Fourth Quarter 2009 Investor Letter
March 1st, 2010 Dear Investor: During the Fourth Quarter of 2009 and for the year, Third Point produced the following net returns: Third Point Offshore Fund, Ltd.
S&P TR
CS Event Event Driven Driven
38.6%
26.5%
20.4%
8.0%
6.0%
4.9%
Annual Standard Deviation
13.7%
16.4%
6.4%
Monthly Correlation to S&P
0.4
1.00
0.6
2009 Annual Performance 2009 Fourth Quarter
The top winners for the quarter were Delphi Corp, Dana Holding, Chrysler, Health Net Inc., and General Growth Properties. Properties. The top losers for the quarter were Barclays, Barclays, PHH, Fortis, Short Financial A, and Punch Taverns. Firm assets under management at January 1, 2010 were $2.5 billion. Quarterly Results
Performance for the quarter was driven primarily by gains in post‐reorganization equities, distressed credit, mortgage bonds, and equity investments in health care companies. The following is a brief discussion of selected positions that impacted the portfolio during the fourth quarter. Credit Investments/Post Credit Investments/Post -Reorganization Equities
CIT Group Inc. filed a “pre‐arranged” Chapter 11 reorganization plan on November 1, 2009 after several several months of planning planning and negotiations negotiations with with key creditor constituents. constituents. The bankruptcy filing was necessitated by CIT’s inability to fund significant debt maturities due to the dislocation in the credit markets and the lack of government support via TLGP, which the company had hoped in vain would be be forthcoming in July 2009. We had been been monitoring the situation, and the Chapter 11 filing provided us with an opportunity to
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purchase senior unsecured debt at what we believed to be a 25%+ discount to the asset values that could be realized in an orderly wind‐down. A restructuring of a $53B non‐bank financial completed within six weeks (plan confirmation was was December December 8, 2009) was was virtually unprecedented. unprecedented. Through our initial initial sizeable November debt investment in senior unsecured bonds, we received as consideration $0.70 of a strip of 7% Second Lien Notes (2013‐2017), and our pro‐rata ownership of 77% of the new common equity of the company via the December emergence. We created our equity position at approximately 0.4x plan book value (~$3B), which quickly traded up to 0.7x plan book value upon listing on the NYSE. CIT is currently one of our largest positions because we believe it presents a compelling option on the potential revitalization of one of the country’s largest middle‐market lenders as it transitions (according to our thesis) to a lending institution which will be funded eventually via a retail retail deposit base. base. This path will require require regulatory approvals, approvals, but the company has already reduced debt by some $10B and has extended maturities so that it has time to attempt this transition to a bank‐centric model while optimizing the value of its non‐bank eligible businesses (e.g. transportation finance) as the economy stabilizes and asset values recover. Since the beginning of the year, CIT shares have appreciated approximately 32%, significantly exceeding the results of the S&P 500 (flat) and the BKX KBW bank index (+10.5%). Mortgage Securities Mortgage securities contributed significantly to our returns during the fourth quarter, and have also performed strongly so far in 2010, both in terms of bond appreciation and pre‐ payments. Most of our current portfolio is composed of single‐name, senior RMBS positions with an average size of $10M. However, we have invested invested opportunistically in mortgage indices as event‐driven trades from time to time, starting with a short of the ABX in the spring of 2007. Late in the third quarter, we entered the CMBX index of commercial mortgages as a means of expressing our conviction that the government’s Public‐Private Investment Partnership (first announced in the fall of 2008) would in fact be funded during the fourth quarter of 2009. The Legacy Securities Securities component of the Public‐Private Public‐Private Investment Program Program (aka P‐ PIP) is a joint initiative between Treasury, the Fed, and the FDIC that was developed to return liquidity to markets for previously issued CMBS and non‐agency RMBS by providing government equity equity co‐investment and and favorable debt financing. financing. As mentioned in previous previous letters, we were not interested in participating in P‐PIP, but saw the opportunity to trade around it as enticing.
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As the manger selection and subsequent private capital fundraising process wore on, the market pulled back its conviction that P‐PIP would be funded, giving us the opportunity to buy the CMBX at a price that translated to a 17‐18% levered return for eventual P‐PIP participants. participants. The bonds we purchased purchased were the top 70% of the capital structure and and we believed that they were covered by their underlying asset values and that, over time, they would return par. Based on the low risk nature nature of the asset and our conviction that the government partnership partnership was imminent, we thought these securities would tighten. tighten. Our thesis proved correct, and we profited in the fourth quarter as P‐PIP starting buying bonds and they tightened, though not as quickly as we had anticipated. Equity Investments
Health Net In the midst of the chaos during last summer’s healthcare debate, we established a position in Health Net common equity when the stock sold off following the announcement of the company’s loss of its Tricare contract with the US Department of Defense and the sale of its Northeast assets to United Health. Health. We believed believed this contract loss was not a fait accompli and that the prevailing prevailing price did not reflect the residual residual value in the business. We also felt that the resolution of healthcare reform legislation would remove the current valuation overhang across the managed managed care space. Health Net’s high quality quality management team is focused on maximizing shareholder value, and CEO Jay Gellert is a significant shareholder in the company. We expect Health Net will increase profitability over the next several quarters as management management focuses on reducing costs. Post health care reform, the benefits benefits of scale will become increasingly important as the industry focuses on wringing costs out of the system. The Company has significant cost reduction opportunities and is well positioned to take advantage of consolidation in the healthcare industry once the regulatory environment stabilizes. Risk Arbitrage Arbitrage Investments
Mead Johnson Nutrition As we mentioned in our Third Quarter 2009 letter, we primarily focus on mergers and acquisitions as fertile ground for compelling fundamental investment opportunities as more often than not, we find unlevered arbitrage spreads uninteresting. A few investments made during the Fourth Quarter highlighted the value in this approach, one of which was a new long position in the shares shares of Mead Johnson Nutrition (MJN). MJN is a global leader in infant formula and pediatric nutrition and is most well‐known for its flagship product, Enfamil. We like the MJN story for two reasons. reasons. First, the company has has a highly attractive earnings earnings growth profile. It generates almost almost 60% of its sales from from emerging markets markets in Asia and
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Latin America, where structural tailwinds like increasing middle class births, greater levels of consumer education, and higher female participation in the workforce are driving sustainable double‐digit double‐digit sales growth. Once birth rates normalize normalize in the developed world, the company will generate one of the fastest long‐term sales and profit growth rates in the large cap consumer staples universe. Second, we believe the company represents a compelling acquisition target for multiple parties following its complete separation from Bristol‐Myers Squibb in December 2009. MJN’s geographic footprint (high market share in North America and key emerging markets around the world and low market share in Europe) is highly complementary to that of Nestle or Danone. Additionally, both companies companies are focused on health and wellness, wellness, have acquired infant nutrition assets in the past (Nestle paid 15.7x EBITDA for Gerber and Danone paid 21.7x EBITDA for Numico), and are currently large enough to swallow MJN. Now that MJN is fully independent, Bristol‐Myers Squibb’s low tax basis in the asset no longer complicates a potential potential transaction. transaction. Though the timing of such an event is of course difficult to predict, and several tax, legal and regulatory hurdles may first need to be overcome, we are content to wait for a buyer to emerge, knowing we paid a fair price for a truly best‐in‐class asset with a long runway of emerging markets‐led growth. Investment Outlook Investment Outlook
We are relatively constructive about markets generally in light of modest valuations, accommodating monetary policy and economic data which suggest growth from the pre‐ crisis lows. However, against this this backdrop remain numerous issues that that weigh on sentiment, creating opportunities for investors, but presenting real risks to robust economic recovery. recovery. Among the issues we track track that have the potential potential to create market market dislocations are: •
• • • • • • •
US government deficits at the municipal, state and federal levels, including entitlement liabilities, liabilities, and their impact on inflation, interest rates, and growth Unwise US regulatory intervention European sovereign default risk weighing on the Euro Middle Eastern defaults Japanese fiscal/demographic crisis Chinese economic growth, credit quality and currency volatility “Peak Oil” impact on geopolitical stability and economic welfare Climate change
Accordingly, since it is difficult to predict which of these "monsters in the closet" will reveal themselves and when (just as it was difficult to predict when the sub‐prime crisis would come home to roost), it is important to continually monitor each of these risks, even as event‐driven, event‐driven, bottom‐up investors. Unlike the subprime subprime debacle, where it was possible to set up bearish bets even after the market started to fail, I am concerned that many of the issues we monitor monitor today could could unravel quickly quickly in a step function. We have begun to set set up various trades to hedge against against "fat tail risk", as we did early in 2009. While we have only a
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small percentage of capital at risk in such protective trades, we expect to increase the amount of protection purchased to about 2% per annum over the coming weeks and months – capital we would be very pleased to lose should such protection prove unnecessary. Notwithstanding a challenging start to the year, with markets flat as of this writing, we have found ample opportunity within our investment framework to exceed market returns and to meet our partners’ partners’ capital gains needs. needs. In particular, distressed credits credits and post‐ reorganization reorganization equities, special special situations and certain certain short positions are doing well. We have also avoided many consensus trades, including cyclical and commodity stocks, gold, Chinese and other emerging markets, all of which were terrific performers for other funds last year but do not meet our framework or qualify as part of the knitting we do best and to which we are sticking. While immediate opportunities in corporate performing credit have waned, we are seeing a strong surge in corporate M&A activity, which produces investment possibilities directly in risk arbitrage arbitrage investments investments and sometimes around around the fringes, as noted noted above. While we have taken down our exposures since their peak in mid‐January, we like our portfolio and remain excited by the new event‐driven event‐driven situations situations we are seeing every day. Capital inflows to the funds suggest that our existing and new investors share these sentiments, and we are ever grateful for the votes of confidence that so many of you have shown. Please feel free to contact Investor Relations or me directly with questions or thoughts. Sincerely,
Daniel S. Loeb
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The performance data presented represents represents that of Third Point Offshore Ltd. All P&L or performance results are based on the net asset value of fee‐paying investors only and are presented net of management fees, brokerage commissions, administrative expenses, and accrued performance allocation, if any, and include the reinvestment of of all dividends, interest, and and capital gains. The performance above above represents fund‐level fund‐level returns, and is not an estimate of any specific investor’s actual performance, which may be materially different from such performance performance depending on numerous numerous factors. All performance results are estimates and and should not be regarded as final until audited financial statements are issued. While the performances of the Funds have been compared here with the performance of a well‐known and widely recognized index, the index has not been selected to represent an appropriate benchmark for the Funds whose holdings, performance and volatility may differ significantly from the securities that comprise the index. Past performance is not necessarily indicative indicative of future results. All information provided provided herein is for informational informational purposes only and should not be deemed as a recommendation to buy or or sell securities. All
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investments involve involve risk including the loss of principal. This transmission is confidential confidential and may not be redistributed without the express written consent of Third Point LLC and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. product. Any such offer or solicitation solicitation may only be made by means of delivery of an approved confidential offering memorandum. memorandum. Information provided herein, or otherwise provided with respect to a potential investment in the Funds, may constitute non‐public information regarding Third Point Offshore Investors Limited, a feeder fund listed on the London Stock Exchange, and accordingly dealing or trading in the shares of that fund on the basis of such information information may violate securities laws in the United Kingdom and elsewhere. _____________________
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