The Art of Vulture Investing

Adventures in Distressed Securities Management

George Schultze, Janet Lewis

• Publisher: Wiley
• Year: 2012
• ISBN:
  9781118234730
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

A detailed and compelling look at distressed securities investing in today's market

In the corporate world, "vulture" investors in distressed securities serve the same cleanup function as vultures do in the natural world: they deal with failing companies, digest bad debt, and mop up after bankruptcies. Since this market's structural and legal complexities create greater inefficiencies than in other investment fields, it's a style of investing that can make money during both booms and busts. While recent economic carnage has made opportunities for vulture investors, more convoluted bankruptcies, conflicts of interest, and even government intervention have made this arena harder to negotiate.

Nobody understands this better than author George Schultze, founder of Schultze Asset Management. During his successful career as a vulture investor, he's learned a number of lessons and developed an investment philosophy that has served him well. Now, in The Art of Vulture Investing, Schultze shares his valuable insights and experiences with you. Engaging and informative, this reliable guide offers a bird's-eye into the opportunities and risks associated with vulture investing. And while it may not always be pretty, you'll see exactly why this process is necessary for our economic ecosystem.

Throughout this book, Schultze explains the theory and strategy of vulture investing in clear and lively prose, illustrating each concept with examples from his own varied experience that show how the landscape has changed in recent years.

• Offers valuable information on distressed securities investing since the 2007-2009 financial crisis
• Examines the opportunities and dilemmas for modern vulture investors
• Includes in-depth case studies of high-profile bankruptcies, including those of Chrysler Automotive and Tropicana Casinos and Resorts

By its very nature, investing in distressed companies can be a complicated and risky business. But once the dust settles, these investments can yield extraordinary profits. The Art of Vulture Investing puts this discipline in perspective and shows you how to excel at this difficult, yet rewarding, endeavor.

CHAPTER 1

Emerging from the Egg

I have no wish to beautify the vulture, but, on the other hand, I cannot acquiesce in the poets’ terrible indictment. They make it ominous and gloomy, hungry and thirsty for blood. … This is all undeniable poetry, but it is all injustice, because out of sympathy with Nature. And Nature is far more poetical than even the poets.

—Philip Robinson, “The Poets’ Birds,”
Atlantic Monthly, June 1882

I have always had something of a knack for business. The youngest of eight children, I spent much of my youth in suburban New Jersey looking for ways to make a buck. Whether it was mowing lawns, shoveling driveways, or delivering newspapers by bike on a paper route, I was usually working to earn some cash during my spare time instead of watching TV or playing video games.

Since money was tight at home after my parents separated, I needed to find for myself the means to keep up with my peers in affluent Upper Saddle River. By the time I was a teenager, I had rotated through all sorts of jobs, learning a good deal about business in the process.

One formative experience was a job I took at a local men’s clothing store when I was in high school. Irv Lerner’s, set in a highway strip mall near the New Jersey/New York State border, paid me minimum wage, then $3.25 per hour, which even at the time was very little. The work was tiresome and boring, but it gave me a firsthand look at how difficult and competitive retailing could be.

One weekend, my manager asked me to bring out clothing from the back room to a big table at the front of the store for Irv Lerner’s annual sidewalk sale. The project took me hours—folding and organizing stacks and stacks of men’s shirts and pants—but when I was done, I was proud of my beautiful display.

Unfortunately, when I returned to work on Monday after the sidewalk sale, I found that although hundreds of shoppers had rifled through my neat stacks, leaving a huge mess for me to clean up, they had bought hardly anything. I quickly decided that retail wasn’t for me (and, I guess it really wasn’t for the owner either, since he barely came to work one day a week). Like most strip-mall retailers of its type, I believe Irv Lerner’s eventually went bankrupt, killed off by the rise of big-box retailing, which transformed the industry with its high-tech inventory management and enormous purchasing power.

My next job was at the headquarters building of Magnavox, the electronics company, in Mahwah, New Jersey. I worked evenings as a maintenance engineer—that is, as a janitor—cleaning the executive offices. I found this much more pleasant, and considerably better paid, at $9.15 per hour.

The lesson for me was that dirty work, although stigmatized, could be much more profitable than a seemingly more-desirable job. Like a vulture investor’s work, a janitor’s work entails handling things someone else has discarded. Nonetheless, as a sensitive teenager, I was afraid of what people would think, so I didn’t tell any of my high school friends or girlfriends where I was working.

Another lesson I learned from cleaning the Magnavox offices was how much you can tell about people from their trash. At the end of the day, it was obvious which employees worked harder—and equally obvious that entire departments just sat there all day, filling up their trash cans with cigarette butts and coffee cups on the shareholder’s dime. For some reason, young as I was, this lack of productivity frustrated me to no end. I yearned to bring the problem to someone’s attention, but of course it was hardly my place to take it up with senior management. I would get my chance later in life.

My next job, walking dogs and hosing out their cages at a boarding kennel, was not nearly as well paid, but it did teach me a few things. One was the value of a monopoly. Since Dr. Totorra’s Dog Kennel was the only real choice in Upper Saddle River for pet owners to board their darlings when they were away, he could charge top dollar for rather bad accommodations. The monotony of the job—which I really hated—also gave me plenty of time to think about the future.

At that point, I decided I needed to find a way to work smarter, not harder. I became more creative, dreaming up all sorts of moneymaking ideas and researching them as best as I could. I would go to the local library in Upper Saddle River and take out every business book I could get my hands on. I ordered a raft of kits from late-night infomercials: “How To Buy Real Estate with No Money Down,” “How To Get Rich Collecting Judgments,” and other money-making titles about buying tax liens and conducting multilevel marketing. I studied them all but concluded that there really was no free lunch and that short cuts mostly don’t work. To be successful, you need to put in the time, so you really have to love what you do.

Although my older siblings took an indulgent attitude toward their baby brother’s wacky ideas, it wasn’t long before they started calling them Wak Get Rich Schemes (my nickname, Wak, was a phonetic play on my middle name, Joachim). However, I ended up getting the last laugh.

While an undergraduate at Rutgers College, I won the Wall Street Journal Award for Excellence in Economics, and in the 1991 AT&T Annual Stock Picking Contest, I placed twenty-third nationwide (from over 14,000 participants) and first at Rutgers. So, by the time I was in graduate school, my father and some of my siblings trusted my business sense enough to give me some of their money to manage—an account they dubbed the Wak Get Rich Fund (WGRF). That fund turned out to be my launch pad into the world of vulture investing. In fact, even after I started Schultze Asset Management LLC in 1998, I kept the WGRF name as a headline file for most of my business documents.

When I graduated from Rutgers in 1992 with a BA in economics and political science, I was 1 of only 10 students accepted that year into Columbia University’s four-year joint JD/MBA program. I knew I wanted to get into business, but I was also convinced that becoming an attorney as well would give me a powerful edge.

As a teenager, I saw firsthand how much influence attorneys can have over the outcome (and duration) of a dispute when my parents went through a very difficult and protracted divorce—which I felt went on much longer than it should have because the lawyers wanted to maximize their hourly fees. On a more positive note, my father often spoke of how important attorneys were as advisers in his business career.

My father was a director in the U.S. office of Agfa-Gevaert, a German photofinishing company that had the second-largest market share behind Kodak. His job was researching acquisition opportunities, since Agfa was constantly looking to increase its U.S. business. My career has taken a totally different direction, but in some respects, the fundamental company analysis I do to research my investments is similar, and I have benefited from my dad’s business insights over the years.

Although I was already doing a fair amount of investing for my own and my family’s account, getting the Columbia dual degree turned out to be a great choice, giving me just the right training for a career in vulture investing. On the business side, Columbia’s highly respected curriculum included value-investing courses, featuring guest speakers such as Warren Buffett, Jimmy Rogers, Seth Klarman, and Mario Gabelli. I was also lucky to have stimulating fellow students and friends, many of whom went on to have successful careers in investment as well.

The legal side of my education was perhaps even more important, since in the United States nearly every distressed company, if not bought out or otherwise rescued, eventually ends up restructured in a federal bankruptcy court. A successful vulture investor, whether in distressed companies, real estate, or securities, therefore has to be able to deal with attorneys, judges, financial advisers, and the court system. A law degree is pretty much an essential.

Of course, earning a dual degree in law and business from an Ivy League school isn’t enough to guarantee success in this business. A true vulture must love sniffing out potential prey. Like most investors, vultures make their money by finding inefficiencies in the market and arbitraging out those inefficiencies.

But the complexity of the structural and legal issues inherent in the distressed-securities market can make those inefficiencies much greater than in many other investment fields, creating a much larger potential for profit. Many holders of distressed securities are legally, or contractually, obliged to sell their positions, regardless of the fundamentals. Rational investors, however, will be happy to buy those same securities after the company’s problems are resolved.

To find those opportunities, you need a laser focus on understanding each investment before taking any action. You must really love doing fundamental company analysis—fortunately, I do. For me, the drudgework to find opportunities is easy, even though it may be time-consuming. Hours, days, and weeks literally fly by when I’m immersed in company investment research.

I find myself going home in the evenings anxious to explain the fun things I’ve discovered that day to my wife and kids. In fact, I believe that the best way to know when you understand a company or security well enough to make an investment decision is when you can explain your ideas to a child. If you can’t distill your ideas to that level of simplicity, you probably don’t know enough to make the right choices.

You also need confidence in your abilities, a willingness to pit yourself against the market, flexibility—and a soupçon of humility. The best investors make most of their money in a very small percentage of their trades, so you must be willing to admit you are wrong and sell out of losing positions before they eat up too much of your profits and investment capital.

When I enrolled at Columbia I didn’t know exactly where my career would take me, but during the third summer of my four-year program, I started to focus on distressed and special-situations investing. That summer, I was splitting my time between an internship at Mayer, Brown & Platt, a large, established law firm, and one at Fiduciary Partners, a small hedge fund that invested in a variety of vulture funds. The stark contrast between those two working environments helped push me toward the hedge fund world.

While at Fiduciary Partners, I had the opportunity to learn about different styles of vulture investing. I was particularly impressed by the operations of one of Fiduciary’s investments, David Tepper’s Appaloosa Management. (Tepper, in fact, became something of a role model for me, so I was pleased in later years to become involved in several deals alongside him.)

My first real-life opportunity in the vulture world was the Trans World Airlines (TWA) bankruptcy in 1995, which ultimately launched my career in this investing niche. At that point, I was working as an intern at Merrill Lynch’s private client office on Sixth Avenue in New York, which mostly entailed cold-calling investors out of the phone book. Since I found this much less compelling than my earlier work at Fiduciary Partners, I began studying distressed-company disclosure statements at night.

TWA was a messy case, complicated by the involvement of the legendary Carl Icahn. As I studied the bulky disclosure statement,1 I realized that the difficulty and complexity of the situation had generated significant “deal fatigue” among investors and participants, which served to further depress the value of TWA securities. TWA bonds had traded on the public markets down from par to below 20 cents on the dollar, even though (as the disclosure statement explained) their holders were likely to get a much higher recovery coming out of reorganization. So I decided to take the plunge and purchase some of these bonds for my own account.

As a fledgling vulture, I wasn’t in a position to participate directly in the furious wrangling that went on for months among the airline unions, Carl Icahn, several creditor committees, and even the Pension Benefit Guarantee Corporation (PBGC). After endless rounds of difficult negotiations, a very complex settlement emerged. Under the plan, investors holding TWA’s bonds would receive a package of securities that included new stock, new preferred stock, and, in an unprecedented twist, coupons giving the holder the right to purchase standby tickets on future TWA flights at a heavily discounted price.

Usually, former lenders are very reluctant to take back anything other than cash, principal, or interest in a restructuring—much less airline tickets. TWA’s lenders couldn’t believe that anyone would have the temerity to offer such payment in kind, and they rushed to the exits in a panic. Well, one person’s garbage is another’s opportunity. One savvy and enterprising vulture firm, M.D. Sass, bought these unsecured bonds at a steep discount to face value and then emerged as the chief purchaser of the TWA standby ticket coupons—at a further discount, of course.

My own investment turned out to be a phenomenal success. The TWA bonds I purchased for about 20 cents on the dollar ($200 for each $1,000 face amount of bonds) skyrocketed to over 60 cents on the dollar after the deal was completed, and I had converted the new securities and ticket coupons that I received into cash. I did, however, hold onto the new publicly traded TWA stock I received in the reorganization. I continued my analysis of this new post-reorganization stock and absorbed as much information as I could about the company’s financial condition and future prospects.

The turning point came for me one day while taking the elevator down from the Merrill Lynch office. The doors opened on a floor labeled M.D. Sass—I had just been reading about Sass’...

Table of contents

• Cover
• Wiley Global Finance
• Series
• Title Page
• Copyright
• Dedication
• Foreword
• Acknowledgments
• Preface
• Chapter 1: Emerging from the Egg
• Chapter 2: Learning to Scavenge
• Chapter 3: Looking for Prey
• Chapter 4: Waiting On a Limb
• Chapter 5: Swooping In: Tropicana
• Chapter 6: Fighting Over the Carcass: Chrysler
• Chapter 7: Digesting the Remains
• Chapter 8: A Vulture’s Philosophy
• Appendix 1: Net Operating Loss Carry Forwards
• Appendix 2: Copy of Continued Objection by Ad Hoc Committee of Washington Group Class 7 Claim Holders
• Appendix 3: Letter to Washington Group's Board of Directors
• Appendix 4: Shareholder Complaint against Winn-Dixie Board et al.
• Appendix 5: Objection by Schultze Asset Management to Owens Corning Disclosure Statement
• About the Authors
• Index
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