Mark Fetting, chief executive officer of Legg Mason, was out of time. His biggest investor, Nelson Peltz, had watched for three years as Fetting struggled to increase profit at the Baltimore-based money manager—home to onetime star manager Bill Miller—and halt $135 billion in fund redemptions. At Peltz’s behest, Fetting cut costs by as much as $150 million a year and bought back at least $1 billion in stock. Still, Legg Mason shares hadn’t gained much since Peltz’s hedge fund bought its stake in mid-2009. With a standstill agreement set to end in November, allowing Peltz to raise his holdings from 11 percent or propose a slate of directors, Fetting quit on Sept. 11. “Patience was clearly running out,” says Jeff Hopson, an analyst at Stifel Nicolaus. “The odds of a dramatic corporate change have increased at Legg Mason.”
Thirty-five years after doing his first acquisition, Peltz, 70, is still shaking up boardrooms. A billionaire and father of 10 children ranging in age from 9 to 49, Peltz made his first fortune in the 1980s, doing leveraged buyouts financed by high-yield bonds sold by Michael Milken of Drexel Burnham Lambert. He is one of the last corporate raiders of that era still active, though he now takes minority stakes in companies and does not use borrowed money. Milken client T. Boone Pickens mostly trades oil and energy stocks these days. Saul Steinberg is out of the game. Another Milken client, Carl Icahn, returned his outside investors’ money in early 2011.
Peltz’s latest target is typical of investments made by Peltz and partners Peter May and Ed Garden, who look for underperforming companies, including H.J. Heinz and Wendy’s, and nudge them to cut costs, spin off businesses, or add new products. That strategy is helping Peltz attract money: His Trian Fund Management is set to wrap up $1 billion in new investing commitments from big institutions betting he’ll outperform other stockpickers in a market where many equities are moving in lockstep.
Yet Legg Mason’s lackluster performance shows the challenges faced by activists like Peltz, who can no longer rely on a market rally to help lift asset values. Trian’s $2.2 billion Master Fund, its original hedge fund, has been flat this year through August, according to investors, as the Standard & Poor’s 500-stock index returned 14 percent including reinvested dividends. The Master Fund has returned an annualized 5.2 percent since November 2005, according to investors. That compares with 3.4 percent for Bloomberg’s stock hedge fund index and about 4.5 percent for the S&P 500. “Our timing isn’t always perfect,” says Peltz, in an interview with his two partners in their Park Avenue offices in Manhattan. “Sometimes it takes longer to create value, but if the companies generate more earnings, the stocks will ultimately reflect that.”
Trian’s performance this year has lagged behind that of other activist funds. Cevian Capital, with holdings including German builder Bilfinger Berger and Danish bank Danske Bank, climbed 16 percent through August, according to investors. Bill Ackman’s $11 billion Pershing Square Capital Management, the firm behind the makeover of discount retailer J.C. Penney, returned 6.9 percent. Ackman has delivered an annualized return of 20.4 percent since starting in 2004. Former corporate raider Carl Icahn posted average annual returns of 11 percent before expenses from November 2004 through the end of 2010.
That Peltz would become a billionaire might have seemed unlikely back in 1962 when he dropped out of the University of Pennsylvania’s Wharton School to become a ski racing instructor in Oregon. To earn money for the drive across the country, Peltz, who’d grown up in Brooklyn and later on Park Avenue, got a job driving trucks for the frozen food distribution company founded by his grand-father. He planned to stay two weeks.
The business intrigued him, and he gave up on Oregon to help expand A. Peltz & Sons. Over the next 10 years, Peltz bought several food companies, and in 1972 he and his brother took their company, then called Flagstaff, public. Peter May, who had been the company’s outside accountant, joined as chief financial officer. After Flagstaff was sold in 1978, Peltz and May went searching for new conquests. In April 1983, the two bought a stake in vending-machine and wire company Triangle Industries with the idea of using it to make acquisitions. Two years later, Triangle, with sales of about $300 million, bought National Can, with revenue of $1.9 billion—using bonds sold by Milken’s Drexel Burnham Lambert. Peltz and May bought Snapple from Quaker Oats for $300 million in 1997. Three years later, after adding new products and reinvigorating the advertising campaign, they sold it to Cadbury Schweppes for $1.45 billion.
In 2003, the two partners were joined by Peltz’s son-in-law, Garden, now 51. A former investment banker at Credit Suisse First Boston, he helped Trian start its first hedge fund. Trian runs a lean operation, with an investment staff of about 15, including Peltz’s 29-year-old son Matt. Trian currently owns stakes in 10 companies and has board seats on six of them. The targets tend to have well-known brands and strong cash flows, yet shares that are trading cheaply.
Before they make an investment, the Trian team writes a 30- to 40-page white paper that examines the company’s problems and outlines Trian’s solutions. For Heinz, the white paper suggested introducing so-called peel-and-dip ketchup containers rather than the hard-to-open packets, to encourage consumers to use more of its product. The stock has risen to $56.49 a share, from about $37 on Feb. 21, 2006, when it became known that Trian was targeting Heinz.
Legg Mason owns mutual fund providers including Brandywine Global and Royce & Associates, as well as the funds named for the company. Assets flowed into the company during Bill Miller’s celebrated 15-year run beating the S&P 500 at his Legg Mason Value Trust. After the streak ended in 2006, investors began withdrawing money. Assets under management fell from a peak of $1 trillion in 2007 to $639 billion at the end of August, reflecting redemptions and investment losses.
Legg Mason’s announcement that Fetting would step down sent shares up 5.4 percent on Sept. 11, as investors bet that the management shakeup would precede bigger changes. “The company remains committed to the affiliate model and will continue to build its products and capabilities,” Mary Athridge, a spokeswoman, wrote in an e-mail. Fetting declined to comment.
Since Fetting had already done a lot of cost-cutting, a new management team may have to consider bolder moves, according to Daniel Fannon, an analyst with Jefferies & Co. “Legg Mason may try to exit some of the smaller affiliates,” he says. “A lot of the options have been exhausted, so what remains is something dramatic.”