Cerberus: Inside the Wall Street power-house
With the closing of the Chrysler deal, the (very) private equity shop is poised to succeed or fail very publicly, say Fortune's Katie Benner and Geoff Colvin.
(Fortune Magazine) -- They're already taking the "Daimler" off the DaimlerChrysler signs at headquarters in Auburn Hills, Mich. It's happening at the big Fenton, Mo., plants where the company makes pickup trucks and minivans, and at other plants across North America. The new corporate stationery is ready. Chrysler dealers nationwide are sending out invitations, filling balloons with helium, and ordering chicken wings for the parties they're going to throw. The occasion: Chrysler is becoming American again, being bought from its German parent by Cerberus Capital Management, a buyout firm that it's safe to say most of Chrysler's employees, dealers, and customers had never heard of until the agreement was announced a few months ago.
The historic deal (which closed Friday) vaults Cerberus to a new level of fame and prominence in the U.S. economy. It also ties the fortunes of Chrysler and its ecosystem of suppliers and dealers to the increasingly troubled world of private equity, which is being dented by rising interest rates and a nasty credit crunch. Cerberus differs markedly from its competitors in many ways, especially in its willingness to take on companies in peril. "They consistently go where angels fear to tread, and they're doing it at scale and profitably," says Glenn Hutchins, co-founder of competitor Silver Lake. With Chrysler, Cerberus will succeed or fail more visibly than ever.
All that attention is actually a downside as far as Cerberus is concerned. Founder and chief Stephen Feinberg has shielded his firm, which is named after the mythical three-headed hound of Hades, from the press for 15 years. (True to form, he refused to be interviewed or photographed for this article.) But the spotlight is unavoidable: Cerberus's portfolio companies now generate revenues of more than $60 billion a year and employ about a quarter-million people, including 80,000 at Chrysler, a company that's in the news every day and that does business with consumers across America.
To understand the firm, one must understand Feinberg. "Everything runs through him, full stop," says a lawyer who has worked with Cerberus on several deals. "Cerberus is Steve Feinberg." No one interviewed for this story could imagine a successor.
Unlike such private equity czars as KKR's Henry Kravis or Blackstone's Steve Schwarzman, Feinberg is an anti-celebrity, man-of-the-people guy who just happens to be a centimillionaire. The 47-year-old son of a steel salesman from Spring Valley, N.Y., he lives in a Manhattan apartment that is modest by Master-of-the-Universe standards and an even more modest house in Stamford, Conn. He drives a Dodge pickup, loves guns and motorcycles, and wears off-the-rack suits.
The firm's Park Avenue offices may be the tattiest in the private equity business. Walk down the narrow corridors on threadbare, coffee-stained carpets and you'll see a warren of bare cubicles and rows of gray-steel filing cabinets. The walls are institutional beige or gray, adorned with cheap framed prints that would suit an inner-city nursing home. The overall effect is that of a ministry of finance in a former Soviet satellite state. And that seems to suit Feinberg just fine.
If you're doing business with him, expect to be neither wined nor dined, ever. "Invariably Feinberg and I would eat sandwiches out of boxes while we worked," says Robert Milton, CEO of Cerberus-controlled ACE Aviation Holdings, parent of Air Canada. A veteran dealmaker says, "His philosophy is having a relationship as opposed to rubbing your back. He won't do lunch or play golf, but he'll help you out. It's very different from what you find everywhere else."
Feinberg went to Princeton (class of '82) and there revealed the intensity and drive that characterize him still. A tennis teammate recalls, "If he'd had any natural ability at all, he would have been national champion," so ferociously did he practice and compete. Colleagues today say he breaks from work only for hunger, and if he leaves the office at 9 p.m. he'll continue working from home. He expects everyone on his staff to be available 24/7, as he is.
To see what Feinberg does care about, observe him in his weekly deal meeting, which all 280 employees are expected to attend in person or by phone. Many staffers are former executives from a range of companies, such as former MCI president and COO Tim Price, former Johnson & Johnson COO Jim Lenehan, and a number of executives from General Electric, including Michael Williams, Jeffrey Fenton, and Paul Bossidy. Other buyout firms arrange for such managers to be on call; Feinberg pays them to staff his so-called operations team and works them full-time. High up in the org chart - if not at the actual day-to-day control levers - are Dan Quayle and John Snow, the ex-Vice President and Treasury Secretary, respectively.
As talk progresses through possible target companies and the state of the portfolio, Feinberg asks his team of corporate veterans to contribute ideas, experiences, connections, and on-the-spot analyses. Through it all, he seems to release an overflow of nervous energy with a peculiar tic: He flicks his wrist back and forth, "playing tennis with his pen," says a former member of his operations team.
The questioning is nonstop, and participants are amazed by Feinberg's memory for numbers. "He fires off granular questions about cash flow from specific divisions over the trailing 12 months, and you'd better have that answer or get it quickly," says one witness to a Feinberg grilling. "The questions are insightful. There's no bullshit, no wasting time. His capacity to recall financial details on all the companies they have an interest in, and at the same time have a big picture in mind, is just astonishing. The people at Cerberus say this guy can see through walls."
If a potential target looks hot, Cerberus throws massive resources at it. An executive at the firm recalls a fast-moving situation involving a troubled company outside the U.S. In 72 hours he had war rooms in New York and overseas occupied by a 35-person SWAT team of Cerberus operations pros, investment analysts, and industry experts from the outside. Thus began a five-week, no-days-off, forced-march due diligence process that yielded thousands of pages of Excel spreadsheets. "The average day went to midnight," this executive recalls. "And many people never went home."
The obsession of that team and all Cerberus teams - other than making lots and lots of money, of course - is risk. All downside risk is modeled, just as every move is thought out in a game of chess (another Feinberg enthusiasm). Cerberus buys companies that look extremely risky, assumes the worst will happen, and plans accordingly.
The risk-centric approach is pure Feinberg. His first finance job out of college was with 1980s junk-bond house Drexel Burnham Lambert, where he learned how high-risk businesses borrow money and, more important, what happens when they can't repay their loans. He later worked for the small Gruntal brokerage. (Those two firms are now defunct; Drexel, you'll recall, went bust amid the Mike Milken scandal. Feinberg emerged from both stints unscathed.) He then started Cerberus in 1992 at age 32. Its specialty was distressed debt, a Wall Street term for loans that the borrowers can't repay.
It's a nasty business. The distressed bonds Cerberus bought produced a decent return if the borrower recovered. If it died, Cerberus used sharp elbows and teams of lawyers to fight over the remains; hence the usual term for this species: vulture investors.
"Cerberus had a lending arm called Madeleine LLC that gave money to companies that were filing for bankruptcy or ready to throw the Hail Mary pass," says a lawyer who has worked in M&A for 20 years. "Sure, they'd lend you the $10 million, but it would cost millions in fees, and they'd also get 10% of the company."
Cerberus became a part owner of many troubled firms, and Feinberg realized there was money to be made by rehabilitating them, says Tim Price. So Feinberg switched gears and began to focus on undervalued companies and distressed businesses that could be turned around.
With all that debt expertise, it's no surprise that finance and consumer-lending companies form the bulk of Cerberus's portfolio. Those businesses could come in handy. As bond markets roil, it's getting tougher to secure financing the way most private equity players do - through investment banks. An ability to fund one's own deals could be valuable; KKR has said publicly that it would like nothing more. But so far it's Cerberus that's building the banking empire.
Calling Cerberus a private equity firm, as most on Wall Street do, isn't quite right. As with most PE firms, investors must commit money for a long lockup period (in this case seven years) and accept that portfolio companies will be held for as long as it takes to create value. But unlike most PE firms, which only take public companies private in the hope of reselling later at a profit, Cerberus uses its enormous war chest - it raised $8 billion for its newest fund - for pretty much any asset it believes is undervalued. That includes equity stakes, debt, real estate, whatever. Cerberus also runs funds with the fee structure and much shorter lockup period (2 1/2 years) of a traditional hedge fund. These funds don't generally trade public equities or use leverage as most hedge funds do, however, and the holdings are largely similar to those of the longer lockup funds. Cerberus doesn't call itself a PE firm or a hedge fund, instead saying it's a private investment firm.
Limited partners (as such a firm's investors are called) report that returns are remarkably consistent, probably because of this unique structure. One longtime investor says his firm invests in both the long-term commitment and the more liquid funds, and that Cerberus is consistently returning more than 20% a year after fees. All four of its buyout-type funds are in the top quartile of distressed funds, according to research firm Private Equity Intelligence. "That is a pretty amazing track record," says Mark O'Hare, PEI's managing director. "Very few if any other firms could claim this."
The deals that Cerberus really likes are the ones most other PE firms really don't: complicated deals that involve lots of hard-to-assess risk, some kind of finance business, and labor unions. Not all Cerberus deals possess those attributes, but a surprising number do - Chrysler being the most famous.
An earlier example, critically important to the firm's decision to go after the automaker, was its purchase last year of a controlling interest in GMAC, the finance arm of General Motors (Charts, Fortune 500). Whether the deal will pay remains to be seen, but the company has dramatically slashed losses in the most recent quarter. It was also the crucial foundation for the Chrysler deal. Cerberus probably wouldn't have looked at a money-losing auto business with $19 billion in pension and retiree health-care liabilities if a healthy auto-finance business weren't part of the package. "I think that Cerberus is probably uniquely positioned as the logical owner because of the fact that it's involved with GMAC," says Wilbur Ross, the distressed-industries investor who has made fortunes in steel and coal.
Much could go wrong at Chrysler. If Congress enacts stringent new fuel-economy rules this fall, as it might, then some analysts believe Chrysler's car business could simply die. Even in the best case (solvency, upbeat sales), the future of the business will depend heavily on the behavior of the unions - and here we see another way in which Cerberus is different.
In general, labor unions hate private equity firms because they see them as asset strippers that close plants and fire workers. Cerberus certainly isn't shy about doing that - it laid off about 10% of the employees within a year of taking control of Guilford Mills in 2004, and moved the headquarters of Vanguard Car Rental (parent of Alamo and National) from Florida to Oklahoma for the cheaper labor pool. Nevertheless, Cerberus has managed to keep the unions mostly happy, as it did with some San Francisco hotels it bought.
Canadian Auto Workers president Buzz Hargrove was a bitter opponent when the Chrysler deal was announced but became a Feinberg fan after they met in Auburn Hills. "We were impressed with his knowledge of Chrysler and its key problems," says Hargrove. "He didn't just give us rhetoric about labor costs. He gave me his cellphone number." And what makes Hargrove think it isn't just talk? Mainly a recent decision to keep jobs at an Ontario plant where the company had good reason to cut them. Hargrove's conclusion: "It shows that under Cerberus, Chrysler is making an extra effort to live up to its commitments to keep jobs."
As Cerberus takes its place in the top rank of buyout firms and as a force in U.S. business, it may yet emerge from the shadows. But that will be a struggle. Teach for America recently honored Feinberg for his fundraising efforts, naming him guest of honor at its latest gala. But even in the Waldorf-Astoria ballroom, he was a ghost. Goldman Sachs president Jon Winkelried praised him in a long speech, but when it came time to invite Feinberg to the mike to say a few words, Winkelried instead said thank you and good night. Feinberg didn't budge from his table. Attendees were stunned. It's hard to think of anyone else too diffident even to stand up at a dinner being given for him.
Other challenges will include those facing the whole PE industry. This sector's supergrowth has been fueled by cheap debt and easy credit that suddenly aren't so cheap or easy. Cerberus was extraordinarily lucky to get the Chrysler deal closed just as the door was slamming, but future prospects will be pricier, requiring even more creativity. Even if Cerberus does keep coming up with deals, there's no guarantee they'll succeed. The firm has had some big flops - Mervyn's, the downmarket retailer, has floundered since Cerberus bought it; bottlemaker Anchor Glass filed for bankruptcy in 2005; GDX Automotive, the car-parts manufacturer, may soon do the same.
Maybe Cerberus's run will end. Or maybe its habit of shaping its business model to follow opportunities will come to its rescue. Like how? Well, in this environment, interest rates on risky loans are rising sharply, and shaky companies will have a hard time making payments. That means lots of turmoil - and opportunity - in the market for distressed debt. And at least one "private investment" firm knows that business quite well.