Tuesday, April 1, 2008

Born and Bred in a Briar Patch

"Who asked you to come and strike up a conversation with this Tar-Baby? And who stuck you up the way you are? Nobody in the round world. You just jammed yourself into that Tar-Baby without waiting for an invitation," says Brer Fox, says he. "There you are and there you'll stay until I fix up a brushpile and fire it up, 'cause I'm going to barbecue you today, for sure," says Brer Fox, says he.

Brer Rabbit and the Tar Baby, retold by Catherine Farrell

Katy bar the door!

Having failed to unwind their ill-thought-out investments in Delta Air Lines and UAL and slink off quietly into a dark corner, as I recommended last November, Pardus Capital has suspended redemptions by its investors.

Pardus Capital Management, the hedge fund manager that has pushed for the merger of United Airlines’ parent UAL and Delta Air Lines, has suspended investor redemptions because the $2 billion firm has been hit by market volatility this year.

“The actions we have taken will allow us to protect the funds and their investors from the external short-term pressure of the broader financial markets,” New York-based Pardus said Monday. “The funds have been disproportionately affected by recent market volatility.”

Pardus, an activist investment firm that takes big positions in a small number of companies, owns stakes in both Delta and UAL and has proposed consolidation in the business. It’s also been active in the automotive industry, with positions in General Motors Corp., Delphi Corp.

While it is true that the volatility1 of Pardus' positions has increased dramatically—along with that of every other stock in the market—I seriously doubt that is why they are barring the door to withdrawals from their long-suffering investors. After all, Pardus is an activist investment fund, one which takes a few concentrated stakes in purportedly undervalued securities, finances them entirely with equity, and pushes for change to unlock hidden or trapped value. Day-to-day or week-to-week fluctuations in the market price of their positions should cause them no worry whatsoever, since they don't get hit with margin calls. Furthermore, the activist investor model requires a certain amount of patience, since even its most impatient practitioners recognize that it takes time to turn around a target company's strategy and performance according to their design.

Rather, I think the value of the Pardus funds has been "disproportionately affected" by something quite different: its managers' spectacularly crappy investment decisions. Airline mergers? The automotive industry? What's next? Changing corporate governance at a French software company?

Pardus has been among the worst performing big activists, losing about $800m, almost a quarter of its value, in November and December and almost another 10 per cent by the end of February, according to investors.

This isn't a case of a little excessive leverage coming back to bite an inattentive manager, but one of a manager purposely choosing to invest his LPs' funds in a couple—or three—of the biggest tar babies in the investment universe.

Now, the investors are stuck, with Pardus telling them not to expect return of their funds for up to two years. What befuddles me is what the Pardus managers think is going to happen in the next two years to pull their chestnuts out of the fire.

Deus ex machina is not a valid investment strategy, Mr. Samii.

1 Volatility is a directionless measure of (stock) price variation, Children. Pardus's investors are banging on its doors because its positions are going down.

© 2008 The Epicurean Dealmaker. All rights reserved.