Jamie Zimmerman aspired to be the first woman on the Supreme Court. Instead, she wound up a rarity in another realm, as one of the few women to found and run a hedge fund. Zimmerman’s New York-based firm, Litespeed Management, specializes in event-driven investing, seeking to profit from asset mispricings resulting from corporate events, such as mergers, spinoffs, or bankruptcy filings. It is hardly a boring way to make a living, and Zimmerman, a lawyer by training who once clerked for a bankruptcy judge, relishes the complexity and challenge.
The event space has struggled in recent years, with performance a poor match for the highflying Standard & Poor’s 500 index (.SPX). Some prominent funds have closed. Zimmerman, who manages about $300 million, has taken her lumps, but is thriving. Her Litespeed Partners fund has generated a 10.6% compound annual rate of return since its 2000 inception, and was up 30.4% this year, through Oct 31.
Small wonder, given her focus and record, that Zimmerman merits her own chapter in Merger Masters: Tales of Arbitrage, a lively new book by Kate Welling, a former managing editor of Barron’s, and Mario Gabelli, chairman and CEO of Gamco Investors and a member of the Barron’s Roundtable. In it, Zimmerman describes her career trajectory, which included stints at L.F. Rothschild, Dillon Read, and Oppenheimer, and some notable past investments. Read on to learn about her current positions, and why she thinks event-driven investing could be poised for a revival.
Q: You’re having a great year, Jamie. What’s your secret?
A: A couple of situations were resolved this year that we had been invested in since 2015 and 2016. Also, with money coming out of this area, the market is a little less crowded. Event-driven funds did better than the broad market post-Lehman Brothers’ collapse until 2015, and assets flowed in. Then, when the S&P 500 soared, event-driven investors didn’t stack up as well, and the money went out. The exodus started in 2015 and has continued. As things reverse, it is probably a great time to be putting money back in.
Q: Why is that?
A: We are in a period of high equity multiples, high levels of corporate leverage, low interest rates, and a lot of mergers and acquisitions. We are moving into an environment with higher interest rates, lower leverage levels, and potentially a lot of corporate restructurings. Risk arbitrage and distressed investing are two sides of the same coin. We prefer distressed because when one doesn’t get paid back on a bond-related security, one can foreclose on the company’s assets and file it into Chapter 11 bankruptcy proceedings. You can’t do that holding a stock; you might get board seats, but no guarantees.
Q: How would you describe your strategy?
A: We think of ourselves as value investors with an event overlay—usually a balance-sheet event. There could be a change of ownership, or an opportunity to buy a security that will be monetized or exchanged for other securities, whether in a merger, restructuring, or another transaction in which we can focus on how much we will make, and when. We try to invest in securities that have bond-like characteristics but provide equity-like returns. We rarely use leverage, and we want to own securities in an enterprise whose value is growing. Our research goal is to figure out the downside if we’re wrong, enabling us to size positions so we don’t lose more than one month’s profit. Also, we want to nail down the timing so we can evaluate the risk/reward. If you’re right about a company’s future, growth will compensate for time erosion. If you understand what something is worth, independent of a transaction, you’ll have an idea of who needs it, and who can pay what for it.
Q: How are you positioned now?
A: Right now, our positions are mostly stocks of companies under strategic review, or involved in mergers and acquisitions or spinoffs. If the cycle turns, we will own more debt.
We have a couple of debt investments, some of which are being harvested because it’s that time in the cycle. For example, we own bonds issued by 99 Cents Only Stores, a dollar-store operator that also sells a large array of perishables. It was bought in 2011 by Ares Management and Canada Pension Plan Investment Board. At the time 99 Cents was generating annual Ebitda [earnings before interest, taxes, depreciation, and amortization] of $148 million. After an ill-fated change in management, fiscal 2015 Ebitda dropped to $40 million.
We bought the 11% senior unsecured bonds at 30 cents on the dollar almost three years ago, and have received our entire cost back in cash interest payments. In late 2017, we helped negotiate a restructuring of $250 million of 11% debentures of December 2019. Ninety-five percent of the bondholders agreed to extend the maturity to April 2022 in exchange for a 13% coupon (11% cash pay plus 2% pay in kind), a third lien on assets, and an agreement by the sponsors to subordinate the $102 million of 11% debentures they owned by converting them into preferred stock.
Under a new management team, 99 Cents has had same-store sales increases for the past eight quarters. Ebitda was $90 million over the past 12 months, and we expect it to move back above $100 million, to a level at which the company will be able to refinance its capital structure. We expect the company to call our bonds at their call price of 102 as soon as it is able in June 2019. The bonds are trading in the 80s, so there is still good money to be made here.
In a situation like this, you want to buy the bonds at a price that creates the company at a value at which you’d be happy owning its equity. Either you get repaid at maturity at a premium to your purchase price, or, in the event of a bankruptcy filing, your bonds are converted to equity at an attractive price.
Q: How do you research ideas?
A: We read a lot, but what you’re reading is yesterday’s news. The question is where the world will be tomorrow. Will the future be different from what the market perceives? We do a lot of investigative reporting. We call a company’s customers. We try to understand the competitive landscape and pricing power. And we look at how compensation is structured—how it might motivate behavior. Does the CEO get a big payment in the event of change of control, which might motivate him to sell the company? Does the compensation structure work against a sale? This stuff really matters.
We own TiVo (TIVO), the digital-video-recorder company, which announced in February the launch of a strategic review. Several months into the process, CEO Enrique Rodriguez was hired away by John Malone, who runs Liberty Media. Rodriguez had received a $1.5 million signing bonus at TiVo that he had to repay, and Malone covered the cost. In fact, in addition to besting his salary, Malone paid him a $4 million signing bonus, and offered him the potential to make another $4 million in a bonus payable at year end. Rodriguez had stock options on 400,000 shares of TiVo stock in the event of a change of control, and the potential to make $8 million if TiVo was bought for $20 a share. His Liberty compensation package compensated him for that possibility, suggesting that he and Malone saw significant upside for TiVo. The company has valuable intellectual property, and we think it will be sold. TiVo is trading around $9.50 a share, and could probably be sold in the high teens.
Q: You have some investments in broadcast television. What is the attraction?
A: President Trump and Ajit Pai, chairman of the Federal Communications Commission, tried to raise the cap on national television ownership reach to 50% from a long-standing 39% by reinstating the UHF discount, which the Obama administration had eliminated. It allows media companies to count only half the coverage-area reach of their UHF stations. Loosening the rules on media concentration has encouraged merger activity.
Sinclair Broadcast Group (SBGI) attempted unsuccessfully to purchase Tribune Media (TRCO). The combination would have reached 78% of the U.S. population. We find E.W. Scripps (SSP) interesting at current price levels as an acquirer and a target. The company has been selling off pieces of its business in the past few years. Recently, Scripps bought a group of 15 television stations from Cordillera Communications, boosting its broadcast business to 51 stations. We think Scripps might buy stations from Cox [it is competing against Nexstar Media (NXST)], which will take its total station count to 65. Scripps could become one of the top five station groups in the country. At the current price, Scripps itself is an attractive acquisition target.
Q: What do you think it could be worth?
A: Scripps has a total enterprise value of $1.85 billion, and trailing-12-month Ebitda of $150 million. The stock sells for 12.3 times enterprise value to Ebitda, which might seem expensive. But Scripps’ 2019/2020 blended Ebitda will be closer to $360 million, meaning that at current price levels you are creating the company at 5.1 times Ebitda. A growing station portfolio will give it added clout to negotiate larger retransmission fees from the broadcast networks. In addition, Scripps just purchased Triton Digital to monetize its national media properties, whose value could add another $2 a share.
Political advertising was a $140 million windfall for Scripps this year. The company generated $58 million in 2014 from political spend, and $101 million in 2016. To value TV stations, you average two years of Ebitda to account for lumpy political spend.
Scripps’ stock is near $17, and we believe it will probably trade up to the mid-$20s, if Scripps is successful in acquiring Cox.
Q: Papa John’s International (PZZA), another recent purchase, was beset by management turmoil. What are your expectations?
A: Often a CEO’s departure leads to a change of control. We think Papa John’s will be sold. Last year the company’s founder and face, John Schnatter, criticized the National Football League’s handling of players’ national-anthem protests. Amid the ensuing controversy, he stepped down as CEO. In February Papa John’s and the NFL ended their sponsorship agreement, and in July Schnatter resigned as chairman after reports that he had used a racial slur. The board then established a stockholder rights plan, or poison pill, to limit his ownership in the company, and he sued. The whole situation got very ugly and the business suffered, but the stock was inexpensive. We created a position at an imputed enterprise value of 10.6 times 2017 Ebitda. That’s inexpensive for a predominantly franchised operation. They usually trade for around 15 times Ebitda.
Inspire Brands bought the Sonic burger chain this year for 15 times the past 12 months’ Ebitda. If it were to buy Papa John’s at the same multiple, the stock would be $70 a share. Bain (BCSF), CVC Capital Partners (CVS), and KKR (KKR) also could bid on Papa John’s. We bought shares in the low-$40s in July after the stock had fallen from $58 a share to $42. It now trades for $58. We expect the company to get acquired at close to $65 a share.
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