A hybrid formula entices investment funds

MONDAY JUNE 4 2007

Companies International

In August 2005, Blue Harbour Group, a small fund based in Connecticut, began buying shares in Laidlaw, operator of America’s largest fleet of yellow school buses and Grey-hound coaches.

The company was weighed down by Greyhound, which was struggling to compete with other forms of transport such as low-cost airlines, but the school bus business was doing well, churning out healthy cash-flow from a series of recurring long-term contracts.

More importantly for Blue Harbour, Laidlaw’s management was receptive to change, including buy-backs and the possible separation of Greyhound.

The fund earned a 40 per cent return on its invest-ment in February 2007, when Britain’s FirstGroup agreed to buy Laidlaw for $35.25 per

share – well above the $23 per share Blue Harbour paid for its stake.

The success of that deal highlighted Blue Harbour’s unusual strategy, which combines elements of both private equity investing and shareholder activism, and is becoming increasingly popu-lar on Wall Street.

Sageview Capital, a fund based in Greenwich and Silicon Valley, founded by KKR alumni Scott Stuart and Ned Gilhuly also puts money to work this way.

Loosely called “private equity-style investing in the public markets”, the strategy has been employed by US in-

vestors such as Warren Buffett and Eddie Lampert.

But Wall Street investors say it has gained traction thanks to a greater open-ness to outside ideas in US boardrooms in the wake of the Enron and WorldCom scandals. “There has been a sea change in the attitudes of boards and senior manage-ments,” says Clifton Robbins, chief executive of Blue Har-bour. “They are listening to shareholders like never before, particularly shareholders who bring value-enhancing ideas to the table.

“And this isn’t temporary: we won’t go back to a world of poor corporate governance,

GENERAL FINANCIAL

24 ★ FINANCIAL TIMES MONDAY JUNE 4 2007

Companies | International

Tata gears up lowest­price car

By John Reed, Amy Yeeand Joe Leahy in Mumbai

Tata Motors is set to unveilthe world’s cheapest car asearly as January as it takesa growing trend for low-costvehicles to a new extreme.

The Indian carmaker is on

schedule to launch itsRs100,000 ($2,467) car by thethird quarter of 2008 andmay unveil it at next Janu-ary’s Auto Expo in Delhi,Ravi Kant, its managingdirector, said.

Separately, Tata Motors isdeveloping a new line ofsmall hatchbacks and mid-sized sedans to be intro-duced next year.

India produces 1.3m cars ayear. With the market grow-ing at 10 per cent to 12 percent per year, this couldreach 3m within a decade.

The four-door car – a pet

project of Tata Group chair-man Sir Ratan Tata – wouldbe the cheapest by far inits class.

The current cheapest, theMaruti 800 produced bySuzuki, sells for more than$4,000, and comparable carssell for much more in richcountries.

Tata’s progress is beingwatched by carmakersincluding Toyota, GeneralMotors and Ford Motor,which are developing, orhave launched, cheap cars inIndia, Russia, China andother emerging markets.

Carlos Ghosn, Renault/Nis-san’s chief executive, saidthe group is working on aneven cheaper variant of theLogan, the global no-frillssedan it launched in April inIndia, where it sells forunder $10,000.

Tata’s car will not conformto European safety and emis-sions norms. However, Tata,which sells cars in SouthAfrica and a few Europeanmarkets, said it could beupgraded should it choose toexport.

Competitors are scepticalabout the price and quality

of the car, which the groupsays will have a 600cc engineand come in a range of mod-els. However, Mr Kant said:“It will be a good-looking carwhich you will want to pur-chase.”

Tata developed the carusing lower-cost Indian engi-neers and is exploring “out-of-the-box solutions” toslash development and pro-duction costs.

Construction on the plantin West Bengal, where thecar will be made, wasdelayed by a land dispute.However, Tata was “on

track” to launch the vehiclein the second to third quar-ter of 2008, Mr Kant said.

Rising prices of steel, alu-minium, copper and othercommodities raised the car’scosts in the four years sinceTata announced it, prompt-ing the group to make somedesign changes for the car.

The plant will have acapacity of 250,000 unitsper year, which Tata aims toreach within two to threeyears. Achieving large salesvolumes will be critical forthe car’s viability, given itslow price target.

AUTOMOBILES

Indian vehicle to belaunched next year

Four­door model tobe about $2,467

A hybrid formula entices investment funds

In August 2005, Blue Har-bour Group, a small fundbased in Connecticut, beganbuying shares in Laidlaw,operator of America’s largestfleet of yellow school busesand Greyhound coaches.

The company was weigheddown by Greyhound, whichwas struggling to competewith other forms of trans-port such as low-cost air-lines, but the school busbusiness was doing well,churning out healthy cash-flow from a series of recur-ring long-term contracts.

More importantly for BlueHarbour, Laidlaw’s manage-ment was receptive tochange, including buy-backsand the possible separationof Greyhound.

The fund earned a 40 percent return on its invest-ment in February 2007, whenBritain’s FirstGroup agreedto buy Laidlaw for $35.25 pershare – well above the $23per share Blue Harbour paidfor its stake.

The success of that dealhighlighted Blue Harbour’sunusual strategy, whichcombines elements of bothprivate equity investing andshareholder activism, and isbecoming increasingly popu-lar on Wall Street.

Sageview Capital, a fundbased in Greenwich andSilicon Valley, founded byKKR alumni Scott Stuartand Ned Gilhuly also puts

money to work this way.Loosely called “private

equity-style investing in thepublic markets”, the strat-egy has been employed byUS investors such as WarrenBuffett and Eddie Lampert.

But Wall Street investorssay it has gained tractionthanks to a greater opennessto outside ideas in US board-rooms in the wake of theEnron and WorldCom scan-dals. “There has been a sea

change in the attitudes ofboards and senior manage-ments,” says Clifton Rob-bins, chief executive of BlueHarbour. “They are listeningto shareholders like neverbefore, particularly share-holders who bring value-enhancing ideas to the table.

“And this isn’t temporary:we won’t go back to a worldof poor corporate govern-ance, insular boards andlimited transparency.”

Activist investors such asNelson Peltz, Ralph Whit-worth and Carl Icahn havealso benefited from thistrend. But there is a funda-mental difference betweentheir tactics and those ofBlue Harbour and Sageview,who exert a level of pressureon managements, but with-

out engaging in proxy fights.Instead, they look at com-

panies through what theydescribe as a “private equitylens”, identifying targetsthat are undervalued andcould do with some transfor-mation, whether in the formof balance sheet restructur-ing, the disposal of certainassets or the sale of theentire company.

“They are applying thesame discipline that privateequity groups do and areshaking up companies,” saysPaul Schaye, managingdirector of Chestnut HillPartners, a New York bou-tique investment bank.

Sageview’s first deal, forexample, involved a stake inGuitar Center, and workingwith management to slow

its store expansion, whichmany felt unnecessary asthe company already domi-nated its music retail niche.

One way in which execu-tives can benefit from bring-ing in an investor such asSageview or Blue Harbour isthat it can deter the appear-ance of an activist.

“As an executive, youmight want to defuse thecriticism that you are under-utilising your balance sheetand not making tough deci-sions,” says Peter Schoenfeldof P Schoenfeld Asset Man-agement, a New York-basedhedge fund.

“A change in strategymay raise the stock priceand require a significantlyhigher buy-out price.”

The strategy has potential

pitfalls. In spite of the factthat their investment hori-zon spans several years, asharp drop in stock marketvaluations could dramati-cally hit these funds’ portfo-lios, while private equitygroups are somewhat pro-tected by swings in publiccompany valuations.

In addition, it remainsuntested across many fundmanagers: it is unclear whatmight happen if a company’smanagement is unable toexecute a plan and the sidesdisagree on future strategy.

But so far the returns lookgood. Although Blue Har-bour declined to commenton its returns, one investorsaid the firm had posted a25 per cent gross internalrate of return last year.

GENERAL FINANCIALNEWS ANALYSIS

Innovative strategieslike Blue Harbour’scombine elementsof private equityand shareholderactivism, writesJames Politi

Former Frenchfinance chiefjoins Lehmanadvisory boardBy Martin Arnold in London

Lehman Brothers will todayannounce the appointmentof Edmond Alphandéry, theformer French finance min-ister, to its European advi-sory board, beefing up a listof strategic advisers thatreads like a Who’s Who ofcontinental business.

Mr Alphandéry wasfinance minister in EdouardBalladur’s conservative gov-ernment from 1993 and 1995,overseeing the bail-out ofCrédit Lyonnais, the failedbank, and privatising someof France’s biggest compa-nies, including Renault, BNPand Elf.

He will become the firstformer French finance min-ister to work for a foreigncompany. His appointmentunderlines the growingtransfer of people betweenFrance’s public and privatesectors and towards foreigncompanies operating there.

The country is a weak spotfor Lehman, which missedout on the three biggestFrench deals of 2006 – MittalSteel’s acquisition of Arce-lor, the creation of Natixisand Alcatel’s merger withLucent – sliding from tenthto fifteenth in CapitalFinance’s league table.

As former head of EDF,the electricity monopoly,member of the Banque deFrance advisory committeeand supervisory board chair-man of CNP, the country’s

biggest life assurer, MrAlphandéry brings experi-ence of important sectors:utilities and finance.

“Mr Alphandéry is ahighly esteemed financial,economic and political figurein France,” said LordTugendhat, the former Euro-pean commissioner and ex-chairman of Abbey Nationalwho has chaired Lehman’sEuropean advisory boardsince 2002.

“He brings to our firmextensive relationships withcorporate and governmentleaders and over 40 years ofexperience. I am delighted towelcome him on board at atime when the firm isactively pursuing its devel-opment in France,” saidLord Tugendhat.

His arrival at Lehman willreunite Mr Alphandéry, aneconomist by training, withJérome Calvet, head ofinvestment banking inFrance for Lehman, who washis deputy chef de cabinet atthe finance ministry.

Lehman’s team of heavy-weight European advisersincludes Rolf Krebs, formerhead of Boehringer Ingel-heim, the German pharma-ceutical group; Aarnout Lou-don, former supervisoryboard chairman of ABNAmro, the Dutch bank; TonyWyand, former executivedirector of Aviva, the UK’sbiggest insurance group; andFranco Reviglio, former Ital-ian minister of finance andex-chairman of Italian oiland gas company Eni.

BANKS

Joystick maker toconsider sale offers

By Sarah Spikes andMartin Arnold in London

Saitek, the maker of theX52 flight simulator joy-stick, has hired CavendishCorporate Finance, theinvestment bank, to sellthe company. The price tagwill be about $50m.

Saitek, which is based inthe UK, is understood tohave decided to pursue asale following an unsolicitedapproach from a possiblebuyer. Golden Gate, theUS private equity firm,Hewlett-Packard and Micro-soft are now understood tobe interested in acquiringthe company.

Saitek is wholly ownedby Eric Winkler, a HongKong national who founded

it in 1979. This year Saitek isset to make about $52m inrevenue, with just over athird of that coming fromNorth America and the restfrom sales in Europe andAsia.

It is only expected toattract offers equal to aboutone year’s revenue, despitebeing second in the marketfor PC games controllersbehind Logitech of the US,because it distributes rela-tively little of its merchan-dise over the internet, andmargins have been squeezedin recent months by compet-ing products.

The company has esti-mated its global marketshare for PC computer gameperipherals, which alsoincludes steering wheels forvirtual driving games, to beabout 30 per cent.

TECH HARDWARE

JAPAN M&A

Doubts raised overDoutor­NRS tie­up

By David Turner in Tokyo

A hedge fund manager hasattacked the logic in combin-ing “spaghetti with coffee”,in the first major interviewwith US fund Harbingersince it questioned thefriendly merger betweenJapan’s Doutor Coffee andNippon Restaurant System.

Harbinger’s doubts aboutthe alliance between NRSand Doutor, in which it hasa stake of more than 16 percent, have turned on theirhead normal expectationsabout the Japanese corpo-rate world.

In Japan, hedge funds aretypically feared for trying toforce mergers againstmanagement will.

But Eli Benson, Japan spe-cialist at $17.5bn “value”fund Harbinger, told theFinancial Times that Doutorwas “capable of a lot more”if it stayed independent. Hesaid: “If you look at Star-bucks’ performance inJapan, you see what Doutorcan do.”

Starbucks has become partof Japan’s urban landscape,

its omnipresent shops areoften used to give directionsin a country with a ratherincomplete address system.

Mr Benson raised doubtsabout both the terms of themerger and whether it actu-ally made sense at any price.Harbinger acquired sharesin Douter before the mergerannouncement and has sincesteadily raised its stake.

Harbinger has not yet for-mally opted against themerger but must decideahead of a meeting of Doutershareholders on June 28,where a two-thirds majoritywill be required for investorsto back the deal.

Doutor is the much biggercompany, with Y69bn($565m) of revenues, morethan double that of NRS.The coffee chain’s marketcapitalisation of Y68bn isalso above the Y59bn ofNRS, which runs a spaghettichain and other brands.

However, the mergerwould give Doutor share-

holders only a 50 per centstake in the new business.One share in Doutor wouldbe exchanged for one sharein a holding company, whileeach NRS share would beswapped for 1.687 shares.

Defenders of the 50-50 splitpoint to Doutor’s latestannual operating profit ofY4.3bn, below NRS’s Y5.8bn.

Doutor and NRS announ-ced the plans on April 26.They said the combinationof two companies that“highly complement” eachother would create a groupwith “competitive power”.

Doutor also said recently:“The decision to merge withNippon Restaurant Systemwas made in light of thesevere operating environ-ment. The market is shrink-ing, competition is fierce andconsumer tastes are diversi-fying.”

Japan’s restaurant reve-nues have contracted toY24,000bn in 2005 from a 1997peak of Y29,000bn.

Mr Benson of Harbingercountered that “simple oper-ational changes could bedone” to improve Doutor’sbusiness, though he wouldnot elaborate for legal rea-sons. Harbinger also thinkscoffee bars and restaurantsare separate businesses,which would not produceobvious synergies.

‘Coffee chain shouldstay independent’Shareholders voteon deal this month

Trust banks cash inon anti­takeover moodBy David Turner

Fear of hostile takeovers hasspawned a brand new indus-try within Japan’s capitalmarket, generating billionsof yen in revenue andemploying specialist teamsof people.

Japanese trust banks pro-viding fund managementand stock-transfer serviceshave set up consulting teamswho create takeoverdefences for a fee of up toY800m ($6.5m).

This service was firstintroduced two years agoafter internet start-up Live-door shocked the country’sbusiness establishment witha hostile bid for FujiTV, the largest broadcasterin Japan.

But business has heatedup recently because of morehigh-profile cases of hostiletakeovers, such as SteelPartners’ attempt to buyJapan’s leading beermakerSapporo.

“Up till last year it wastargeted companies thatwere interested,” said Fuy-uki Yamamoto, head ofMizuho Trust & Banking’sfive-strong team providinganti-takeover service.

Starting this year, how-ever, “even companies thatdo not feel an immediatethreat have been introducingmeasures”, he said, adding

that the team has builtdefences for almost 50 com-panies since 2005.

These specialists differfrom western-style invest-ment bankers who are justas willing to devise takeoverbids as they are to advise thetarget companies.

They only help companieswith building defensive

measures and they nevermeet the opposing side. “Weare at the back of the stage,doing the practical work,”Mr Yamamoto said.

The head of one trust bankanti-takeover team explainedthat, in a country where hos-tile takeovers are seen bymany as immoral, associa-tion with a hostile biddercould lose clients.

Many consultants andeven public relations compa-nies have adopted the policyof only working for the tar-

get company. The most com-mon technique recom-mended is to introduce atrigger system whereby ashareholder who acquiresmore than 20 per cent of acompany will have to submitinformation on “who theyare, why they bought such alarge number of shares …how they plan to treatthe employees,” said AmaneFujimoto of SumitomoTrust & Banking, whohas advised about 50 compa-nies on anti-takeovermeasures.

A committee approved byshareholders could introducea dilutive rights issue if theacquisition was judged “abu-sive”, he added.

Even some hedge fundshave decided to assist Japa-nese companies in theirdefence against takeovers,turning the concept of theM&A arbitrage fund on itshead.

Mamoru Taniya, chiefexecutive of Asuka AssetManagement, said it wasbetter in Japan to assumethe role of defender becausethe hostile bidder was lesslikely to succeed.

His Value-Up fund hasworked with potential tar-gets in improving manage-ment and generally workingtowards satisfying existingshareholders as a bulwarkagainst a takeover.

The service wasintroduced afterLivedoor shockedthe country’sbusinessestablishmentwith a hostilebid for Fuji TV

Eli Benson:raised doubtsabout theterms of themerger

Blue Harbour GroupCore investments

Source: Company

Note: Blue Harbour's other core investments have included Community Health, CSK Auto, Domino's Pizza, Houston Exploration, Jacuzzi, Neenah Paper, Reader's Digest, Sears Canada, and Triad Hospitals Photo: WPN

Clifton Robbins,CEO of Blue Harbour

Idea(s) proposedby Blue Harbour

Company Strategy pursuedby company

Totalreturn

45%

40%

50%

40%

Monetisation of non-core assets; share buyback, cost/R&D reductions

Balance sheet recapitalisation, possible sale or spinoff of Greyhound

Swap assets for MLP* units; buy back stock; purchase Transcanada's general partner interest in MLP; highlight general value

Recapitalisation of balance sheet; reposition company as both a retailer and consumer products manufacturer

$400m sharerepurchase plan; subsequent sale of company to LSI Logic

$500m Dutch tender and share repurchase plan; subsequent sale of company to FirstGroup

$3bn swap of assets for MLP units; $300m share repurchase; purchase of general partner interest; dividend increases at Oneok and at MLP

Sale of company to Madison Dearborn

Agere

Laidlaw

Oneok

Yankee Candle

* Master limited partnership

INTERVIEWInnovative strategieslike Blue Harbour’scombine elementsof private equityand shareholderactivism, writes James Politi

Reprinted with permission by Media Revenue Services Limited.Not to be reproduced without authorisation.© The FiNANciAL TiMeS LiMiTed 2007

insular boards and limited transparency.”

Activist investors such as Nelson Peltz, Ralph Whitworth and Carl Icahn have also benefited from this trend. But there is a funda-mental difference between their tactics and those of Blue Harbour and Sageview, who exert a level of pressure on managements, but without engaging in proxy fights.

Instead, they look at companies through what they describe as a “private equity lens”, identifying targets that are undervalued and could do with some transformation, whether in the form of balance sheet

restructuring, the disposal of certain assets or the sale of the entire company.

“They are applying the same discipline that private equity groups do and are shaking up companies,” says Paul Schaye, managing direc-tor of Chestnut Hill Partners, a New York boutique invest-ment bank.

Sageview’s first deal, for example, involved a stake in Guitar Center, and working with management to slow its store expansion, which many felt unnecessary as the com-pany already dominated its music retail niche.

One way in which ex-ecutives can benefit from

bringing in an investor such as Sageview or Blue Harbour is that it can deter the appear-ance of an activist.

“As an executive, you might want to defuse the criticism that you are underutilising your balance sheet and not making tough decisions,” says Peter Schoenfeld of P Schoenfeld Asset Manage-ment, a New York-based hedge fund.

“A change in strategy may raise the stock price and require a significantly higher buy-out price.”

The strategy has potential pitfalls. In spite of the fact that their investment horizon spans several years, a sharp

drop in stock market valu-ations could dramatically hit these funds’ portfolios, while private equity groups are somewhat protected by swings in public company valuations.

In addition, it remains untested across many fund managers: it is unclear what might happen if a company’s management is unable to execute a plan and the sides disagree on future strategy.

But so far the returns look good. Although Blue Harbour declined to comment on its returns, one investor said the firm had posted a 25 per cent gross internal rate of return last year.