Hedge Funds: M&A Target?

Two giant funds made deals last week. Will there be more?
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Traditional asset managers want to tap into alternative assets to broaden the services they can offer to investors. More often than not, this leads them to acquire hedge funds, recruit hedge fund managers or incubate new hedge funds inside their firms. Often, buying outside talent through an acquisition is the fastest and most efficient way to grow a hedge fund business, says Ben Phillips, managing director at Putnam Lovell.

This trend was illustrated twofold last week. On April 26, Sparx Asset Management, a giant money-management fund in Japan, announced the acquisition of Hong Kong-based hedge fund PMA Capital Management for $226 million. As a result of the deal, Sparx, which already runs approximately $8 billion in hedge funds assets, will become the biggest alternative-investment player in Asia. And Asia is where a lot of the growth in hedge funds is now taking place.

On the same day, Pioneer Investments, a $200 billion global-asset-management firm, bought Vanderbilt Capital Advisors, a $13 billion hedge fund located in Boston.

Other deals are sure to follow. Morgan Stanley is pursuing its goal to acquire a hedge fund and is talking to a variety of different alternative shops for a possible acquisition, says a source familiar with the firm's plans. John Mack, Morgan Stanley's chairman, was recently talking to hedge fund manager FrontPoint Partners, but the negotiations have come to a standstill after the defection of one of FrontPoint's key traders, as previously reported in this column.

There is no doubt that the pressure to make alternative products available through traditional money managers comes from investors. "Traditional asset managers have institutional clients, particularly pensions that desperately need absolute returns that will give them steady streams of income," says Phillips. But individual investors are also a factor, he adds. "Many boomers may say, 'I don't want a mutual fund growing at 10% with a loss every five years; give me 7% per year no matter what.' "

Going forward, asset managers will tend to view funds of funds as better acquisition targets than hedge funds, mainly because hedge funds are less diversified and riskier. "You're going to see more funds-of-funds acquisitions," says Eric Weber, head of the asset-management practice at Freeman & Co, a merger and acquisition boutique specializing in financial services. "Nobody wants to write a $300 million check for a hedge fund where you have key personnel risk and volatility of revenues risk. I can be comfortable projecting the revenues of a fund of funds over the next three years. With a hedge fund, good luck!"

Recent landmark acquisitions of funds of funds by traditional money managers include Julius Baer buying GAM last September for $4.6 billion and

Legg Mason

(LM) - Get Report

acquiring Permal Group in June for $935 million.

Third Point Is At It Again

Third Point's Dan Loeb has again put some pressure on

Massey Energy

(MEE)

. In a 13D filing last week, Loeb, who owns 5.8% of the coal company, asked for the representation of two of his nominees at the upcoming board meeting scheduled for May 16. In his letter, Loeb complains about the "extravagant compensation" last year for Massey's CEO, who received $33.7 million, more than four times the average compensation for Massey's competitors' CEOs. Last year, Massey's stock returned 8.8%, while the Bloomberg U.S. Coal Index posted a stunning 81%. Loeb also criticized the company for delaying a buyback plan of up to $500 million that he had obtained in September after pressuring the company for it.

On Friday, while announcing its disastrous earning figures for the first quarter, Massey made a mild concession to Third Point, authorizing an immediate $50 million buyback. But it's unlikely that the gesture will satisfy Loeb, who wants a significant buyback immediately. "Loeb is upset because the stock hasn't moved much compared to its competitors," notes an analyst. One reason for the discrepancy, this analyst says, is the labor shortage Massey faces as a result of its location in the Appalachians. On the other hand, Massey should do better, he adds, being the biggest U.S. producer of metallurgical coal, a variety of coal in demand because of its strong pricing and high heat content.

And while he's at it, Loeb, in a13D filing, penned another letter to Brendan Barba, CEO of

AEP Industries

(AEPI)

, a plastic-film manufacturer in which Third Point has a 23% stake. "Brendan, it's time for you to put your money where your mouth is," the letter reads, in typical Loeb fashion. Loeb asked management to buy back his 2 million shares for $36 each or to sell the company to the highest bidder. If the company agrees to the buyback, Loeb will do well, considering his initial investment of 2 million shares was purchased at $16.50 a share a year ago.

Alternatively, the letter says, AEP could sell the company to an undisclosed private-equity buyer, whose name Loeb doesn't mention, but who he says may be willing to bid at least 20% above the current price. It is not inconceivable to get an offer above $40, adds Loeb in his letter. On Thursday, Barba wrote back to Loeb with an invitation for him to meet with representatives of the company.

For Those Who Thought Buying Shares in US Airways Was a Dud Investment . . .

It looks like Boston-based hedge fund PAR Capital Management invested its money wisely when it pledged $100 million last year to help

US Airways

(LCC)

complete a merger with America West. Since the completion of the merger in September, the stock has more than doubled. PAR Capital continues to add to its position, and recently bought 1.75 million shares from another participant in the restructuring, ACE Aviation Holdings.

"The stock has been doing great, and the merger has done better than what people thought," says Roger King, airlines analyst with CreditSights, a credit research firm. "Load factors are increasing, so you have more people per plane, and fares are rising, which brings more money per plane. The whole sector has improved and the equity of all airlines is up in general," he says. PAR Capital, U.S. Airways' largest shareholder, now owns 18.6% of the airline.

Hedge Funds: The New World Tag-Team Champions

Here is a tip: When hedge funds want to shake up a company, two agitating funds are better than one. Activist hedge funds never admit that they act in concert, but when they agitate at the same time, one can be sure that a company felt the heat and gave in. This is seldom bad for investors. Take

PW Eagle

(PWEI)

. Caxton Associates, one of the largest hedge funds in the world and not a traditional activist, owns 6% of the company and asked for board changes. Pirate Capital, owner of 17% of PW Eagle's shares, made similar demands.

Last week, PW Eagle agreed to nominate seven new board members and granted the elimination of the staggered board elections. Under the activist pressure, it is likely that the new board will put the company up for sale, says Robert Brown, analyst at Craig-Hallum, a boutique investment bank. Year to date, the stock is up 40%. Meanwhile, profits soared after last year's expensive and deadly hurricane season boosted demand for pipe products, the company's main business.