Oxstones Investment Club™
Russell D. Glass hears a time bomb ticking in the background, but it’s not the threat of a double-dip recession. It’s the $200 billion private-equity firms raised before 2007 and still haven’t spent. If they don’t find a use for it in the next 36 months or so — horrors! — they might have to give it back to their investors and forgo $4 billion a year or so in management fees that come with it. Companies themselves, meanwhile, have a record $1.8 trillion in cash, the equivalent of chum in the water for buyout artists.
Hence Glass’s thesis for investing in the coming months: Think like a corporate raider.
“We are very confident that in the next 12-36 months you are going to see a tsunami of PE buyouts,” says Glass. “We know, because we get approached by these funds to find buyout targets.”
Once the No. 2 executive in Carl Icahn’s buyout shop, Glass now runs his own firm, RDG Capital Management in New York. He’s a Name You Need To Know because, while his firm is small, his theory about where the market is headed is big. Glass, a Stanford Business School graduate who helped Jerry Jones buy the amazingly undervalued Dallas Cowboys back in 1989, has been investing in stocks long enough to know that truly great investment opportunities only come along once a decade or so. The days of buying super-cheap Graham & Dodd stocks for less than the value of the cash on their books are over.
Many stocks are still cheap relative to what PE firms and competitors might pay for them, however, Glass says. To figure this out he looks at a few financial measures he used at Icahn, most importantly the value of capital investment and research and development a company has spent that the market doesn’t seem to appreciate. Management can make spectacular blunders when it spends shareholder money (see: Bank of America’s Countrywide purchase at the peak of the subprime bubble) but Glass thinks by and large capital improvements and R&D pay off.
“What I’ve found over the years is that companies that spend a lot on capex or R&D don’t get rewarded until the public sees the benefit,” Glass says. “If you can recognize the spending while it’s occurring and buy ahead of the income that’s going to come from it, then you’re investing ahead of the curve.”
One investment-bloated firm Glass has been stalking for a while is Benihana, the restaurant chain that seemed to have peaked during the Carter administration but still has 97 restaurants and more than $300 million a year in revenue. Jaded investors might be turned off of the stock because of the reputation of its mercurial founder, Rocky Aoki, known for his powerboat racing and philandering more than his attention to management.
“I agree that would be a negative,” Glass deadpans, “except for the fact that Mr. Aoki has been dead for more than two years.”
In his absence the company has spent $150 million on capital improvements, yet its entire market capitalization was $75 million when Glass started buying. It’s since risen to around $130 million but Glass thinks the benefits of all that investment are just beginning to flow. Meanwhile Benihana has hired Jeffries & Co. to “explore options” including a sale.
Glass has more picks I will discuss in a future magazine article. Some other measures he looks at include: Sustainable free cash flow, which he defines as earnings before depreciation and taxes minus historical depreciation. If the company is in expansion mode, he also subtracts the typical yearly costs of expansion. Then, if the company has an attractive free cash flow multiple for its industry, he starts looking for hidden assets, just like he did when he was president at Icahn Associates. Real estate, unappreciated R&D, a secret formula or two, anything hiding on the balance sheet that might be attractive to a PE buyer or a competitor looking to expand.
Because ticking in the background is that time bomb, packed with the dry powder of purchasing power at PE shops and public companies themselves. It increased from $259 billion in 2005, Glass figures, to $504 billion by the end of 2009. Add in $900 billion of cash on the books of non-financial companies in the S&P 500 and the 2-3 times debt the PE artists can use to amplify their capital and we’re talking trillions. Front-running that trend is truly a once-in-a-decade opportunity.
Since this is part of our “Names You Need To Know” feature I’d appreciate it if you forward other investors who have interesting, contrarian or sure-to-be-prescient takes on where the market is headed next. It’s a chance for readers to pull the coverage where they think it should go for a change. Feel free to comment below, or email me at dfisher@forbes.com.
Tags: north america, private equity, U.S.A.