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Around the World With Robert Chapman

The activist is back from a tour with two new hedge funds.

Robert Chapman, founder of Los Angeles-based takeover and turnaround shop Chapman Capital, is back from sabbatical with two new hedge funds. Following a surfing accident in October 2003, Chapman returned money to his investors in Chap-Cap, a fund that produced a 20% annual performance from 1996 to 2003, and embarked on a 49-nation travel odyssey. He continued to manage an activist side pocket during his sabbatical with a net return of 55% and 61.9% in 2004 and 2005, respectively.

In April, Chapman plans to launch a tightly hedged, long/short fund called Chap-Cap Partners II, which will replicate his first fund. He also plans a highly concentrated activist fund named Chap-Cap Activist Partners.

spoke to him about his travels and his return to full-time investing.

TST Recommends What did you learn from your 16-month sabbatical that pertains to investing?

Robert Chapman

: Two lessons: Capitalism is contagious and a global inevitability; and China's economy is no miracle. Combine thousands of years of pent-up consumer demand with a government allowing businesses to have near-zero environmental and labor costs, and you get the world's next hegemony. However, those same images of 60-year old men digging ditches in Cambodia for the one-dollar-a-day compensation they were thankful to earn will end up haunting the lavishly and wastefully overcompensated public company fiduciaries I plan to target in 2006.

You're known to be a tough activist. What is your most successful transaction?

USA Detergents. Within six months of our original 13D filing, we were able to persuade the company to sell itself to

Church & Dwight

(CHD) - Get Report

. We got an absolute return of over 132% and an annualized return on invested capital of over 264%. We had approximately an 8% position at the time of our 13D, which is somewhere between a three-quarters and a full position, given our risk management policies.

What was your most significant defeat?

Of the 17 total original Schedule 13Ds filed since 1997 by Chap-Cap Partners, not a single one experienced a capital loss, and the only one with a sub-20% annualized net return (and thus dilutive to the Chap-Cap's eight-year track record) had an exceptionally low-risk profile (due to valuation, fundamentals, etc.) and was closed out quickly.

There is a great deal of interest in activism among hedge funds. Why?

For the most part, equity shareholder activists have put up some of the best numbers in the long/short and event-driven space in 2004-2005. We have much respect for what Third Point, Jana, Pirate and Barington, to name a few, have accomplished. However, outside of that group, it is a quantum leap from filing one or two Schedule 13Ds to calling oneself, legitimately, a shareholder activist. The key grading metrics for wearing the shareholder activism badge are: how many original 13Ds have you filed; how many 13D amendments have you filed; and how much alpha did you create as an activist.

Anyone can jump on a charter boat, slap a sardine on a hook and throw it overboard into a school of marlins. The real test, however, comes after his line sets and the pole bends violently, when the fisherman is forced to spend up to 10 hours getting that beast into the boat. There are an estimated 11,000 public companies in America alone. I would argue that at least 10% of these potential activist targets are managed and overseen by executives and directors whose replacement, through 13D filings, proxy fights or company auctions, would result in the doubling in stock price upside that Chapman Capital seeks in its activist targets.

What do you think of Carl Icahn's agitation with Time Warner (TWX) ? Would you join him?

Carl Icahn will be, for all time, the first bronze bust you see when entering the Activist Hall of Fame. His killer instincts and methods are unrivaled. However, Chapman Capital has a very specific size criterion in its target selection process: pick on someone your own size. Essentially, we try to avoid becoming insiders of our target companies, making the 10%


definitional threshold a cap of sorts. Furthermore, we shall have a 10% risk-management position limit in Chap-Cap Partners II, just like with its predecessor. These two guidelines dovetail into Chapman Capital's tendency to target companies matching our assets under management. Obviously, as successful as is King Icahn, his assets under management have not yet grown to Time Warner's $82 billion market cap. I would not put it past him, though, to get there sometime soon.

Have you thought of joining forces with other hedge funds?

Chapman Capital, for a variety of reasons, is not a general advocate of "wolf pack" activism. However, we did a joint filing with Third Point in

BindView Development



In that case, I had been professionally acquainted with

Third Point Manager Dan

Loeb for 13 years since we met as young arbitrage analysts in 1988. We shared similar perspectives on target selection, tactics and exit/accumulation triggers. I would jointly file13Ds with Dan at any opportunity -- he and

partner Jeff Perry are true investment geniuses. We also filed 13D jointly on Cinar Corp. with Highline and David Brail's Palestra Capital, and found both David and Jacob Doft to be exceptional partners. But, in general, I prefer to split 13D responsibilities with my partner, David Voyticky.

What's your outlook on the hedge fund industry?

Industries, whether financial or industrial, experience margin collapse when supply and demand become unbalanced for extensive periods. Curiously, our count of 15,000 hedge funds is not seeing alpha strain due so much to excess capital as was the case with convertible arbitrage, but due to excess personnel recruitment. The shortage of truly qualified hedge fund talent, from analysts to traders to administrators, is astounding. We received nearly 14,000 resumes over six months for five-10 positions, with maybe 100, at the high end of estimates, being of the caliber required to compete in the fashion we consider paramount for success in this space.