December 9, 2009
Dear Investor,
Performance and Top Holdings Set forth below is our performance for Glenview Institutional Partners, L.P. for the period ended September 30 th, 2009.1 Gross Return
Net Return
Gross Long Exposure
Gross Short Exposure
Net Equity Exposure
Net Credit Exposure
January Fe bruary Ma rch Quarter 1
6.50% -0.54% 3.30% 9.42%
6.50% -0.54% 3.30% 9.42%
1 31 % 124% 118 % 124%
-51% -56% -55% -54%
48 % 39% 33% 40%
31 % 29% 30% 30%
Apri l Ma y June Quarter 2
14.93% 9.42% 5.89% 33.18%
14.93% 9.42% 5.89% 33.18%
130 % 132% 135% 132%
-62% -65% -72% -66%
35% 34% 36% 35%
33 % 32 % 26 % 31%
Jul y Augus t Se ptem ber Quarter 3
6.87% 7.59% 2.84% 18.25%
6.87% 7.59% 2.84% 18.25%
132 % 12 7 % 12 2 % 127%
-68% -72% -49% -63%
43% 36 % 61 % 47%
21 % 18 % 12 % 17%
YTD 2009
72.32%
72.32%
128%
-61%
41%
26%
310. 310.03 03% %
211. 211.82 82% %
17.68 .68%
14.0 14.02 2%
Incep nceptio tion n to Date ate (Feb (Febru ruary ary 2001 2001)) Incep ncepti tion on to Date CAG CAGR
As of September 30 th, our top ten long positions listed alphabetically were AmerisourceBergen, CVS, eBay, Express Scripts, Fidelity National Information Services, Laureate Education (credit position), McKesson, Oracle, RR Donnelley, and XM Satellite (credit position). Our top ten positions collectively represented 40% of our capital. Our top ten short positions represented 11% of our capital. Our short positions included three diversified diversified industrial/manufacturing industrial/manufacturing companies, a chemicals company, a restaurant, a discount retailer, a telecom wireless equipment company, a human resources firm, an insurance firm and a pharmaceutical services firm. firm. In addition, throughout the quarter, we held short positions in various indices as hedges and, as described in our Q2 2009 letter, in the sovereign debt of six primarily European countries as a hedge against a second global liquidity crisis. Our performance attribution is set forth below: Performance Attribution (Gross Ret urns)
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Q1 09
Q 2 09
Q3 09
YTD 09
Equit y Long
-4.83%
27. 08%
19.37%
53.03%
Equit y Short
7. 86%
-13.72%
-8.82%
-20.00%
C redi t Long
7. 18%
19. 65%
7. 78%
40.03%
C redi t S hort
-0.79%
0.17%
-0.09%
-0. 74%
T otal Gross Retu rns
9.42%
33.18%
18.25%
72. 32%
Performance and exposure information in this report are calculated excluding Designated Investments (or "side pocket" investments). investments) . Exposure figures are averages for the time period represented.
Executive Summary i) The fund returned 18% during the quarter, continuing our strong portfolio performance during 2009. ii) The economy has started to recover, but the pace and shape of the recovery are unclear, and our portfolio is not levered to any particular economic scenario. iii) Reflecting the bottoming of the economy, we have reduced gross short exposure and established some long positions in businesses that are attractive in all scenarios outside of a free-fall economy. iv) We have reduced corporate fixed income exposure and increased net equity exposure, resulting in a portfolio that is more liquid while offering attractive medium term returns. v) We have initiated event driven positions within the equity and distressed fixed income strategies, and we expect such opportunities to grow over the next twelve months. vi) Our equity portfolio continues to exhibit favorable characteristics of strong operating momentum and low valuation (11.1x 2010 earnings, 9.6x 2011), against a backdrop of overall constructive liquidity conditions.
Third Quarter Discussion Our performance for the quarter continued to exceed our long-term expectations with returns of more than 18%. This performance was driven by: a) b) c)
Strong performance across our equity long portfolio, including healthcare, business services and financials. Continued broad strength within distressed fixed income, where security prices continue to recouple with the relatively strong fundamentals of our underlying issuers. While these gains were offset by losses in our equity short book, our reduction in gross short equities throughout the quarter reduced the magnitude of such hedging losses.
During the quarter, we reduced our gross short equity position to reflect our increasing confidence that an economic bottom of some form had been established based upon anecdotal commentary of a broad number of contacts across a wide variety of industries. Given improving liquidity, liquidity, a firmer economy and relatively low valuation levels, we believed it was prudent to reduce our gross short book to control the risk of a significant short squeeze across most most equities. In order to contain our net exposure at reasonable levels, we also selectively trimmed our gross long equity exposure. Concurrently, we also began to reduce our our gross long credit exposure as prices prices began to more significantly recouple with fundamentals fundamentals in a positive manner. As a result of these actions, our gross exposure came down approximately 25 points through the quarter, and our net exposure shifted from what was approximately a 50/50 split between equity and credit strategies in the second quarter to a positioning that ended September with approximately 3:1 exposure in favor of equity based strategies. strategies. We believe that credit’s relative attractiveness attractiveness to equity most likely peaked early in Q3 09, and as such we are reallocating risk dollars to superior, superior, risk adjusted equity opportunities.
Economic Discussion I’d Like To Buy a Vowel, Pat Most of us have seen the popular game show “Wheel of Fortune”, in which contestants guess letters of a puzzle until enough letters have been revealed for the contestants to solve the puzzle. While the object of the game is to earn the most money by guessing consonants that are contained in the word before solving, players may reinvest some of their prize money to buy a vowel, and with that additional information they increase their odds of correctly solving the puzzle. In our prior letters, we set forth our framework that liquidity and economy were the two central questions, and that we felt the answers to the liquidity liquidity puzzle were clear enough to base investment investment decisions upon. In contrast, we believed that the answers to the economic puzzle were still highly speculative, and that three months ago we only knew enough to project that the economy had likely ceased its contraction, albeit for an indeterminate period of time. As such, we were willing to take on long exposure to those stocks stocks or bonds whose securities were attractive attractive assuming that a bottom had been put in, regardless of the strength, length or shape of the recovery.
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After three months of additional data and observations in order to determine the economic forecast over the medium term, we are forced to mutter those those three little words that scare scare us all: “We don’t know”. While we recognize that there is probably much to be gained in correctly anticipating the course of the economy in 2010 and 2011, we also recognize that there is much to be lost in prematurely jumping to an inaccurate conclusion. Since a picture tells a thousand words, the easiest way to demonstrate the conundrum facing investors today is through the following set of pictures:
Scenario 1 Death Spiral
Scenario 2 V Recovery
Scenario 3 W Recovery
Scenario 4 Saw bottom
Scenario 5 Square Root
As you are aware, every market pundit has their own description of the shape of the economic recovery, or lack thereof. Five of those are are pictured above. At this point in in the economic cycle, cycle, we know the following following data points on US (quarter on quarter annualized, latest revision) and G lobal (year on year) GDP:
Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09
US 1.5% (2.7%) (5.4%) (6.4%) (0.7%) 2.8%
Global 3.8% 2.6% (0.1%) (2.4%) (2.1%) (0.9%)
In pictorial terms, terms, we know that the beginning of this puzzle is a “V”. However, that could be the beginning of scenarios 2, 3, 4 and 5 above. Obviously, securities of issuers issuers in cyclical industries industries such as capital goods, retail, retail, basic materials and semiconductors semiconductors will react quite differently in the event of a V recovery, a W or double dip economy, a saw bottom filled with fits and starts, or a square root economy of a small recovery followed by zero growth for a prolonged period of time. time. Not unlike three months ago, we believe believe that we only have enough information to rule out scenario 1, an economic “death spiral”, where unprecedented monetary and fiscal stimulus still failed to stem the decline in economic activity broadly.
The Waiting is the Hardest Part (Tom Petty) We sense from talking with market participants, and our own investors, that everyone would like an answer to this puzzle. Of course, we would like like an answer as well. well. However, while in our last last quarterly letter letter we presented what we thought was broad based and clear evidence of a bottoming of economic activity over the summer, today’s observations and anecdotes are are by no means clear. Set forth below is a sample of the conflicting conflicting cross currents that are being reported by market participants regarding present economic conditions:
Industry Housing
Upbeat Commentary Lowe’s: We’re encouraged by the signs of stabilization we’re seeing in our business, and we're confident we’re wellpositioned to capture additional market share.
Cautious Commentary DR Horton: There are still a number of headwinds in front of us operationally in the business so we are still very cautious as we look forward to next year in terms of really what the market is going to bring to us. We think we’re very well positioned within the industry but un til the unemployment rate starts to drop and there are jobs created, then we're going to have a tough time.
Consumer
Target: I think the consumer is in a better place and more confident.
Wal-Mart: Customers continue to tell us they’re concerned about their own finances and unemployment.
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Industry Technology
Upbeat Commentary Google: We believe the worst of the recession is clearly behind us, and we're seeing lots of signs of that in all of the industries that we pay attention to.
Cautious Commentary Nokia: Let's be clear, uncertainty in end consumer demand remains.
Cable
Comcast: The economy economy appears to be stabilizing.
Time Warner Cable: The macroeconomic factors that are most relevant to our residential subscription business remain sluggish at best.
Media
CBS: There is no question we are seeing strong evidence of a recovery right now, but our general optimism is based on trends both in the economy as a whole and in the advertising environment.
News Corporation: We prefer to remain conservative in treating this recovery as still a little fragile. I expect 2010 to be a year of stability that puts us in a great position to be ahead of the full economic recovery.
Gaming
Las Vegas Sands: There is no doubt whatsoever that the economy is returning.
Wynn Resorts: The uncertainty in the U.S. economy is devastating.
Financials
Bank of America: Over the past several months, almost every business day has brought new economic reports showing that home prices are stabilizing, that industrial production is picking up, that inventories are coming down, and that job losses are slowing. In short, that our long recession is finally coming to an end and that an economic recovery has begun.
SunTrust: It would be premature to declare broad victory over recessionary pressures or to start talking about turning corners, about hitting a bottom and the like.
While I’ve learned a lot from the markets over the years, I’ve also learned a lot from my children. When I attended my son Adam’s preschool parent teacher conferences in 2004, his teachers had many nice things to say about him, but they did complain complain that Adam didn't participate in in one circle-time circle-time activity. Everyone would put their their heads down, one child would be selected to tap the others on the head, and then the children would look up and guess who the "tapper" was. Every time it was Adam’s turn to guess, he refused to say who he thought had tapped him. A month ago, I went to Adam’s fourth grade grade parent teacher conference. conference. His teacher also had nice things things to say about Adam, but she did point out that in math, sometimes he gets frustrated because while he raises his hand every time to give the answer, they often ask if anyone "other "other than Adam" wants to answer this one. It would be easy to conclude that Adam simply got over his shyness; however, I believe Adam is simply exhibiting the skill set of a disciplined investor. It makes little sense sense to guess at an outcome where the odds of being being wrong are quite high. Rather, it is much better to wait for situations in which there is a right answer that can be arrived at through logic and reason before you you speak up and offer offer your views. We patiently await await additional data data points to determine determine the strength and shape of the economic recovery, and we continue to resist the temptation to wager capital on what we continue to believe is a highly uncertain uncertain economy. We will maintain low exposure to cyclicals cyclicals and consumer discretionary categories until enough letters have been turned over that we may solve the economic puzzle. Fortunately, there remains a large opportunity for attractive risk adjusted returns in non-cyclical, recurring revenue franchises, and these types of investments continue to dominate our investment portfolio.
Portfolio Review In our last quarterly letter, we set forth our case for the continued strong performance of distressed corporate fixed income. Since the end of June, the high yield index has increased increased approximately approximately 20%, including 15% during the quarter, and its yield to maturity has fallen from 12.7% to 9.3%. Furthermore, our fixed income portfolio portfolio outperformed the indices, indices, with cash on cash returns of 36% since June 30, including including 26% during the quarter. As a result of the significant price appreciation of our bond portfolio, we have reduced our gross long exposure in fixed
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income by approximately one third, and we continue to look for opportunities to monetize positions where securities prices have approached levels that reduce forward return profiles below our investment hurdle rates. While more functional credit markets diminish the future distressed fixed income opportunity, the return of functional liquidity to the corporate markets increases the opportunity set in both equity investing and event driven strategies. In particular, the past three three months have seen a restart of cash cash financed M&A activity, with the LBO of IMS Health, the all cash acquisitions of Sun Microsystems and 3Com, the part cash acquisitions of Affiliated Computer Systems and NBC Universal, and the cash cash financed offers for Cadbury, among among others. We expect this trend to continue well into 2010, and while event driven strategies were largely dormant during the credit crisis, we believe that there is an increasing opportunity set for Glenview to penetrate in the coming quarters.
Xerox Corporation (XRX: $8) / Affiliated Computer Systems (ACS: $56) On September 28 th, Xerox Corporation announced that it would be acquiring Affiliated Computer Systems for 4.935 XRX shares and $18.60 in cash for each Class A and Class B share. In addition, Darwin Deason, the founder founder of ACS and sole Class B shareholder (with super voting rights) received $300M in convertible preferred stock in Xerox, for which he pledged his 43% voting interests interests in favor of the transaction. transaction. Xerox shareholders reacted reacted negatively to the transaction, transaction, and Xerox shares fell 15% on the day of announcement. announcement. Additionally, the arbitrage spread between ACS and Xerox shares set up with a 28% annualized return. We believe that ACS is attractive as an arbitrage position, and furthermore, we believe that Xerox is attractive as a fundamental long position. position. As such, we have a long position in both securities, securities, with approximately 70% of the exposure in ACS shares. The investment thesis thesis can be broken broken down into two parts: parts: the arbitrage position position and the long investment position in the combined entity. We believe that the merger arbitrage spread set up wide of normal returns due to three concerns, all of which we believe to be misplaced: i)
ACS holders, and arbitrageurs, were concerned that the difference in compensation between A and B shares was inappropriate, and lawsuits were filed in Texas and Delaware to attempt to force parity of compensation between all classes classes of shareholders. This added uncertainty to to closing and expanded the arb spread. ii) Additionally, traditional arbs questioned the industrial logic of the deal and feared that ACS w as a heavily shopped property, which may be selling selling for good reason. As such, arbs felt there was a higher than average average chance that fundamentals at ACS were a problem and that the “break price” of a failed deal would create a meaningful loss. iii) Because of the negative reaction of XRX shareholders to the deal, and the deal’s requirement for a majority approval by XRX shareholders, many arbs felt there was significant deal risk on the XRX side that the acquirer would simply walk away. Based upon our understanding of Xerox over time and reinforced in conversations with management, we believe that Xerox is firmly committed to the deal and that the likelihood of closing is extremely high: a)
While in theory one can understand the resentment of ACS Class A shareholders to receiving less compensation than their super voting, Class B counterparts, from a legal perspective we believe ACS shareholders have no basis to achieve parity for their holdings. holdings. Thus, we expect the remaining Delaware lawsuit to be resolved quickly and amicably; the Texas suit was resolved on November 23 rd. b) Despite the initial shock and confusion among Xerox shareholders, we believe that they will comfortably achieve the majority vote necessary to consummate the transaction, as the acquisition is accretive to earnings, cash flow, growth and shareholder value. c) While Xerox’s commitment to the transaction diminishes the risk of a deal break, we also believe that skepticism regarding regarding the independent value of ACS should a deal fall through through was excessive. ACS continues to perform admirably given the economic environment, and we believe that margins and cash flows are sustainable at current levels. Taken together, we gained increased confidence in a closing of the transaction during Q1, and we therefore established the arb position with an annualized return potential in the high 20% range.
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Rather than short XRX equity, however, we have chosen to become implicitly long the stock through our ACS ownership and have furthermore enhanced our investment through purchasing XRX shares directly once the spread tightened. Our bullish thesis on Xerox is as follows: follows: 1)
The merger makes strategic sense. Strategically, the combined company becomes a global provider of business processing outsourcing (“BPO”) and document management hardware, software, and services. ACS brings XRX a path to scale in BPO services, where XRX had been incrementally shifting shifting over time, as well as a path to revenue growth for the company overall, which X RX had been struggling to achieve in recent years. XRX brings ACS a well-recognized global brand brand and a sales team that will give it the the opportunity to expand more aggressively into international markets. 2) The merger makes financial sense. sense. We expect the deal to be 4c (5%) accretive accretive in CY10, with greater accretion over time as management management executes on synergy targets. targets. XRX and ACS are both steady cash generators, and the combined $2B+ in annual free cash flow will be used for debt reduction near term and aggressive share buyback and growth-driving acquisitions longer term. 3) We see EPS upside on improving trends for for the two businesses and merger accretion. accretion. XRX is guiding CY10 EPS at 75-85c and CY11 EPS at $0.95-1.05; we think these estimates will prove conservative and our model is above these targets. targets. Core XRX is performing well, as management management is executing solidly solidly on cost cutting efforts despite despite still-weak revenues. In 3Q, XRX reported EPS of 14c, above consensus at 12c and above guidance of 10-12c primarily primarily due to higher than expected margins. margins. XRX is guiding CY10 revenue up 1% Y/Y, which we believe is conservative given our expectation of 2-3pts of FX tailwind as well as stabilizing demand demand conditions in tech. For ACS, we believe recent strong bookings bookings will translate to high single digit revenue growth. 4) We believe that the projected synergies are reasonable and achievable within the announced timeframe. XRX expects $100M (~5c) in profit synergies in the first year, or ~1.5% of ACS costs, which we believe is reasonable if not conservative. conservative. By way of comparison, Hewlett-Packard achieved achieved >4% in synergies in the first year of the EDS deal, albeit with a significantly significantly more aggressive aggressive cost reduction plan. Three to five years out, further synergies depend on leveraging XRX’s brand and relationships to garner additional BPO services deals, using XRX technology to drive greater efficiencies in ACS’ BPO processes, using ACS’ IT outsourcing and business process outsourcing capabilities within XRX, and growth through acquisitions. XRX expects to drive $375M+ in synergies in in year 3 and $575M+ in synergies in year 5. These medium term estimates are more difficult to confirm with accuracy, but we are comfortable with these targets, as we believe management will execute on internal projects, while our initial proprietary checks confirm that XRX should be able to drive additional deals due to its brand and relationships. 5) The acquisition is conservatively financed, and the combined company will be able to resume the productive use of free cash flow within within 18 months. XRX pursued a deal financed primarily primarily with equity in order to maintain an investment grade rating, which gives XRX ready access to credit markets while recognizing XRX’s strong and consistent consistent cash flow generation and solid solid balance sheet position. Following the acquisition, the combined XRX/ACS will generate $2B+ in free cash flow, with much of that from recurring sources. The $2.6B in debt that XRX expects to pay down represents represents less than 1.5 years of this FCF. We expect XRX to use cash in excess of dividends to pay down debt in in the first 18 months following following the acquisition, and thereafter to utilize cash for share buybacks and accretive acquisitions. 6) We believe the risk reward is compelling. We believe new Xerox will earn $1.10 in 2011 and $1.25+ in 2012. Using a modest 12 forward multiple, multiple, which is a discount to historical ACS and in line with Xerox’s long term multiples, we project a $13 stock in approximately 15 months, generating a 70% absolute and 55% annualized return profile. profile. Supporting the stock on the downside is a P/E ratio ratio below 10x, and a likely relief rally once the arbitrage dynamics have passed and fundamental holders can analyze the investment free and clear of any legal or process uncertainties.
Equity Investing We continue to find a large supply of well capitalized, defensive growth businesses with recurring revenue and earnings streams at attractive attractive prices. Our long investing portfolio portfolio is trading at 11.1x 2010 earnings, and 9.6x 2011 earnings, each an approximately 30% discount to prevailing market multiples.
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We continue to emphasize healthcare within our equity investments, and healthcare as a sector represents approximately 45% of our long equity exposure. We reduced exposure to managed care in late September and early October, as the risks of negative healthcare reform outcomes increased, while concurrently the H1N1 outbreak was putting upward pressure on medical costs as doctor visits surged throughout the Fall. We are likely to rebuild exposure to the managed care sector should the outcomes of healthcare reform prove less punitive than the most draconian measures being pursued by some in the healthcare reform debate. While we believe that managed care equities will ultimately be attractive investments, there is a large supply of healthcare equities that combine attractive business franchises with low absolute and relative valuations and which participate in sectors within healthcare that are likely beneficiaries of the White House and Congressional healthcare agenda.
McKesson (MCK: $60) During the quarter, we significantly added to our holdings in McKesson, a long-time holding of Glenview since October 2004. McKesson is the largest of three pharmaceutical distributors distributors (the other two are AmerisourceBergen and Cardinal Health). MCK, AmerisourceBergen and Cardinal Health Health account for roughly 90% of the the pharmaceutical wholesale market. market. McKesson’s business is approximately approximately 80% drug distribution and 20% HCIT (healthcare information information technology). Our initial attraction to McKesson was as part of our “Pills in 2006” theme to play the implementation implementation of Medicare Part D along with the generics generics cycle. As a steady performer and cash generator, the stock has performed well over the years, and yet has continued to trade at an attractive multiple of earnings and free cash flow. McKesson shares fell precipitously precipitously during the Fall of 2008 as AXA, the large large life insurance company, reduced its stake from 15% to below 5% in a rapid liquidation, and the stock sold off again in March 2009 due to fears of competitive pricing and the overall negative impact of the economic environment. However, pharmaceutical consumption grew at 3% in the first half of 2009, consistent with our view of the business as non cyclical, and fears of pricing irrationality into a weak economy w ere also misplaced as the industry has functioned as a rational oligopoly oligopoly with a focus on service rather than than price. As such, McKesson remains on pace to grow earnings at a double digit rate through the economic downturn, and we expect earnings growth to accelerate to the high teens in the coming few years, driven by the following factors: a)
Generic drug wave ongoing through 2014 (see known patent expiry of 2009 $13B, 2 010 $12B, 2011 $18B, 2012 $28B, 2013 $5B, 2014 $16B, 2015 $9B). b) Demographic aging of America (seniors take more pills). c) Uptick in utilization from proposed healthcare reform (IMS suggests a 4-6% utilization uptick around 2013 should reform pass). d) MCK is responsible for distributing the H1N1 vaccine through an exclusive contract with the CDC. e) Within the 20% of the business that is healthcare information technology (HCIT), the combination of budget recovery within hospitals, stimulus programs and pent up demand will cause revenue growth to accelerate to high single digits which levers to high teens EBIT growth in the segment. f) The combination of a low to mid teens EBIT growth and the productive use of free cash flow will generate high teens earnings growth over the medium term. In addition to this strong growth rate, McKesson also exhibits significant balance sheet strength and cash flow characteristics characteristics that make it not only an attractive but a safe investment: i)
The company has net cash of $400M and gross cash of $2.7 billion, providing significant financial flexibility. ii) Free cash flow exceeds net income by 10-20%. iii) Combining excess cash, incremental debt capacity and one year of free cash flow, we believe that McKesson has the capacity to repurchase more than 20% of its shares, or to make accretive acquisitions that would grow their capacity geographically, in specialty distribution, in tuck-in domestic acquisitions or in complementary technologies within HCIT. Finally, McKesson’s valuation multiples multiples are representative of the overall healthcare opportunity. opportunity. Coming into 2008, healthcare equities traded at 110% of the multiple of the S&P500 – this measure bottomed at 70% in May and is a modest 80% relative multiple today. For all of the reasons stated above, we clearly believe McKesson deserves a premium valuation for its business quality, lack of cyclicality, strong growth prospects, fortress balance sheet and high cash conversion, and as such we believe McKesson will return to a 15-17x forward multiple, generating an $83-$94 price target on calendar 2011 earnings, or a 38-56% increase in one year.
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Distressed Fixed Income As we discussed, we believe that the opportunities to invest in wonderful business franchises at highly attractive prices through the debt structure are diminishing, and as such we have been harvesting many of the fixed income positions initiated in late late 2007 and throughout 2008. While such opportunities opportunities are narrowing, we do expect a steady stream of event driven trading opportunities within the distressed world to capitalize upon opportunities in refinancings, reorganizations and, at times, bankruptcies.
CIT Group During the quarter, we initiated a position in the most junior debt securities of CIT Group (the CIT 12s and CIT 6.10s). Set forth below is a very cursory summary summary of CIT’s capital structure: structure: Capital layer Senior Secured and Structurally Senior Debt Senior Unsecured Notes and Credit Facility Senior Subordinated 12% Notes (“CIT 12s”) Junior Subordinated 6.1% Notes (“CIT 6.10s”) US TARP Preferred Non TARP Preferred Book Equity Before Restructuring
Amount 29B 30B 1.1B 0.8B 2.3B 1.1B 3B
CIT Group is a commercial finance company. It provides lending and leasing products to small and middle-market businesses. Its balance sheet, which represented assets of approximately $70 billion, is comprised comprised primarily of loans and leased assets. Over the past two years, CIT suffered earnings headwinds from cyclical credit costs, like most financials. Unlike banks, which could rely on the stability and security of their deposits, CIT relied on a wholesale funding model, meaning that if at anytime the capital markets became concerned with CIT’s ability to repay, it would have significant difficulty rolling over its debt obligations, and a crisis of confidence could spiral into a selffulfilling prophecy of bankruptcy. Naturally, during the height of the credit crisis, CIT’s liquidity became challenged from the stress in the capital markets and the market’s revaluation revaluation of its credit profile. As a result, at the end of 2008, CIT sought to transition to a b ank-centric business model model so that it could fund its operations with deposits. In December, CIT converted into a bank holding holding company and received $2.3B of TARP funds. Further to its efforts to achieve funding stability, it planned to access future liquidity support from the US government in the form of (i) admittance into the FDIC TLGP program, so that it could issue new bonds at government-subsidized government-subsidized yields, and (ii) exemptions under Section 23A of the Federal Reserve Act in order to transfer assets to its bank subsidiary and thereby increase its deposit funding mix. However, as capital markets healed throughout the first half of 2009, the government revised its view of CIT’s systemic importance and, in turn, reduced its willingness to subsidize CIT’s liquidity. In July, the FDIC and the Fed rejected CIT’s request to to participate in TLGP and for an additional additional Section 23A waiver. The subsequent disclosure of of these rejections caused a partial partial “run on the bank” as the company company th experienced higher draws on its its financing commitments. commitments. On July 20 , in order to stave off a “free-fall” bankruptcy, CIT entered into a secured credit facility with some of its large existing bondholders. This financing provided time to devise a restructuring plan that would be less disruptive to CIT’s operations than a free-fall bankruptcy and therefore provide the most recovery to CIT’s constituents in the aggregate. Shortly after CIT secured the facility, we initiated a position in the CIT 12s, and then later added to our position through the CIT 6.10s. Our thesis was as as follows: 1)
The secured credit facility materially reduced the chance of a disorganized and value-destroying bankruptcy process. 2) Although the odds of such a scenario were low, if CIT was able to restructure out of court, there was the opportunity to make several times our investment given our basis at a low percentage of face. 3) In the likely scenario of a prepackaged or prearranged bankruptcy, the senior unsecured portion of the capital structure, which controlled the restructuring process, had meaningful incentive to agree to an
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4)
acceptable recovery to the subordinated tranches of the capital structure in order to avoid a valuation fight, as a valuation fight would have been time consuming and costly to the franchise value. The senior unsecured creditors could provide recovery to the senior subordinated note holders at relatively little cost as the senior unsecured layer of the capital structure had 25x the thickness of the senior subordinated layer (i.e., each 1c of recovery forgone by the senior unsecured layer would result in 25c of recovery to the senior subordinated layer).
During September, after organizing with other senior subordinated and junior subordinated bondholders, we negotiated with the company and the steering committee on the appropriate split of the equity across the different classes of creditors in the deleveraged and more liquid reorganized company. company. As a result of these negotiations, the CIT 12s and CIT 6.10s received 70% more equity than than was offered under the original plan. The company was to effectuate the restructuring restructuring in bankruptcy court in order to eliminate free-rider issues. Because it was a prepackaged bankruptcy, the duration of the bankruptcy was to be relatively quick and cause relatively little disruption to CIT’s operations. CIT filed for bankruptcy in in early November, and it plans to emerge on December December 10 th. Through the senior subordinated and junior subordinated notes, w e were able to create reorganized equity at approximately 60% of estimated estimated year-end “fresh-start” book value. The “fresh-start” adjustments adjustments mark the balance sheet to fair value, w hich accounts for future credit costs on assets as well as the yields on assets and liabilities. With CIT’s emergence from bankruptcy, we expect reorganized equity value to appreciate from retained earnings, asset dispositions and implementation of the bank-centric business model. We will continue to look for situations such as CIT, where we can combine fundamental analysis with situational analysis and a willingness to participate in a constructive process, to obtain an outcome that is mutually beneficial for all stakeholders. We look forward to CIT emerging as a strong strong and functioning lender that can can continue to serve the thousands of businesses that rely on CIT to finance their daily operations.
Organization Set forth below are important updates regarding our team, our fund administration, our liquidity terms and a review of our compliance procedures.
Personnel As we begin to restore performance and investor confidence, we are pleased to continue to make investments in additional personnel who will assist our efforts in future years. In November, Charles Zvibleman joined Glenview as an analyst reporting to Brad N euman on the Consumer Team. Charlie is a recent graduate of the University of Michigan, Ross School of Business school, where he majored in Finance and Accounting and graduated with with High Distinction. Charlie joins us from Morgan Morgan Stanley, where he spent his summer and the past year and a half as an Investment Banking Analyst in the Global Industrials Group. In September, Jose Hernandez joined us a full time Researcher on the Prop Research Team, after interning with us during the summer. Jose is a KIPP alumnus and a graduate of Union Union College. In October, Bobby Burns joined us a Proprietary Proprietary Research Analyst. Bobby previously worked at The Royal Bank of Scotland, where he spent time as a Credit Markets Research Analyst and a High Yield Capital Markets Analyst. Bobby is a graduate of Yale University. Finally, in late November, Drew Cardona joined joined Glenview as a Staff Accountant on the Finance Team. Team. Drew is a graduate of Boston College, where he majored majored in Accounting and Finance. Drew joins us from Rothstein Kass & Company, where he spent the past four years and was most recently a Supervising Senior on their staff.
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Fund Administration In our Q4 08 letter, we informed you of our intention to fully outsource our fund administration function to Goldman Sachs as a third party administrator. administrator. As you recall, we have used Goldman Sachs for the administration administration of our offshore funds since inception, while our internal finance and operations teams have been responsible for administering the onshore onshore funds. However, we wanted to be responsive to investor preferences preferences for the additional additional security of knowing that all of our funds have third party administration. Our team has worked closely with Goldman Sachs to prepare for the implementation, implementation, and the final cutover will occur January 1, 2010. As part of this transition, you may be contacted contacted by Goldman Sachs should they need additional additional account information. information. We appreciate your assistance as we implement this change to continue to offer best practices for investor security and safety.
Liquidity Terms As liquidity has returned to the investment community, a number of both existing and new investors have expressed an interest in investing capital into the Glenview Funds product but have indicated that they are unable to invest capital with a multi-year lockup as is our historical practice. We have determined that we will reduce the initial lockup period to approximately one year, allowing quarterly liquidity beginning the first quarter subsequent to a one year mandatory lock (thereby reducing the initial lockup to 12-14 months depending on when during a quarter the investment is made). We believe this change is appropriately responsive to investors and the current environment, environment, and we are confident in our ability to balance fund flows in a manner that protects the best interests of our long term clients. We are extremely proud of our track record of meeting every redemption, on time and in cash, even through the difficult liquidity conditions of late 2008, and we are confident that such liquidity terms can be provided without risking undue harm to our continuing investor base.
Compliance As you are aware, insider trading charges were filed against the executives of two significant hedge funds in the past few months. Glenview has no relation relation to those firms firms nor were we active active in the securities securities in question. question. However, in anticipation of increased scrutiny of our industry's compliance practices and procedures by both investors and regulatory authorities, we wanted to provide you with a brief overview of our compliance policies, philosophy and approach. The first thing we learn in compliance training is to establish the appropriate tone at the top: Everyone at Glenview is aware that our objective is to operate with integrity, honesty and transparency. While compliance procedures are ultimately reliant on the good values and common sense of our team, we have constructed our compliance policies and procedures with an eye towards conservatism, checks and balances and reasonable safeguards to reinforce our overall culture of compliance. There are three simple steps to avoiding insider trading: 1) Know the rules. 2) Take reasonable steps to prevent receiving insider information. 3) Properly identify situations where inside information has been received, and place such companies on trading restriction until such information becomes public. At the core, we believe that it is our job to compete compete vigorously, but fairly. It is our responsibility responsibility to play by the rules. As such, the first step is to ensure that our team knows the rules. We have for years years conducted annual compliance training, including issues related to when information is considered "inside information" and thus restricts us from legally trading in those securities. securities. Each new employee, on their first day at Glenview, receives compliance training on these issues as well. Our fiduciary duty to our investors is to make educated investment decisions based upon fundamental fundamental research. Our research activities encompass a variety of areas to attempt to gather, assimilate and analyze information about industries and companies that can help us make fundamentally sound, intelligent investment investment decisions. As part of these activities, our analytical team speaks with companies' senior management and investor relations professionals
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as well as sell-side analysts who publish and distribute their own research to us and our competitors. In addition, we have a team of proprietary research analysts who identify and speak with other industry experts so that we may understand a broader number of viewpoints than simply those which are broadcast to us and our competitors by syndicated research houses. As you may recall, we initiated this proprietary research effort after suffering suffering losses in Tyco International, which highlighted the risks of an overreliance on the assertions of the CEO and CFO of a company without also verifying business and industry conditions with a broader set of contacts. Since every conversation and every communication between a member of our team and an executive, employee or industry expert has the potential to convey inside information, information, we are well aware that compliance is not a "once a year" activity, but rather a daily commitment from our firm and our team. In order to prevent receiving insider information from these communications, we take the following steps as safeguards: a)
We meet with executives of companies companies who are specifically authorized authorized to speak with investors: investors: CEOs, CFOs, Investor Relations staff and o ther Operations business managers who are arranged by the company's investor relations department. department. We do not compensate such individuals individuals for speaking with us, and we have gift policies in place to safeguard against providing any incentive for such a company representative to give us an unfair edge or advantage. b) We use expert networks with robust compliance policies to identify consultants, but we often employ more conservative guidelines than such expert networks in approving consultants. consultants. We maintain a prohibition on speaking to consultants about their employer. Further, consultant relationships relationships with any public company employee that is in Glenview's portfolio, is being evaluated for addition to our portfolio by our research team, or was in our portfolio within the last 30 days require specific approval from our legal team. c) Beyond the compliance policies of expert networks, we have our own disclosure and policies that every consultant is required required to affirm directly to Glenview Glenview before any consultation consultation commences. commences. For example, consultants must confirm to us that they have the consent of their employer to participate in such consultations. Notwithstanding these protections, there are occasions where our team comes across information that may qualify as inside information. If a team member suspects this may be the case, they are directed to consult directly with our legal team of Mark Horowitz (Partner, COO and General Counsel) and Kara Brown (Legal and Compliance Counsel), who determine, either independently or with the assistance of outside counsel, if such information is material and non-public and therefore subject to trading restriction. restriction. Our legal team maintains a list of securities we are restricted in, which is posted on our intranet and regularly disseminated via email to the appropriate personnel. Further, our trading desk can not enter these securities into our order management system as they are automatically blocked from trading; this prohibition can only be lifted by our compliance team. Augmenting this "self policing" mechanism, our legal staff monitor and review emails to audit for compliance and adherence to our compliance policies and procedures. A more complete presentation of our compliance approach and procedures is available upon request, and Mark Horowitz is available to speak to any investor who would like additional information or has specific questions.
Liquidity and Risk With our modest shift of capital and risk from credit based strategies to liquid equity opportunities, we continue to improve the overall liquidity of the portfolio and increase our flexibility to adjust to the possibility of rapidly changing economic or liquidity conditions in the future. Within Glenview’s portfolio, approximately approximately 2% of NAV is invested in debt securities that remain highly illiquid, and those generate a 22% current yield (implying that in cases other than default, we will receive our capital back within approximately four years). At the end of Q3, the median market equity capitalization capitalization of our equity portfolio was $8.5B, with our longs averaging $7.6B and our shorts averaging $11.2B. Portfolio volatility during the third quarter averaged 11%, which represents a significant decline from the second quarter average of 21%. Our volatility was approximately 40% of the market’s average volatility volatility during the third quarter as measured by the VIX index. Since June, portfolio volatility volatility has been averaging low to mid teens, teens, reflecting both improved liquidity conditions and a gross and net investment posture that we believe is appropriate to the environment.
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We are pleased to continue our progress progress in restoring your capital, capital, your trust and your confidence. Should you have any questions that remain unaddressed, please feel free to contact our investor relations professionals, Elizabeth Isacco (212) 812.4723 or Chris Venezia (212) 812.4722, 812.4722, at any time. As always, we appreciate your continued investment, loyalty and support. Best regards, Larry Robbins Chief Executive Officer
Net returns reflect the reinvestment of all dividends, income, interest and prior performance returns. In addition, net returns include the deduction of all performance and management fees and expenses. Returns reflect Glenview Institutional Partners, L.P. (the "Fund's") overall returns. Returns related to a particular individual's investment will vary depending on whether such investor participates in designated investments and/or "new issues" and when the investor invested in the Fund. Past performance is not indicative nor a guarantee of future returns. There can be no assurance that the Fund will achieve comparable results in the future. Investment losses may occur, and investors could lose some or all of their investment. Please refer to the Offering Memorandum for a description description of the relevant risk factors pertaining to an investment in the Fund. This Performance Report is for the use of its intended recipient and may not be copied or otherwise distributed or published.
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