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The secret of Cerberus

Cerberus Capital Management has emerged to become one of the most active private equity investors in the world. But the firm's high-profile deals, such as GMAC, contrast with an extremely private culture. How long can the firm avoid the spotlight? Dave Keating reports.

Last March, as Cerberus founder Stephen Feinberg made his pitch to the board of General Motors in a basement room of the Four Seasons Hotel in New York, he faced a skeptical audience. GM, after all, hadn't been seeking out a private equity player to acquire its struggling financing unit, General Motors Acceptance Corp, and the board members knew little of the suitor in front of them.

As the members of the GM board listened intently, 46-year-old Feinberg delivered a patriotic plea to the group to entrust the successful financing unit of the struggling automaker to a mysterious group called Cerberus Capital Management. GM, a symbol of American industry, had its very future at stake, Feinberg reportedly argued. The question for the board was whether Cerberus was the firm that could bail it out.

Feinberg certainly had to overcome some strong doubts. GM and its credit rating agencies had initially envisioned a blue-chip bank taking the financing unit, not what appeared to be a scrappy hedge fund specialising in distressed companies.

“We were not a favoured bidder,” says one professional who worked on the GMAC deal. “The ratings on GMAC's debt were being dragged down by GM, and the ratings agencies wanted a bank to acquire it.”

But it was private investment firms that took the keenest interest. Cerberus, along with Kohlberg Kravis Roberts and Citigroup, eventually emerged the victors in this monumental deal, valued at $14 billion (€11 billion).

“Given [GMAC's] history, this was a deal that a lot of private equity firms wouldn't go near, it looked too risky,” says a person close to the deal. “But Cerberus has a history as a distressed investor. They will do transactions that have a lot more hair on them.”

The sheer size of the deal has thrust Cerberus into the spotlight. The firm, historically extremely secretive, has resisted giving up its reclusive ways. Only after the GMAC deal did the firm launch a web site, possibly in response to some media outlets questioning why they didn't have one. The firm has consistently refused to grant interviews to the media, including Private Equity International.

“Cerberus still prefers to be media shy,” says one former employee who did not want to be identified. “Given the nature of private equity and how large its transactions are, a certain level of media exposure is inevitable. But there's no incentive to have a lot of media exposure – there's no up side, only a down side. In general, everyone involved with the fund is told to tread very carefully with what information they provide.”

Considering that by some estimates Cerberus is now the seventh-largest financial institution in the US based on assets, this secrecy may be hard to maintain. Portfolio companies bring in a combined $45 billion in annual revenues, according to its web site, and at the end of 2005 the company had over 106,000 employees. Add to this the recent political activity of the firm, including various lobbying efforts and the appointment of former US vice president Dan Quayle as chairman, and you're bound to whip up some interest. Some in the media have begun to question whether it is Cerberus' political connections which require it to be so secretive.

The firm is now reportedly raising a $6 billion distressed fund that will capitalise on continuing interest rate increases and the corporate failures that could result. Considering how well Cerberus' previous funds have performed, investor interest is expected to be huge.

HUMBLE BEGINNINGS
Cerberus has come a long way from its beginnings as a small “vulture” hedge fund dealing mostly in debt. The history of Cerberus is in many ways the story of one man, Stephen Feinberg, a former Drexel Burnham Lambert employee who founded the firm in 1992 along with co-founder William Richter. Cerberus was launched with about $10 million. The name comes from the three-headed dog which guards the gates of Hades in Greek mythology. The firm has said the symbol was chosen because one of the heads is always awake, just as someone would always be awake to watch Cerberus' investments. But to many the creature has become a symbol of the firm's fierce reputation.

Cerberus spent its first decade investing in distressed debt and lending to struggling companies. Early investments included adult cable channels and Penthouse magazine. Its initial acquisitions were often won in bankruptcy courts. Feinberg began using the proceeds of his distressed lending programme to buy small companies and real estate properties. He soon developed a strategy of changing management and forcing improvements

Over time, what had started as an opportunistic pool of capital evolved into a firm that today looks more like an integrated conglomerate than a traditional private equity house. Today Cerberus has investments worldwide in: sportswear; paper products; military services; real estate; energy; retail; glassmaking; transportation; and building products. Headquartered in New York, the firm also has offices in Chicago, Los Angeles, Atlanta, London, Baarn (Netherlands), Frankfurt, Tokyo, Osaka and Taipei.

Cerberus' funds have performed well. Its first fund returned an IRR of 13.1 percent to investors, and its second vehicle showed an IRR of 25.8 percent. The firm has racked up successful investments in high-profile companies such as Tyco, a manufacturing and services group; Mervyn's department stores; Albertson's grocery stores; and cable operator Galaxy Cable. Portfolio company Vanguard Car Rental Group, which operates the National Car Rental and Alamo brands, has filed to raise as much as $300 million in an upcoming IPO.

Feinberg himself is a Princeton alumnus and former Army Reserve paratrooper whose quiet demeanor belies his reputation as a hardnosed negotiator. Co-workers describe his office as almost completely bare. They say Feinberg, the son of a steel salesman, has a simple, no-frills nature and steers clear of the spotlight. Cerberus COO Mark Neporent was the public face of Cerberus for the GMAC deal announcement. But despite his low profile, from the early days of the firm Feinberg's personality and leadership has driven the direction of Cerberus, and associates say that, today, he remains strongly at the helm.

“He's the sole GP, that pretty much sums it up,” says one former employee. “It's still his place.”

The growth of Cerberus, however, has meant the addition of numerous professionals who Feinberg relies on. “It's not like Cerberus is solely reliant on Stephen Feinberg like it was when it was younger – but he was very personally involved in the GMAC deal,” says a source who has worked closely with Feinberg.

THE STRATEGY
There is no one secret to Cerberus' success, but rather several. “Cerberus operates in terms of silos,” says one former employee. “Each silo has its own culture and motivating force. The private equity unit may get the most press coverage, but there's also the real estate group and the private lending business, which is a dominant force in and of itself.”

The firm's four main areas of focus are corporate distressed private equity, real estate, loan origination and advisory services. What makes Cerberus unique as a private equity player is its ability to combine its different activities to the benefit of portfolio companies. In addition to Cerberus' own finance company, which Feinberg launched in 1996, the firm also acquired Japan's Aozora Bank in 2003 and has since used both assets to become a lender to the firm's own companies. This enables Feinberg to assemble large amounts of cash for acquisitions very quickly, a fact which likely helped him in the GMAC deal, to which Aozora Bank contributed $1 billion

“They're able to move faster than traditional private equity funds,” says a source who has done business with the firm. “And they can also write big checks. That's a powerful combination.”

Feinberg likes to combine the resources of portfolio companies in other ways. The firm has a pool of almost 100 experienced executives surveying the globe for the best deals. Once acquisitions are made, the executives step into management roles, collaborating with other executives on the Cerberus team. Feinberg reportedly convenes a large number of his top managers every Monday to discuss firm-wide strategy. This tactic enables Cerberus to behave more like a strategic buyer, and the various portfolio companies are able to help each other out.

“These are people who can do difficult deals,” said Willem DeVogel, president of Three Cities Research, which worked with Cerberus when the two firms jointly acquired bankrupt rail manufacturer ABC-Naco in 2002. “These are very smart people who act extremely rationally and quickly.”

A WIDE NET: 2005 TO DATECerberus' activity in the past year and a half has been varied.

Target Industry Value $m # deals
Retail * 17,356.0 1
Finance 9,165.4 5
Forestry & Paper 2,300.0 1
Transportation 1,800.0 3
Dining & Lodging 1,158.4 1
Subtotal 31,779.9 11
Total 32,950.8 26

BIG DEALSCerberus' major investment from 2005 to present.

Acquisition Date Announced Value $m Country
Albertson's Inc 23-Jan-06 17,356.0 United States
General Motors Acceptance 4-Mar-2006 7,400.0 United States
Corp – GMAC (51%) (pending)
MeadWestvaco Corp 18-Jan-05 2,300.0 United States
(paper business and asso-
ciated assets)
Debis AirFinance 25-Apr-05 1,306.3 Netherlands
Pitney Bowes Inc 17-May-06 1,245.0 United States
(Capital Services External
Financing Business)
Kokudo (44.89%) 18-Oct-05 1,158.4 Japan
Bank Leumi Le-Israel 15-Nov-05 520.4 Israel
(9.99%)
Box Clever Ltd 17-Jan-05 374.0 United Kingdom
E.Piphany Inc 3-Aug-05 325.8 United States
Johnson Controls World 11-Feb-05 260.0 United States
Services Inc