he was a natural athlete. "He was a hustler," recalls roommate Gallen. "He wasn't the most talented player, but he had incredible willpower." He was also private back then: In his entry in the senior class directory, Feinberg mentioned Gallen as one of a handful of people who were his "few real friends."

Feinberg majored in politics, producing a senior thesis arguing that drugs and prostitution should be legalized. For the paper, he not only delved into theories about the appropriate role of government but also spent a summer interviewing cops, hookers, and pimps in New York City. Feinberg took the position to impress a professor who he perceived as liberal after receiving a bad grade arguing the opposite view in a paper the previous year, says a person close to him. Today Feinberg contributes to Republican causes. He and his wife Gisela sent $114,000 in the 2003-2004 election cycle to committees working to elect Republicans to Congress.

His first finance job was as a novice trader at Drexel Burnham. But he soon moved on to Gruntal & Co., where he worked on the same floor as Steven A. Cohen, now a hedge-fund star who runs SAC Capital Advisors LLC. By 1992, when he was 32, Feinberg wanted to strike out on his own and teamed with co-founder Richter, who ran his own brokerage firm.

They named their firm Cerberus, for the ferocious three-headed dog that guards the gates of Hades in Greek mythology. Feinberg liked the idea that one of the dog's heads was always on watch, just as his firm would guard its clients' investments around the clock, says J. Ezra Merkin, managing partner of hedge-fund firm Gabriel Capital Group. Merkin -- whose clients included university endowments and wealthy New York families -- became Feinberg's partner in a number of funds and deals. "I thought he would be able to move from passively investing in securities to building a business and actively managing companies," says Merkin.

TOUGH NEGOTIATOR

Initially Feinberg focused on trading the risky debt of troubled companies. Often he ended up owning big chunks of them once they landed in bankruptcy court, earning a fearsome reputation as a tough-as-nails negotiator. Sometimes he made a killing by changing management and forcing improvements. He soon realized that he also could make money by lending directly to distressed companies at rates of up to 20%.

With his assets quickly growing, Feinberg pondered how he could deploy more capital. So he started buying small, struggling companies -- sometimes outright, such as auto-parts maker Ganton Technologies Inc. in Sturtevant, Wis. -- and other times with partners, as he did with apparel maker Esprit, now based in Hong Kong. Along the way, he went into real estate, buying several Marriott International Inc. (MAR) hotels that Cerberus still owns.

But as he pursued more and more deals, he found that his hard-boiled image often scared off targets. Sticking with the name Cerberus -- despite the pleas of bankers to change it to something less frightening -- didn't help matters. Neither did launching a fund called Styx, named after the river that separates the living from the dead in Hades. Says an adviser who has worked with Feinberg: "When people hear that Cerberus is looking at a deal, they groan."

After the stock-market bubble burst in 2000, Feinberg tapped into the $1 trillion that surged into hedge funds. That enabled him to move beyond basket cases. He never makes hostile bids, instead targeting companies with willing sellers -- and plenty of scope for his management SWAT team to do their job and boost value. Lately that has led him to snap up divisions shed by blue chips such as DaimlerChrysler (DCX) and Bayer (BAY).

Feinberg's image has been softened somewhat in recent years, thanks partly to Quayle. A mutual friend, George Zahringer III, a senior managing director at Bear, Stearns & Co., introduced the two after Quayle dropped out of the 2000 Presidential race. Quayle agreed to work for Feinberg part-time and use his connections in Japan to clear the way for what became a 62% stake in Aozora Bank. Now, as Cerberus' chairman of global investments, Quayle goes to Japan and Germany at least five times a year each to "tee up eventual deals." He recalls: "I spent my first two-and-a-half years in Japan trying to convince my Japanese friends -- the business community, the regulators, and the political folks -- that we were not one of those vulture funds. It has now changed entirely."

Nevertheless, his firm's reputation almost cost Feinberg a big deal last year. With the parochial Canadian press giving Feinberg a hard time, Air Canada (ACJAQ) parent ACE Aviation Holdings Inc. feared that he might chop up the airline. So the ACE board chose a Canadian citizen -- Victor Li, son of the Hong Kong megabillionaire Li Ka-shing -- to buy a bunch of its shares. Then Li backed out after tussling with the unions. Feinberg came back after his team repeatedly emphasized that Cerberus wanted to help the carrier grow. He also agreed not to sell his 9% stake for at least two years. The reward: the value of his investment of about $197 million has risen by more than 70% in just under a year.

Feinberg's mission to revamp companies, combined with his awareness that he isn't the right person to actually manage them, earns respect from veteran executives who might resent having a financial whiz kid involved in their decision-making. "You and I might have a bowl of soup for lunch, but he has a bowl of data," says Vanguard CEO William Lobeck. "He has a memory like a steel trap," says SSA Global's Michael Greenough. "This guy never takes notes. Yet four years later he will remember something granular in the company that I would know, and I'm thinking, 'Why would he remember that?"'

BULKING UP

It's not only his smarts that enable Feinberg to attract and keep talent. Some of the top folks at Cerberus headquarters earn up to $40 million a year, says one insider who asked not to be named. Executives who run companies for Cerberus could land compensation packages of as much as $20 million a year -- twice the average CEO salary.

The key to making Feinberg's strategy work, however, is to get his companies operating profitably year after year. To do that, Feinberg has bulked up some of them by making acquisitions. In March, a Cerberus-owned military supplier, IAP Worldwide Services, bought a division of Johnson Controls Inc. (JCI) that transformed it from a $100 million supplier to a $1 billion one. After a similar maneuver, SSA Global Technologies Inc., an enterprise-software-applications and services provider, quadrupled its revenues, to $700 million. Four years ago, now-CEO Greenough hatched a plan with Feinberg to use Cerberus financing to gobble up eight software suppliers for $367 million.

But he also isn't afraid to take an ax to a company or dump an executive. Greensboro (N.C.)-based Cerberus textile manufacturer Guilford Mills Inc. informed the city's mayor in April that it plans to close a plant and lay off almost 10% of its workforce. At Vanguard, Cerberus turfed 35 senior managers and replaced them with just five new people as it relocated its headquarters from Fort Lauderdale halfway across the country to Tulsa.

Feinberg is a tycoon with an edge, even when he's jesting. Three weeks after he took over SSA Global, Greenough says, Feinberg called and said, "I think I'm going to close you down tomorrow." Greenough scrambled to change Feinberg's mind. "After about five minutes he said, 'I'm just pulling your leg,"' he adds. "He has almost a childlike sense of humor." Greenough got back at him months later when he told Feinberg that they lost a deal due to Feinberg's tardy response to one of his messages. "He was speechless," Greenough recalls.

Feinberg shuns the social whirl of charity galas and opening-night parties. Last year he agreed to co-host a dinner at The Waldorf-Astoria in New York with the Today show's Katie Couric and GSO Capital Partners co-founder Douglas I. Ostrover to help raise money to fight Parkinson's Disease, which two of Feinberg's friends' fathers have, says a person close to him. Then he failed to show up. It turns out that while he agreed to lend his name to the affair and make a donation -- he characteristically declined to attend.

That's no surprise. Feinberg's long hours leave little time for socializing. He puts in late hours in his office pondering potential deals all over the planet and scrutinizing the myriad details of his far-flung empire. As interest rates rise, and the economy slows, more companies will find themselves on the ropes. This is exactly when Feinberg is at his best in his never-ending game of high-stakes poker.

By Emily Thornton, with Susan Zegel in New York, Joseph Weber in Chicago, Lorraine Woellert in Washington, Hiroko Tashiro in Tokyo, and bureau reports


Reviving Keynes
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