Oct. 24 (Bloomberg) -- Barry Rosenstein had a blunt message for Cnet Networks Inc. Chief Executive Officer Neil Ashe: Fix your company, or else.

At $7 a share, the online reviewer of technology gear was trading for half of what it had two years earlier. Now, in early March, Rosenstein and a retinue of Internet experts, including Jonathan Miller, former CEO of America Online, were crowded into Cnet's San Francisco boardroom to lay out their turnaround plan for Ashe and some of his directors.

Cnet had to increase its search engine hits, syndicate ad sales to other companies and upgrade its technology, he was told.

Given that Rosenstein's hedge fund firm, New York-based $7 billion Jana Partners LLC, was one of Cnet's biggest stockholders, Rosenstein also wanted seven board seats. He figured that with a thorough reorganization, Cnet could fetch more than $11 a share.

Ashe listened without comment and moved to wrap up the meeting, according to several attendees. Rosenstein, decked out in a hand-tailored Borelli suit, dropped the niceties. ``We own 15 percent of this company, and we're not going anywhere,'' he said, carefully enunciating every word. ``You're stuck with us. If we don't succeed this year, we'll be back next year.''

Two months later, after negotiations, recriminations between Jana and Cnet management, and a Jana suit challenging a Cnet bylaw that went to the Delaware Supreme Court, CBS Corp. announced it was buying Cnet for $1.8 billion, or $11.50 a share. Jana's take: about $100 million, for a 50 percent gain on its original investment.

Bare-Knuckle Activism

The deal was a triumph for Jana investors in the bare-knuckle arena of hedge fund activism. Rosenstein, 49, is one of a growing number of hedge fund operators who in recent years have forced corporate management to make the kinds of changes that push up the price of their companies' shares.

These days, activist hedge funds like Jana are in the red, with long-short funds in general suffering some of the heaviest losses in the hedge fund industry as stock markets collapse and regulators restrict short selling of financial and other shares.

David Einhorn's Greenlight Capital LP was down 16.4 percent this year through September, according to a shareholder letter. Daniel Loeb's Third Point Partners LP was down 18.1 percent. David Slager's Atticus European Fund was down 43.5 percent over the same period.

``For activist managers, this was a disaster,'' says Daniel Celeghin, a director at investment management consultant Casey, Quirk & Associates LLC in Darien, Connecticut, referring to the ban on short selling, which in the U.S. lasted from Sept. 19 to Oct. 8. ``They couldn't implement their positions. It was a case of the government coming in and invalidating their businesses.''

14.7 Percent Fall

Jana's flagship fund, the Jana Master Fund Ltd., with more than $4 billion in assets, has held up somewhat better than its rivals, falling 14.7 percent for the year as of Sept. 30. Two smaller Rosenstein funds, Jana Piranha and Jana Nirvana, were off 3.1 percent and 8.9 percent.

The Jana funds benefited from their lack of leverage, defensive posture and the fact that they hadn't been shorting bank or brokerage stocks. More important to Jana has been a 52 percent falloff in crude oil prices from their July 3 peak to Oct. 23, which pummeled Jana's extensive energy holdings.

Energy-related companies accounted for three of its top five stock positions on June 30, according to data compiled by Bloomberg. Jana also owned a 9.1 percent stake in MF Global Ltd., a Bermuda-based derivatives trading service that plummeted 80 percent in 2008 through June 30. ``This stock has been an utter disaster so far and is headed for the Jana hall of shame,'' Jana wrote in a June 30 shareholder letter.

Beating the S&P

The bottom line is that unless things turn sharply, 2008 will mark Jana Master's first calendar-year loss ever, while the overall hedge fund industry is on course for its worst year since at least 1990. Even so, Jana has beaten the Standard & Poor's 500 Index every year since Jana was founded in April 2001.

Playing hardball with CEOs has made Jana lots of money. Jana Master notched an annualized return of 20.9 percent from April 2001 through December '07 versus 9.4 percent for the average hedge fund, according to Chicago-based Hedge Fund Research Inc.

Jana Piranha, which targets companies with market capitalizations of $2 billion or less, returned 14.7 percent from when it started, in January '05, through '07. And Nirvana, which was started in April '07 and focuses on Jana's best investment ideas, returned 17 percent.

Jana has participated in more than 30 activist campaigns, both public and private. Jana didn't profit in every single case, yet Rosenstein says all of them resulted in the target company adopting at least one ``shareholder-friendly'' proposal. Jana takes a 2 percent management fee and 20 percent of profits.

New Challenges

Activist funds such as Jana face a fusillade of new challenges in the wake of the 2008 stock market crash and credit crisis. The leveraged-buyout machine has ground to a halt, meaning that activists who buy up shares of a target company can no longer hope that a quick sale to a private equity firm will bump up a target's stock price.

Companies will be loath to add debt to their balance sheets by initiating share buybacks or increasing dividends, so activists like Rosenstein are on the hunt for new ways to turn a profit.

``In a world of infinite credit, it's an easier business: You sell the target company to a private equity firm,'' says Bob Lessin, vice chairman of New York-based investment bank Jefferies Group Inc., which has worked with Jana. ``Now it's clear that you've got to go beyond that kind of financial restructuring.''

Tapping Industry Talent

Cnet was Rosenstein's first move into the kind of activism he envisions in Jana's future -- a strategy that taps industry talent in order to implement nuts-and-bolts changes that can send shares upward. In addition to AOL's Miller, Jana's turnaround experts for Cnet included former EHarmony.com Inc. CEO Jaynie Studenmund and former IAC/InterActiveCorp chief of business operations Julius Genachowski. Jana teamed with venture firm Spark Capital Management and three other investment firms on the campaign.

Jana is building a brain trust to tap for advice on future activist campaigns or to serve on boards. One member is Jerome York, 70, former chief financial officer of Chrysler Corp. and International Business Machines Corp., who also works with Tracinda Corp. CEO Kirk Kerkorian. Another Jana adviser is John Kanas, 61, former CEO of North Fork Bancorp, which was sold to Capital One Financial Corp. in 2006.

Rosenstein has gotten the attention of the hedge fund world's elite. ``Barry is a strong investor with unique market insights and an excellent ability to execute on his ideas,'' Steven Cohen, founder of SAC Capital Advisors LLC, said in an e-mail. SAC has worked with Jana on at least one campaign.

The CEOs of the companies Rosenstein targets have a different view. In 2004, John Collins, head of data processor InterCept Inc., accused Jana of disseminating inaccurate information about his Norcross, Georgia-based company. Jana says all of its statements were supported by the public record.

Recriminations

In 2005, Oklahoma City-based oil company Kerr-McGee Corp. sued Rosenstein and investor Carl Icahn, his partner in a proxy fight, accusing them of violating a federal law that required them to properly disclose their investment to regulators. The suit was dropped, and Kerr-McGee later agreed to a major restructuring.

And Cnet's Ashe slammed Rosenstein for trying to take over his company on the cheap. In a March memo to employees, he wrote, ``We don't believe that opportunistic shareholders, like Jana, should be able to secure control of our company without providing a premium.'' Jana says it never sought to acquire a controlling stake.

Rosenstein, who honed his craft at the feet of 1980s corporate raider Asher Edelman, says he pins CEOs against the wall because it's often the only way to get them to pay attention. ``At the end of the day, there's no such thing as friendly activism,'' Rosenstein says. ``Unless you have a hammer, management will push you as far as they can go.''

Wall Street Outsider

At 5 feet 11 inches (1.8 meters) and a lean, tanned 160 pounds (73 kilograms), Rosenstein doesn't look the part of a rabble-rouser as he settles into a leather chair in a conference room at Jana's headquarters in midtown Manhattan. Though he dons expensive suits for outside meetings, in the office he wears loafers, faded jeans and, on this day, a multicolored striped shirt with an open collar.

``His dress is not Wall Street dress; his demeanor is not Wall Street demeanor,'' says Leon Cooperman, founder of Omega Advisors Inc. and an early Jana investor. ``More often than not, he's taking on the establishment with his activism.''

Rosenstein says he stays relaxed with daily sessions of vinyasa yoga, a fast-paced exercise system that incorporates synchronized breathing techniques. He says that after he hurt his back in a windsurfing accident in 1992, his yoga sessions helped to cure him.

Value Investor

Activism Jana-style is disciplined value investing -- with attitude. The firm relies on deep-diving research by its more than 20 analysts to pick companies whose stock is undervalued. Jana Master devotes as much as 15 percent of its portfolio to activist investing.

Rosenstein says Jana is always on the lookout for a catalyst -- say, a possible merger -- that will lift a beaten-down stock. When he buys, he looks for what Benjamin Graham, the father of value investing, called a margin of safety -- that is, a fat discount to an investment's fair market value.

Rosenstein says the market crash didn't affect his method of finding fair value: by looking at fundamentals and discounting future cash flows. He accumulates his stakes in target companies over time, so buying shares in those companies got cheaper in September. Finding a catalyst to drive up the price, he says, is just as important as ever.

Margin of Safety

The margin of safety provides a cushion in the event of a miscalculation. When Jana built a position in TD Ameritrade Holding Corp. in early 2007 at $15-$17 a share, Rosenstein wrongly thought that Charles Schwab Corp. might buy it for as much as $25 a share, he says. The stock rose anyway, partly because the market had overestimated the impact of free stock trades being offered by other firms.

Jana turned a profit of more than $80 million.

Though Rosenstein is Jana's public face, investment decisions are made as a group. He shares ownership with four managing directors: Gary Claar, 42, who oversees Jana's daily operations; Kevin Lynch, 40, a co-founder who knew Rosenstein when both were private equity investors; Marc Lehmann, 36, a former Appaloosa Management LP fund manager; and head trader Ben Hoyer, 38.

For a firm that makes a lot of money turning up the heat on CEOs, the atmosphere at Jana is relaxed. Rosenstein pads around the office in his socks. There's a pool table and coffee bar, cupcakes on birthdays and outings to Bowlmor Lanes in Greenwich Village.

`Activist SWAT Team'

When it appears that a company might be ripe for a campaign, Jana convenes what Rosenstein calls his ``activist SWAT team.'' It includes: himself; Charles Penner, Jana's chief legal counsel and communications chief; and Scott Ostfeld, senior managing director. Rosenstein personally takes the lead in talking to CEOs.

Penner, 36, who got his law degree at the University of Pennsylvania, looks at corporate governance issues and scours company bylaws to see what kinds of defenses are in place. At Cnet, he found a rule that said only shareholders who had held their stock for at least a year could make proposals at the company's annual meeting. He concluded that the provision wouldn't hold up in court -- and it didn't when Jana sued to overturn it in Delaware.

Ostfeld, 32, who has a law degree and an MBA from Columbia University, takes charge of valuing the target company. He questions competitors, customers and suppliers. Most important, he reaches out to other investors, to explain Jana's research and ideas in an effort to win their votes if Jana's demands result in a proxy contest.

`V-Squared'

``We call it `V-squared,''' Rosenstein says. ``You need for the valuation to be correct and you need to have the shareholder votes. If you don't have both, it doesn't work.''

In the case of Cnet, Ostfeld shared Jana's analysis with Randy Befumo, Legg Mason Capital Management's research director. Befumo then talked to Ashe and urged him to listen to Jana's proposals.

Rosenstein has long tacked against convention. He grew up in working-class West Orange, New Jersey, the middle child of Herbert and Harriet Rosenstein. His father was an accountant for individuals and small businesses, which put the family near the top of the town's socioeconomic heap.

Rosenstein was no model student. In his senior year at Mountain High School, he was suspended for spray painting the basketball coach's garage as a prank. It was thus no surprise he was denied a place on the rolls of the school honor society despite his high grades. It didn't hurt his popularity.

Lynyrd Skynyrd

``Everybody loved Barry,'' says Jim Laing, a high school pal who cranked up the Lynyrd Skynyrd tunes in Rosenstein's blue Chevy Nova as they cruised the town.

Rosenstein attended Lehigh University in Bethlehem, Pennsylvania, where he earned an accounting degree and graduated in 1981. He worked for a year at accounting firm Price Waterhouse's New York office and then, in 1983, headed off to the Wharton School of the University of Pennsylvania to earn a Master of Business Administration. His parents thought the expenditure unnecessary.

``My parents were like, 'Wharton? Who cares? You're a CPA!''' he says.

Upon graduating, he began to think they may have been right. ``In B-school, there are the guys who get all the interviews and all the job offers,'' Rosenstein says. ``I wasn't one of them.''

Still, in 1984, he ended up working at Merrill Lynch & Co. as an investment banking associate. He hated the corporate culture. At one point, his supervisor took him aside to criticize his suits, which had ventless jackets with European styling.

``At that point, I knew I wasn't an institutional guy,'' Rosenstein says.

Joining the Raiders

In the 1980s, corporate raiders were kings, and Rosenstein decided to become one of them. One day, he cold-called Asher Edelman's office after 5 p.m., when he knew his secretary would be gone. Edelman, who ran Plaza Securities Corp., picked up. Rosenstein began talking fast, pitching his credentials. Edelman agreed to have lunch.

Fifteen minutes into their pasta, prepared by the office chef, Edelman told Rosenstein he'd like to hire him and asked how much money he wanted, Rosenstein says. At the time, Rosenstein was making $40,000, with the possibility of a $30,000 bonus. The talk on Wall Street was that Merrill bankers were making $1 million, so that's what Rosenstein says he asked for.

``He stared at me for a full minute and then said, 'OK, done, but you have to start tomorrow,''' Rosenstein says. ``I would have slept there overnight if he had wanted.'' Edelman, now 68 and a full-time art dealer, denies that he offered Rosenstein $1 million, though he says he does recall the cold call and the lunch.

Art of the Deal

Rosenstein researched corporate targets, set up financing and crunched numbers for the takeover group. And Edelman taught Rosenstein the art of the deal. ``I developed an instinct; I learned deal structure, finance,'' Rosenstein says. Companies he helped Edelman raid included Burlington Industries Inc., Lucky Stores Inc., Ponderosa Inc. and Telex Corp.

In 1991, Rosenstein moved to San Francisco, where he landed a job building the investment and merchant banking division of Genesis Merchant Group Securities LLC, a boutique firm started by Will Weinstein. ``He was smart, tenacious, creative,'' Weinstein says of Rosenstein.

Rosenstein remained at Genesis until 1996. One of his more successful investments was Copart Inc., a company based in Fairfield, California, that auctions damaged cars for insurance firms. Investors more than quintupled their money -- and as a public company Copart in June was Jana's largest stock holding.

No Private Equity Please

Rosenstein wanted to run his own show, so he founded Sagaponack Partners LP, a San Francisco-based private equity firm. He ran the firm for four years. He says it would be charitable to call Sagaponack's performance ``middling.'' One lesson he learned was that he doesn't like private equity because too often the party that wins a company ends up overpaying.

``Often if you win, you've really lost, because you just paid more than the other guy,'' he says.

When Rosenstein founded Jana in 2001, his idea was to take advantage of the collapse of the stock market. ``The Internet bubble had burst,'' he says. ``Stocks were cheap, and I saw opportunities in the public markets.'' At the same time, management credibility was at a low ebb as the tales of accounting trickery at Enron Corp., Tyco International Ltd. and WorldCom Inc. unfolded. It was a splendid period in which to push management for changes.

Jana Master started with just $17 million in assets, which Rosenstein scraped together from acquaintances. Given his fund's size, he initially focused on small companies. Jana's first target was Herbalife International Inc., a Los Angeles-based distributor of nutritional and weight loss products.

Herbalife a Target

Herbalife's founder, Mark Hughes, had died in May 2000 after overdosing on alcohol and sleeping pills. Control of Herbalife passed to three trustees overseeing Hughes's estate, all Herbalife executives: CEO Christopher Pair; executive vice president Conrad Klein; and Chairman John Reynolds, Mark Hughes's father.

From its peak before Hughes's death to July 2001, when Rosenstein began buying shares, Herbalife stock tumbled 38 percent to less than $10. Rosenstein calculated it was worth $17-$20. He teamed up with Warren Lichtenstein of hedge fund Steel Partners II LP and together they accumulated 3.9 percent of Class B shares.

In July 2001, Jana and Steel Partners sent a letter to Herbalife's board accusing the trustees of enriching themselves and asking that Herbalife put itself on the market.

Doubling Your Money

After some discussion, Pair stepped down in October 2001. In April 2002, Herbalife agreed to be bought by private equity firms Whitney & Co. and Golden Gate Capital Inc. for $685 million, or $19.50 a share. Jana nearly doubled its money.

Jana was off and running. In its first nine months of operation in 2001, Jana Master garnered a 27.9 percent return, while the S&P 500 was flat. Rosenstein increased his firm's assets by merging with $50 million New York hedge fund firm Marathon Advisors LLC, then run by Claar.

In 2002, Jana Master again trounced the S&P 500, returning 10.3 percent versus a loss of 22.1 percent for the index. Assets began to pour in, with Jana surpassing $100 million by year-end.

Rosenstein became expert in turning what he saw as grievous corporate governance against managements -- and making a bundle. One target was InterCept, which provides payment processing services to banks. By the end of October 2003, shares had fallen 77.3 percent from their 2002 high. The company announced that CEO Collins was considering taking the company private. He couldn't get financing. He abandoned the effort and subsequently refused to consider offers to buy the company.

Proxy Battle

Rosenstein began buying InterCept shares at $12, eventually purchasing a 9.8 percent stake. Jana launched a proxy battle for control, proposing four nominees to the six-member InterCept board. In May, InterCept offered Jana two seats on an expanded nine-member board, which Rosenstein rejected. ``Your offer is nothing more than a slickly designed trap to deny your shareholders the right next year to replace your handpicked cronies on the board of directors,'' he wrote. By late May, Jana had support: Loeb's Third Point LLC had built up a stake of more than 7 percent.

On June 11, 2004, Collins folded, publicly agreeing to hire a banker to explore a sale. The company was purchased in November by Fidelity National Financial Inc., a Florida title insurer, for $18.90 per share. Jana made roughly a 50 percent return on its investment.

Bigger Game

By late 2004, Jana's assets had grown to more than $2 billion, and Rosenstein trained his sights on bigger game: Kerr- McGee, an independent oil and gas producer with a market capitalization of $8.8 billion. Crude was selling for about $45 a barrel, and Kerr-McGee shares traded in the $56-$60 range. Jana energy analyst August Roth calculated that the company's share price put an $11.80-a-barrel price tag on Kerr-McGee's 1.2 billion

barrels of proven, in-the-ground reserves.

Jana began buying Kerr-McGee shares in late 2004 and, in February '05, invited Icahn, whom Rosenstein had known since his days with Edelman, to join him. Rosenstein and Icahn called Kerr- McGee CEO Luke Corbett and outlined their ideas in an hour-long conversation.

They wanted him to sell Kerr-McGee's chemical business, which they figured would fetch $1.7 billion, and to sell forward contracts on 250 million barrels of oil annually during the next five years at $35-$38 a barrel.

That would yield $8.75 billion in cash, which they wanted Corbett to use to buy back 116 million Kerr-McGee shares at $90 a share. With that stimulus, Rosenstein and Icahn figured, the stock could go as high as $132.

Increasing the Pressure

In March, Icahn and Rosenstein, who by that time had together amassed a 7.8 percent stake, increased the pressure by saying they would nominate themselves to Kerr-McGee's board to push their plan forward.

Corbett tried to meet them partway. On March 8, Kerr-McGee announced a plan to sell its chemical business and unveiled a $1 billion share buyback. At the same time, Corbett slammed the forward sales plan. ``Mr. Icahn's proposal is tantamount to mortgaging the company's future,'' he said in a public announcement.

Corbett then went on the road, visiting institutional investors to drum up support for management. Rosenstein says he followed each Corbett visit with a phone call to the investor. He says that most of the investors supported him and Icahn. Corbett was unavailable for comment.

Wrangling

Weeks later, Rosenstein and Icahn were in a Kerr-McGee conference room in Oklahoma City, wrangling with Corbett over details of the forward sales and share buyback. Corbett suggested the shares be bought back at $81 or $82 a share. Icahn says he and Rosenstein suggested $85. Then Icahn began singing lyrics from the musical ``Oklahoma!'' in his gravelly voice: ``The farmer and the cowman should be friends/Oh, the farmer and the cowman should be friends ...''

Icahn says Corbett laughingly offered to raise the buyback price to $85 if Icahn would stop singing, though Icahn says he suspects that was Corbett's intention all along.

By the end of 2005, Kerr-McGee shares had risen to almost $90. In June 2006, the company split its shares 2 for 1. In August 2006, Woodlands, Texas-based Anadarko Petroleum Corp. acquired the company for $16.4 billion, or the equivalent of $141 a share. Jana made more than $160 million on the campaign.

That kind of success is difficult to find today, when hedge funds are in as much disarray as the markets they invest in.

``Hedge funds have a public relations issue,'' says David Waddell of investment firm Waddell & Associates Inc. in Memphis, Tennessee. ``Half the funds don't deserve the fees they're charging.''

Nimble Will Prosper

The nimble funds will prosper. Rosenstein began taking advantage of opportunities thrown open by the financial crisis as early as April, when he plunged into the market for auction-rate securities. He bought bonds with a face value of $1.5 billion that yielded 12.5 percent. Auction-rate securities are long-term bonds whose interest rates are reset periodically via auctions. The market for them stalled in February.

Jana also expects to make money from so-called distressed investing. It's a strategy that in 2003 helped Jana earn its highest calendar-year return, 45.9 percent, after Rosenstein bought bonds of bankrupt companies such as Leap Wireless International Inc. and Mirant Corp.

Rosenstein says he sees parallels between the markets now and during Jana's early years. ``It's very comparable,'' he says. Stock valuations are low, fear is rampant and a tide of indignation abounds at the avarice of corporate CEOs.

``The activist strategy is much more credible than in 2001,'' Rosenstein says. ``If we find undervalued assets and a need for change, that's where we'll be.''

All kinds of stocks now have low valuations. The trick for Rosenstein is to find companies where his intervention might make a difference -- a tougher task when a falling tide has sunk everyone's boat.

-- Editors: Michael Serrill, Jon Asmundsson.

To contact the reporter on this story: Richard Teitelbaum in New York at rteitelbaum1@bloomberg.net.

Last Updated: October 24, 2008 00:04 EDT