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Scouring the Junk Yard

By Robert Barker Besides bonds or bond funds, another way to play junk is in stock of companies with heavy loads of debt. Taking that tack is Fidelity Leveraged Company Stock Fund (FLVCX), which opened for business just before Christmas. At the controls is David Glancy, a former Standard & Poor's credit analyst and veteran Fidelity junk-bond picker. While running Fidelity Capital & Income (FAGIX) over the past five years, he has managed to outpace 95% of his rivals.

To learn more on his outlook for junk stocks as well as bonds, I reached Glancy by phone the other day at his Boston office. Edited excerpts of our conversation follow:

Q: Is this a good time to launch this fund?

A: It's certainly better than a year ago, given where prices are. Whether or not it's a great time, we won't be able to tell for a year. But we didn't just pick a time to do it. We just think it makes sense for an investor over an extended period.

Q: What motivated you, then?

A: We've been investing in leveraged companies for a long time at Fidelity pretty successfully. At times, we've owned the equity of the leveraged companies in our bond funds when we felt that the market wasn't fully reflecting the value of [their] equity and the success the company was having putting its leverage to good use.

Q: Such as?

A: If you go back 15 years, MCI and Turner were good examples of companies that used leverage very effectively and grew to become big, enormous companies. More recently, there have been lots of telecommunications companies that have successfully done it -- cable TV companies, satellite TV companies -- [that used] debt as growth capital.

And then there are other leveraged companies that are Old Economy but are effectively using leverage as a sort of financial engineering tool, to either buy back stock or make some type of accretive acquisition where they think they're going to earn a return greater than the cost of the capital. So I think there are lots of opportunities in each category.

Q: Risks, too.

A: The caveat is that, by definition, leverage makes things go faster, up or down. With that understanding, and our view that over time we've [done a reasonably good job picking] out who's using leverage successfully and who isn't, then this is a [fund] that people should have some interest in because, done well, you're going to do well faster.

Q: When I looked at the most recent portfolio for your Capital & Income Fund, I was reminded of nothing so much as the 1980s at Mutual Shares (MUTHX) -- the ones that Michael Price and Max Heine put together. Do you see this new fund as fishing in the same pond?

A: We're definitely fishing in the same pond. I don't think part of our strategy is to accelerate the returns that we expect to get by being activist shareholders [as Mutual Shares was]. But those funds made a lot of money buying leveraged companies that maybe the rest of the market wasn't focused on. I think that the pond has changed a lot, though, since even five or six years ago.

Q: What do you mean?

A: There's a smorgasbord of telecommunications/media companies out here that had grand plans and issued lots of debt and lots of equity, too, and used to have $20 billion market caps and now have $2 billion market caps.

And some of them are going to have $50 billion market caps and some of them are going to have no market cap. We'll have a good shot at picking the ones that will go from $2 [billion] to $50 [billion] and avoiding the ones that are going to go from $2 [billion] to 0.

Q: Is it a safe assumption that a lot of the names in the common stock portfolio for Capital & Income will also be appearing in the Leveraged Company Fund? I'm just looking here at EchoStar, Pathmark, and Allied Waste.

A: Forgetting about whether or not I'm buying those, EchoStar (DISH) and things like NexTel (NXTL) and Allied (AW) and Pathmark (PTMK) are interesting [examples] of the different types of companies that are in this universe.

People always want to ask me, is this a growth fund? Is this a value fund? I'm saying [the fund has] companies that have debt. And some of those are growth, as people in the business of putting labels on things would define them, and some of them aren't.

Q: Go on.

A: [Some] are companies that have borrowed enormous amounts of money to build new platforms from which they wanted to provide either a new or better product more cheaply.... In NexTel's case, [it was about] more services and better cellular service focused on the business market than had been offered heretofore.

In EchoStar's case, [it's] satellite television that's cheaper and better than cable. Allied and Pathmark are more of the plug-and-chug variety.... But we're not buying the rumps of companies. We're buying real companies that are growing earnings and book value and cash flow.

Q: Which is a little different from what Max Heine did. He would buy the rumps of companies and wait for a liquidation.

A: Right. those kind of cases, you need to make sure that there's some sort of facilitator there -- that there's somebody who's going to rattle the cage. We're not going to do that. That's not to say you wouldn't buy something like that if you thought it would happen, but that's not the purpose of this fund.

Q: Do you think that satellite will continue to steal share from cable?

A: If you look at the growth in subscribers of cable vs. satellite television, you know satellite adds more in a quarter than cable adds in a year.... It's gotten to the scale where its financial viability is beyond question, and there are lots of companies out there like that. They've borrowed a lot [and] have gotten the scale to...where it looks like it's right at that inflection point where the asset value is starting to grow enormously with only a little bit of additional capital required -- and they're over the hump.

Q: One worry that individual investors might have about the fund is that you have another whole big fund to run. Is your attention going to be divided?

A: That's an understandable question, and it has a pretty easy answer. The universe [of companies] that I'm looking at [for both funds] is essentially the same.... It's not like I'm going out to run Blue Chip Stock Fund or something. It's the same old squirrelly, single-B [rated] companies.

Q: Has the high-yield market seen its worst days?

A: I hope so. I've told people that 2000 and '01 to this point are pretty analogous to 1990 and 1991. Defaults peaked in 1991, but the Merrill Lynch High-Yield Master II Index was up [39%] in 1991 because all of the '91 defaults had been reflected in 1990's prices.

At the same time, I don't think it's going to be quite as easy as that, because in 1990 you had some really great companies that had done what in hindsight were the exact wrong financial transactions at exactly the wrong time. But they were great, market-leading companies -- U.S. Gypsum, Macys, Federated (FD), Southland. All went out and borrowed a lot of money at exactly the wrong time as we went into recession. So for somebody in my shoes it was just a question of figuring out, O.K., where do I want to be in the pecking order, who's going to get what when they split up this pie? And what should I pay for that?

Q: And now?

A: [With] today's distressed company in many cases, their existing debt is sort of their third-most important problem. One, they need new money in order to, two, determine whether or not they have a viable business plan. Those are things that are much more challenging to figure out.... I don't know if we're going to be up 40%, but I think it would be difficult not to do well from here over the next 18 to 24 months. Barker covers personal finance in his Barker Portfolio column for Business Week. For more on Glancy, click here.

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