Christopher Hohn is beside himself. Its a dreary rain-swept morning in early September, and Hohn, looking more like a graduate student, with his rimless glasses and rumpled shirt, than the most feared shareholder activist in Europe, strides briskly across a conference room in his hedge funds stark, glass-partitioned, modern headquarters in Mayfair, London, and drops down into a black leather chair. The intensely private, 41-year-old founder of the Childrens Investment Fund Management (UK) has just made a rare public announcement and still wears the pained expression of the reluctantly exposed: TCI is joining with New Yorkbased Atticus Capital to once again challenge the management of German stock exchange operator Deutsche Börse Group.
The companys valuation has collapsed this year, and shareholders are suffering, declares Hohn. Were frustrated with Deutsche Börse.
These are frustrating times, indeed, for Hohn, the golden boy of activist investing, who rose to fame by halting Deutsche Börses 2005 bid for the London Stock Exchange and who last year single-handedly sparked the sale of ABN Amro Bank the biggest banking transaction in history. In five years his assets under management have soared 30-fold, to more than $15 billion.
But 2008 has been another story entirely. Hohn is struggling seemingly everywhere with markets, investment targets, uneasy investors and, increasingly, with himself. His high-profile effort to challenge corporate culture in Japan by trying to take a commanding stake in one of its largest energy wholesalers has been thwarted by the Japanese government. And in late May he had to endure a public grilling for more than an hour in open court in New York City in his yearlong battle with CSX Corp., the U.S. railroad group that operates an extensive network of freight lines and port connections on the East Coast.
Above all, after a heady run of eye-catching returns, Hohns flagship, the Childrens Investment Master Fund, is losing money. And Deutsche Börse is a very big reason why. With the global credit crisis hammering financial stocks, the German exchanges shares have plunged by more than half since January, dragging down the returns of TCIs flagship fund, which lost 12 percent through June 30 a painful experience for a manager whose highly concentrated, long-biased portfolio had delivered net annualized returns of 42 percent in its first four years through December 2007.
All this has sent the thin-skinned, highly focused Hohn deep inside himself to question even the basics of his investment approach. His anxiety and self-doubt were laid bare this spring when, as part of the discovery process related to the CSX lawsuit, private e-mails between Hohn and his colleagues were made public, revealing the TCI founders fears about the credit crisis, his portfolios volatility and what he perceived as his teams failures to anticipate price movements in their key positions. In March, Hohn even contemplated raising more capital, but wrote in an e-mail to TCI co-founder Patrick Degorce that it may damage [TCIs] long-term franchise.
Like many hedge fund managers, Hohn is not usually prone to self-doubt. He has led a largely charmed life since 2003, when he left Richard Perrys New Yorkbased hedge fund firm, Perry Capital, where he was a rising star. In January 2004 he launched TCIs Master Fund with a then-sizable $500 million, attracting a whos who of top foundations and endowments like Carnegie Corp. of New York and the Massachusetts Institute of Technology. Investors were willing to accept three- and five-year lockups and unusual fee structure: One third of TCIs management fees go directly to the Childrens Investment Fund Foundation, a charity set up by Hohn and his wife, Jamie Cooper-Hohn, which she runs (see related story, click here).
This year, however, Hohn is coming under enormous pressure as fiercely fought proxy battles and lawsuits have forced TCI into the spotlight. Since last fall Hohn has been locked in a struggle with Jacksonville, Floridabased CSX, whose CEO and board of directors have done everything in their power to neutralize TCIs influence on other shareholders. Just this month, on September 15, CSX finally agreed to seat the four dissident directors elected to the board including Hohn at its annual general meeting in June, but only after spending millions of dollars fighting feverishly to bar him from the door.
He has also been waging a longer but equally intense war with Tokyo-based utility Electric Power Development Co., better known as J-Power, trying to force its management to double the companys dividend, appoint independent directors to its board and reduce its cross-shareholdings with other Japanese corporations. In January, in an effort to increase pressure on management, TCI sought to raise its equity stake in J-Power from 9.9 percent to 20 percent but in May the seemingly irresistible force of Hohns personality met an immovable object in the form of the Japanese government, which flatly rejected TCIs request, citing national security concerns.
Unaccustomed to losing money and feeling the effects of battle fatigue, Hohn is rethinking his mission. He is also opening up. Starting this spring, Hohn agreed to a series of in-depth interviews with Alpha to discuss his investing philosophy, the true cost of TCIs bruising proxy fights and the future of his firm. In the past Hohns unassailable belief in his own highly rational, well-researched investment ideas formed the foundation of his approach to risk management, but he now recognizes that he needs to be a better downside risk manager in turbulent global equity markets to protect his investors capital.
This has been a brutal period for long-biased investors like us, who have limited hedges, and it is painful to lose money, says Hohn. I think the key for us is to maintain our core philosophy of long-term investing. As long as we still believe in our positions, we wont let the markets change our minds.
Still, Hohn is changing the way he operates. At an investor day held by TCI in New York in June for 300 of the firms clients, Hohn spoke at length about mitigating risk by diversifying his portfolio investing at the margins of his funds 15 to 20 core positions and adding more names as well as increasing the funds short positions from 10 percent to 15 percent of its net asset value. But the biggest bombshell he dropped that day was the news that he wants to be less of an activist going forward.
While were not going to rule out taking an activist stance on existing investments, like Deutsche Börse, we are going to be more cautious about it when we look at making new investments, because quite frankly activism is hard, Hohn concedes to Alpha. It has been very profitable for us, but it is unpredictable and expensive. Just look at CSX. Weve already spent over a year trying to effect change and paid out more than $10 million in legal fees on the proxy fight.
For a reclusive hedge fund manager who rarely gives interviews and loathes having his picture taken, Hohns newfound openness is stunning. But his change in strategy is less an abrupt shift than a retrenchment a return to his roots. Hohn has always been a deep-value investor, a tireless researcher who makes tough and canny judgments. Lord Jacob Roths-
child, whose son, Nathaniel, works for Atticus, once described Hohn as a harsh and brilliant critic.
When Hohn launched TCI, he sought to apply a private equity managers fundamental mind-set to researching publicly traded companies and seeking out deeply undervalued stocks. Hohn noticed that many companies that were laggards also had entrenched, well-compensated boards. When his efforts to meet with their directors met with resistance, he reacted with a dissidents wrath. In 2007 he famously put ABN Amro in play when he sent its board a scathing letter demanding that the Dutch banking giant be broken up or sold.
But Hohns faith in corporate democracy has been shaken by CSX. I think Chris has had second thoughts about activism, because the fight with CSX has become this exhausting, all-consuming thing, says Richard Elden, founder and former chairman of Chicago-based fund-of-hedge-funds firm Grosvenor Capital Management and currently a principal in Chicago-based Lakeview Investment Manager.
Adds Elden, who has known Hohn and invested with him for more than a decade: The question is, How many of those kinds of investments do you really want to have in your portfolio in any given year? The commitment they require is enormous.
Hohns us-against-them attitude stems in no small part from his working-class upbringing in class-conscious England. His father was a car mechanic who emigrated to the U.K. from Jamaica in 1960; his mother worked as a legal secretary. The couple eventually settled in the leafy village of Addlestone, Surrey, where Hohn was born in 1966. He graduated from Southampton University, a red-brick school far from Oxford and Cambridge, with a BS in accounting and business economics in 1988 (earning first-class honors) and took a job with accounting giant Coopers & Lybrand.
Hohn left Coopers to pursue an MBA at Harvard Business School and graduated in 1993. Finishing in the top 5 percent of his class, he was named a Baker Scholar a distinction that he shares with adversary Michael Ward, chairman, president and CEO of CSX Corp. (class of 1976). After Harvard, Hohn did a short stint at a consulting firm, then took a job as an analyst at London-based private equity firm Apax Partners in 1994. He resigned and moved to the U.S. after marrying American-born Jamie Cooper in October 1995 and then took at job at Perry Capital in 1996. Hohn began as an analyst researching midcap European companies and just a year later started running a subportfolio for Perrys flagship fund. In 1998 he moved his family back to London to open Perrys first office in the U.K. and launched his own portfolio, the Perry Capital European Fund, in the spring of 2000.
Hohn who has always been attracted to companies with substantial free cash flow never fully adopted Perrys event-driven, merger arbitrage style of investing. He also chafed at some of the restrictions that Perry placed on his managers, such as his insistence on running portfolios with relatively low net market exposure. According to Elden, Hohn who was delivering annualized returns in excess of 20 percent a year with the Perry European fund thought he could do better if he had the freedom to pursue his style of deep-value fundamental research and maintain higher net market exposure. With a three-year track record and investors lining up in the hope that his then-closed $1 billion fund would reopen, Hohn broke away in early 2003 to start his own business. Perry was taken aback by the defection and shut down the Perry European fund when Hohn left.
In planning TCIs portfolio structure, Hohn decided that he didnt want to be geographically restricted and told prospective investors he was going to be more global. He also wanted TCIs portfolio to be more concentrated than his fund at Perry, taking core stakes in just a dozen or so companies. And he decided to do less hedging than he had at Perry and to short only those positions that offered him a means of capturing alpha on a stand-alone basis. He knew his fund would be volatile, so he required prospective investors to sign up for one of two share classes that entailed either a three- or five-year lockup.
Chris wanted a longer lockup that would force his prospective limited partners to self-select, says Steve Berger, a co-founder of Boston-based fund of hedge funds Adamas Partners. Only those who could tolerate more interim volatility were welcome to join him.
Within months Hohn had recruited a French-born friend and fellow fund manager, Degorce, who was then running the European Dynamic Fund for Merrill Lynch Investment Managers in London. They were joined by Snehal Amin, an American private equity specialist with an MBA from Stanford University who had been working in Goldman, Sachs & Co.s merchant banking division. Timothy Crowe, former chief investment officer at the John S. and James L.Knight Foundation (he now runs Coral Gables, Floridabased Anchor Point Capital, a fund of hedge funds), first met Hohn and Degorce in London at a hotel in the summer of 2003 before they even had office space. He was struck, he says, by Hohns blend of fundamental research and macroeconomic insight Hohn was convinced that the euro would strengthen to $1.50 against the dollar (which seemed preposterous at the time) and that China would have a huge impact on the global markets.
We see so many managers who are myopic, Crowe says. They can tear apart a balance sheet and come up with what they believe is value, but they dont put that value in the context of the global economic scene. When I met Chris, I was thinking, This is exactly the kind of manager we want, because if youre going to do event-driven arbitrage in Europe, you need to know how macroeconomic forces are going to affect a companys valuation.
Thanks to his previous track record, Hohn started with more money than most young hedge fund managers, and the first few years were heady times for his investors. In 2004, TCIs Master Fund was up 43 percent. The next year was even better: The fund delivered a return in excess of 50 percent, driven in part by Hohns successful battle with Deutsche Börse. In 2006 it posted a gain of more than 40 percent. And last year, despite the nascent credit crisis, the fund delivered a return of 37 percent.
Hohn invited a few like-minded colleagues and fund managers to launch their own hedge funds alongside him. In exchange for an equity share in the management companies of those funds, TCI provides technology, back-office, administrative and legal services to the firms, which share its operational platform but invest independently of one another. TCI currently has links to three such homegrown hedge fund firms: Algebris Investments, co-founded by Davide Serra, who previously ran Morgan Stanleys global banking equity research team, and Eric Halet, a former bank analyst for Wellington Management Co.; Parvus Asset Management, started by Edoardo Mercadante, a former European small-cap expert at Merrill Lynch Investment Managers; and KDA Capital, founded by David Baverez, previously a star mutual fund manager at Fidelity International. The firms assets and investment teams have grown swiftly: Algebris now has a squad of 13 overseeing $2.5 billion; Parvus has seven looking after $3 billion; and KDA has a team of seven investing $1 billion.
Hohn himself leads a group of 16 investment professionals at TCI Investment Fund Management; the separate company that provides services to all four hedge funds, TCI Investment Fund Services, has 48 employees. The hedge fund firms are headquartered in an elegant, Edwardian building on Clifford Street, in the heart of Londons tony Mayfair district.
Chris Hohn did not start off as an activist investor. He first began to consider becoming one in late 2004, when his firm invested in exchanges, including Euronext and Deutsche Börse. Hohn was also an unlikely crusader: He seemed shy and spoke haltingly, picking out his words with great care, Crowe says. But he was passionate about his ideas and didnt like being thwarted by management teams. TCIs fight with Deutsche Börse kicked off in earnest in early 2005, when Hohn found out that the exchanges then-CEO, Werner Seifert, had been quietly courting the London Stock Exchange instead of buying back shares. Hohn was incensed, and in the ensuing battle, he worked alongside another large institutional shareholder, Atticus run by his Harvard classmate Timothy Barakett which then held a stake of just over 5 percent in Deutsche Börse, as well as Baverez, then at Fidelity, which also held a 5 percent stake. Deutsche Börse was forced to withdraw its bid in March 2005, and Seifert resigned in anger two months later.
Subsequently, German regulators at the Bonn-based Bundesbank and the German Financial Supervisory Authority, or BaFin, tried and failed to find some evidence of wrongdoing and collusion among the hedge fund firms. Seifert, however, pursued his own form of revenge, writing a wrathful book about his professional ordeal, titled The Invasion of the Locusts. The disparaging metaphor was first used by Franz Müntefering, former chairman of Germanys Social Democratic Party, in reference to foreign private equity investors not hedge funds buying up German companies, but the expression stuck to TCI. Despite the name-calling, Hohn, who had scored a major victory with Deutsche Börse and watched as its stock price nearly doubled, to 84.75 ($100.63), by the end of 2005, was unfazed. He liked the taste of success and quickly realized that he could use a fairly small equity holding to leverage institutional shareholders dissatisfaction and spark profitable shareholder revolts.
Hohns tactics worked perfectly when it came to ABN Amro: With a stake of just over 1 percent of the banks equity, TCI issued a challenge to management, demanding in a February 2007 letter that ABN Amro either solicit takeover offers or sell or spin off some of its assets. TCIs complaint hit a nerve, and other institutional shareholders joined to put pressure on the bank to consider a merger or breakup. In response, chief executive Rijkman Groenink entered into talks with British banking giant Barclays and then, reluctantly, had to extend the same bidding privilege to Royal Bank of Scotland, Fortis and Banco Santander Central Hispano. The RBS-led consortium won the bidding war, paying 70 billion, or 36.95 per share, for the Dutch bank almost exactly in line with the breakup estimate of 38 that TCIs team had forecast.
Hohn, easily irritated by shareholders who bemoan any change in the status quo, simply points to the openness of the voting process when challenged. When people say that what we do is bad and wrong, we ask them, Why is shareholder democracy bad and wrong? he says. Shareholders are owners of companies, and they always have a choice. They should exercise their rights.
Hohns attraction to CSX was inevitable. In searching out bargains hiding in plain view, he and his team at TCI often look for midcap to large-cap monopolistic companies that are undervalued on an absolute basis, have significant free cash flow and operate in industry sectors where there is a high barrier to entry a moat, as he describes it.
In 2006, Hohn and Amin, who oversees TCIs investment strategy in the Americas, began researching railroads in the U.S. just as Berkshire Hathaway CEO Warren Buffett began exploring the sector. They believed that CSX and similar rail companies, which had been struggling for years, were poised to see a big rise in freight volumes and revenue, benefiting from the combination of global economic growth and higher energy costs (shipping by rail is far cheaper than moving goods long distances by truck).
In the course of the teams due diligence, TCI contacted the management groups of several companies. Amin says that CSX chairman and CEO Ward, unlike his competitors, would not publicly disclose any of his companys productivity targets before TCIs involvement a charge Ward vehemently denies.
As our earning power has increased over the past five years, we have said publicly that we are going to do share buybacks, increase our dividend and invest for the future, Ward told Alpha this May, before CSXs annual meeting. We were doing that before TCI arrived, and we are going to continue to do that TCI has not made it happen, although they like to take credit for it.
In the winter of 2006, as TCIs Amin made repeated requests for face-to-face meetings with senior management to discuss various options, including the possibility of a leveraged buyout, communications between the hedge fund firm and the rail company broke down. As TCIs demands escalated, CSXs resistance rose: When Amin finally met with the railroads CFO, Oscar Munoz, in March 2007, Munoz told him he would have to agree to a listen-only meeting and not ask any questions.
Frustrated, Amin and Hohn began organizing a proxy fight in mid-2007. The struggle quickly moved from behind closed doors to the open forum of the financial markets when TCI wrote a letter to CSXs board in October 2007, accusing management of failing to fully understand the economics of the business and being undisciplined about spending.
Instead of bowing to the pressure, however, CSX fought back with hardball tactics of its own including lobbying Congress to interrogate TCI. On March 5, Amin was summoned to Washington to testify before the House Subcommittee on Railroads, Pipelines and Hazardous Materials about the hedge fund firms motives. Representative Corrine Brown, a Florida Democrat who chairs the subcommittee and whose home district includes Jacksonville, where CSX is based took the lead, introducing TCI in the Congressional Record as the firm that has been referred to as locusts in Germany. She then added that it was important to protect critical infrastructure from the potential harm of foreign ownership.
Two weeks after the hearing, CSX filed a lawsuit in New York alleging that TCI and its New Yorkbased investment partner, 3G Capital Partners, had violated securities regulations by amassing a stake in excess of 5 percent by buying stock and using total-return equity swaps, which do not confer voting rights, to gain influence over CSX without disclosing their holdings in a timely manner. The lawsuit also charged that TCI and 3G had pursued a so-called common investment strategy in CSX which also requires disclosure before they announced on December 19, 2007, that they had formed an investment group. The judge, Lewis Kaplan of the United States District Court for the Southern District of New York, took a dim view of TCI and 3Gs e-mail correspondence and found fault with the two hedge fund firms on both points. Despite his opinion that the funds should have operated more openly in building their positions, Judge Kaplan denied CSXs most consequential request: to block TCI and 3Gs voting rights at the shareholder meeting in June. All he did was issue an injunction stopping the firms from violating securities laws in the future.
For Hohn, who took the stand to testify this summer in a crowded Manhattan courtroom, the experience was a stinging introduction to the political risks and realities of investing. But instead of retreating into silence, he has chosen to abandon his penchant for secrecy: This spring TCI created a Web site, Toward a Stronger CSX, where Hohn and his team laid out their investment thesis and posted all their correspondence with the CSX board of directors.
The simple fact that TCI allowed that degree of transparency may have helped Hohn prevail at the shareholders annual general meeting this summer, as four of the five dissident directors were elected. Remarkably, even after the vote was certified by an independent auditor, CSX still refused to seat two of the new directors including Hohn claiming the shareholder vote was still controversial and filing an appeal trying to have TCIs votes invalidated after the fact.
But CSX finally ran out of options when, on September 15, the U.S. Court of Appeals for the Second Circuit issued a summary order denying CSXs appeal and supporting Judge Kaplans previous decision not to enjoin TCI from voting at the shareholders meeting. The firms votes stand; Hohn is now one of CSXs 12 directors and will finally be allowed to take a seat at the boardroom table.
Hohns other major proxy battle, however, shows no sign of letting up. In January, TCI applied to the Japanese government to double its investment stake in Tokyo-based energy wholesaler J-Power after a quiet two-year struggle. The government turned the firm down cold.
We knew that TCI had already demanded that J-Power double its return on equity, says an official from the Ministry of Economy, Trade and Industry, who spoke on the condition that he not be identified. We asked TCI how it proposed to do this without interfering with the planned expenditure for the Ohma nuclear power plant, and they said that it was none of our business. But the Japanese government is legally bound to investigate whether there is a possibility of damaging national security by allowing this investment to go forward, so we said no.
Hohn was deeply frustrated. The decision was the first time that the Japanese government had used the Foreign Exchange and Foreign Trade Law to refuse a foreign investment firm, and Hohn immediately lobbied politicians in the U.K. and Europe to respond. Peter Mandelson, the European Unions trade commissioner, voiced support for TCI during a speech in Tokyo, condemning Japan as the most closed investment market in the developed world, but his criticism fell on deaf ears: At J-Powers annual general shareholders meeting on June 26, TCIs shareholder proposals failed miserably.
If some institutional shareholders had been hoping that TCIs activism might affect the companys stock price, their hopes were quickly dashed. J-Powers share price dropped by nearly 7 percent on the news of the vote, to close at ¥3,810 ($35).
Corporate governance in Japan is nonexistent, Hohn says bluntly. The government passes laws to stop foreign investors, but it doesnt do anything about Japanese companies adopting poison pills and increasing their cross-shareholdings to insulate themselves. Until it does, the overriding message is: Dont bother to invest in Japan. It is a stagnant economy and stock market.
The battles with CSX and J-Power have set Hohn back on his heels. Until now he has been confident in his ability to wear down opponents and rally enough support from other shareholders, including fellow hedge funds, to win any given vote. But these recent difficulties have forced him to reconsider the personal and political costs of shareholder activism. Hohn seems ready to take a less bare-knuckle approach to investing and to avoid costly skirmishes that sap his energy.
Buffett has always said that he looks for good management teams, because theyre easier to work with, Hohn says. Weve often done just the opposite. Weve frequently looked for excellent companies with underperforming management Deutsche Börse, Euronext, CSX. Activism has been profitable for us, but its getting much harder; the political and regulatory environment is changing.
As tough as TCIs investment in CSX has been, Hohn has still made money on it. When the firm bought into CSX in October 2006, the companys stock was trading at about $35 a share. By late May, it had doubled to nearly $71 a share but it had retreated to $58 by mid-September, pulled down by the recent broad market sell-off in equities.
By comparison, TCIs long-standing position in Deutsche Börse has cost Hohn dearly this year. At a moment when exchanges all over the world are consolidating, Deutsche Börse has no intention of breaking up or spinning off its three main businesses the exchange itself, posttrade processing firm Clearstream and derivatives exchange Eurex. On an investor call in mid-July to report TCIs second-quarter results, Hohn spoke about needing to find a way to capitalize on the value of Deutsche Börses subsidiaries and said that he didnt think the company ought to exist in three pieces.
If Eurex were a stand-alone company, a pure play, he said on the call, it would be valued at 25 times forward expected earnings. Deutsche Börse, by contrast, is valued on a blend of its three businesses at ten times forward earnings.
The news this month that TCI and Atticus are teaming up to try to salvage their investments in Deutsche Börse made headlines. Atticus, which this year has seen its two largest funds fall by 32.9 percent and 25 percent, respectively, through August, was also fighting market rumors of a complete meltdown. It was no accident that TCI and Atticus went public and declared their allegiance. Hohn was loath to have anyone accuse him of forming an investment group without giving regulatory notice; Barakett wanted to reassure his investors that he was still in fighting form. In their joint statement the two hedge fund firms said that they wanted to expedite shareholder value creation, which will likely mean trying to replace the legacy board members of the exchange before any effort to break it up or sell it.
But Deutsche Börse is not about to submit to such treatment willingly. On September 12 its supervisory board held a meeting to consider the possibility of spinning off one or more of its businesses in light of the growing pressure from TCI and Atticus, and voted unanimously to continue to pursue its current business model as the best means of delivering trading, posttrade and custodial services to its customers.
The integrated business gives us the best platform with which to compete in the future, says Deutsche Börse spokesman Rüdiger Assion. It would be a mistake to sell our individual business units to anyone else.
The question hangs in the air: If Hohn is to succeed in extracting more value from Deutsche Börse, he needs the transformation of the business to be as effortless as his assault on ABN Amro and he is clearly counting on other disappointed shareholders to take his side. If they do, he may be able to step back and let events unfold; if they dont buy his arguments, hell be stuck with another draining proxy battle, which he clearly doesnt want. Hohn appears to be operating under no illusions now about the risks he runs in waging wars he cannot win and he is tired of disgruntled chief executives lobbying politicians to block his progress.
The current political and regulatory environment has become dangerously passive, and shareholders are already the worse off for it, he says. Just look at the boards of Citigroup, Merrill Lynch and UBS: You could argue that they have utterly failed their shareholders in the current financial crisis but their boards are still very much intact.
Even if Hohn is ultimately successful in his latest skirmishes in Germany, the U.S. and Japan, he seems intent on changing his ways. Gone are the days of putting his investors money at risk fighting protracted, expensive proxy battles without being able to gauge the likelihood of a positive outcome. And so, for the first time in years, he is returning to his intellectual roots: deep-value investing, driven by his passion for fundamental research and analysis. If he is to succeed in maintaining his funds remarkable track record, Hohn will have to keep his wits about him and his ambition in check. He needs to remember that despite the strength of his convictions not all shareholders can be made to think alike.