“Bondholders are like workers in a factory. … On their own they have no leverage. But if someone pulls them together, they can negotiate with anyone.” -Wilbur Ross
He is now a prominent politician, but before becoming secretary of commerce, Wilbur Ross (Trades, Portfolio) was a prominent value investor, a turnaround expert who raised not only troubled companies, but also controversy.
He came to prominence a few years after starting his own firm in 2000 by bold moves in the troubled steel, textiles and coal industries. Along the way, he has also been involved in other ventures, such as buying into troubled banks in Europe, but those first three big operations made his name.
At the center of those operations was a strategy to use bonds to gain control of not only troubled companies, but many companies in each sector that could be merged together. In this article, we examine his strategy to make money by investing in what Warren Buffett (Trades, Portfolio) would call “cigar butts.”
Who is Ross?
Born in New Jersey in 1937, Ross received a bachelor’s degree from Yale College; while there he edited a literary magazine and contributed to a campus radio station. Also according to Wikipedia, his first impulse was to become a writer, but found generating 500 words a day draining. A faculty advisor at the school helped him land a summer job on Wall Street, however. Following that, he went on to earn an MBA at Harvard Business School in 1961.
He went on to work at a money management firm where he had some engagement with bankruptcies, to Rothschild Inc. in 1976 and then started his own turnaround fund in 2000. While working for Rothschild, he became a prominent bankruptcy expert, and was part of a team that allowed Donald Trump to maintain control of the Taj Mahal casino when it went bankrupt in 1990, according to American Prospect.
And, of course, President Trump appointed him secretary of commerce earlier this year.
A would-be writer makes a career shift (before really beginning his career), and goes on to become one of America’s most prominent financial figures. The years spent at Rothschild undoubtedly gave him knowledge and experience upon which he could apply his growing expertise to some of the thorniest bankruptcies in recent American history.
What is W.L. Ross & Co.?
Formed in 2000, Ross combined his reputation with the deep-pocketed resources of other investors to create a firm that would become a so-called “bottom feeder.” Such firms step in when essentially all hope is lost for troubled companies.
According to CNN.com and American Prospect, these are the business highlights of the firm:
- 2002: Acquires Bethlehem Steel, one of several industry acquisitions and mergers, and creates International Steel Group (ISG). He becomes its chairman, and the company goes public the following year.
- 2003: He initially acquires and merges two textile firms, then adds others, and brings them back to health as International Textiles Group (ITG).
- 2003: Repeats this process again with International Coal Group (ICG) after acquiring some assets of Horizon Natural Resources in a bankruptcy option.
- 2005: The steel group is sold for a hefty return.
- 2006: He sells W.L. Ross & Co. to Amvescap (now Invesco) in 2006 for $375 million, but stays on as the chairman and chief strategy officer of the company (under the Amvescap umbrella). A Forbes article published shortly after the deal reported Ross would nearly double the value of assets under his control, to $6.8 billion.
- 2010: Buys 21% of Virgin Money (LSE:VM.) and goes on to help Richard Branson buy Northern Rock, a British bank.
- 2011: International Coal is sold to Arch Coal (ARCH, Financial) for $3.4 billion.
- 2011: Buys a 9% stake in the Bank of Ireland.
- 2016: International Textiles is sold to Platinum Equity.
- 2016: W.L. Ross Holding Corp. (a subsidiary launched in 2014) buys Nexeo Solutions Holdings LLC for a reported $1.6 billion; in the wake of the deal, a Nexeo news release states W.L. Ross Holding will change its name to Nexeo Solutions Inc. (NXEO, Financial) and trade on Nasdaq.
While Ross has succeeded in successfully turning around failing or bankrupt companies, he has also attracted much criticism; he has paid to settle differences with employees of companies he owned, and to regulators. An article in American Prospect reports on some of those issues:
- Ross used the provisions of Chapter 11 to "dump millions or billions in health-care and pension liabilities." Note, of course, that had the companies gone under, all might be lost. In response to that potential objection, the author of the article says bankruptcy provisions allowed healthy companies to be put under, shed their obligations to employees and then return to business.
- Board members and investors of Cone Mills accused Ross of pushing the company into an unnecessary bankruptcy so he could buy it up for much less than its intrinsic worth.
- In 2003, the United Mine Workers accused Ross of conspiring with Horizon Natural Resources to stage the company's bankruptcy.
- Critics say Ross supported free trade when it allowed him to send jobs to Mexico and elsewhere, but also embraced a protective tariff against the foreign dumping of cheap steel when it benefited the International Steel Group.
- The article concedes members of the United Steelworkers liked Ross, and called him a pragmatist for saving their steel mills and thousands of jobs.
Wikipedia reports Ross paid $81 million to settle a lawsuit by investors in two companies that Ross merged; the shareholders argued Ross had breached his fiduciary responsibilities.
In 2016, according to CNN, the Securities & Exchange Commission ordered W.L. Ross & Co. to pay $2.3 million because it had not properly disclosed the fees it charged.
It is not easy being a turnaround or bankruptcy capitalist—in fact, its practitioners are sometimes referred to as “vulture capitalists.” There are allegations of pushing healthy companies into bankruptcy for personal gain, but Ross has never been convicted of any criminal act. Note, too, the turnaround industry was earlier defined in part by “Chainsaw” Al Dunlap; he publicly reveled in laying off or firing employees of the companies of which he took control. So it is going to hard for any turnaround practitioner to win the respect of the public.
Ross’ investing strategy
After launching his new company in 2000, Ross studied the steel industry for two years. It was failing at the time, so Ross got together with the United Steelworkers to get concessions and went on to buy several bankrupt steel companies. These were merged into a new entity called the International Steel Group. According to American Prospect, he paid 3.6% of their value, or $90 million in cash plus assumed liabilities of $235 million, for assets valued at $2.5 billion (unless otherwise noted, this section is based on specifics from the American Prospect article).
Because the companies were in liquidation, he did not need to assume any health or pension obligations; retirees lost their health coverage, and pension liabilities were shifted to the federal Pension Benefit Guaranty Corp.
A month after his initial steel mill purchases, the federal government imposed a 30% tariff on imported steel. In 2005, just three years after getting into this industry, Ross sold the steel group to Mittal Steel Co. in 2005 for $4.5 billion dollars.
The next target was the textile industry; he identified Burlington Industries and began short-selling its stock. The company filed for bankruptcy in 2003, and Ross bought up the remaining bonds for 11 cents on the dollar. That allowed him to take over the company. Next, he acquired the bankrupt Cone Mills, where he extracted union concessions and dropped the pension liabilities onto the Pension Benefit Guaranty Corp. These two companies were the platform for the International Textile Group, which was sold in 2016 for an undisclosed amount.
Coal was the third industry Ross addressed. In 2003, he began looking at buying the non-union assets of Horizon Natural Resources, which was then on the edge of bankruptcy. He bought about two dozen non-union mines from Horizon and combined them with additional coal properties to create the International Coal Group. It became the fifth-largest coal company in the country. That entity was sold to Arch Coal in 2011 for $3.4 billion (Arch would itself go bankrupt in 2015).
Ross would later say, “Bondholders are like workers in a factory… On their own they have no leverage. But if someone pulls them together, they can negotiate with anyone.”
American Prospect reports Ross had a strategy while making these deals. He would buy at least a third of the debt of a bankrupt company, debt which could be bought for pennies on the dollar. That made him the largest creditor and a powerful player in the bankruptcy proceedings. Thus, he was able to take over a company and pay for it by forgiving the loans he had made to it. That meant the debt would be eliminated, and he would become the biggest or only shareholder in the rescued company.
Ross has done much more in the financial arenas, but these three cases show a relatively common strategy—extra-deep-value investing. He is buying dollar bills for perhaps 10 cents to 20 cents, but is also taking on more risk. His homework allowed him to see the bigger picture and pull several ailing companies into each fold, shed health and pension obligations and resurrect the company.
Holdings
As this GuruFocus chart shows, Ross’ firm currently runs an ultra-concentrated portfolio, with almost two-thirds of his holdings in just one sector:
This table shows the four stocks that make up the portfolio:
This chart and table show the firm’s holdings some six months after Ross left it to become secretary of commerce. It could be typical of what the firm has held in the past; a firm would not normally change its strategy too quickly after its founder’s departure, nor is it likely to stray far from a strategy that has previously generated strong results (as Ross apparently has).
Performance
Since Ross operated a private equity firm and invested in or created third-party companies, little objective data is available. The only apparent exception is this snippet from GuruFocus:
As we saw, Ross did well in his steel venture, using $90 million in cash and taking on debt obligations of $235 million to create a company he sold just a couple of years later for $4.5 billion.
When taking his long-term results into account, however, the results may be more prosaic. When asked by a Globe & Mail interviewer about his worst investment, Ross replied, “Anybody who invests in risky things is bound to make mistakes, but it's a fairly small percentage. We try to make returns on the order of 20% a year, so you can't afford too many.”
Also, the 2006Â Forbes article about Ross says private equity investors look for returns of about 20% per year.
Approximately 20% per year is probably a reasonable assessment for the long-term average. He does operate in a highly competitive market, so had huge profits consistently accrued to the firm, the field would likely have become too competitive for any firm to earn ultra-high returns.
Conclusion
Ross took deep-value investing to great depths, acquiring companies in or nearing bankruptcy. With sophisticated financing and industry restructuring, along with shedding obligations to employees, he brought those companies back to health and profitability.
While we might focus on the machinations that got those companies to profitability, our attention might be more profitably spent on understanding how a deep-value investor turns around a very troubled company.
Can it be done without the deep pockets Ross and his investors had? That is a good question and one worth considering.
Disclosure: I do not own positions in any of the companies listed, nor do I expect to buy any in the next 72 hours.
