One of the prime assets that the estate of the bankrupt Lehman Brothers still has to sell is a 20 percent stake in the $22 billion hedge fund D. E. Shaw. But so far, Lehman has found no takers.It should be an easy sell.
Over the last six months, the Lehman estate has been trying to drum up interest in the stake, which the Wall Street bank bought a year before it collapsed. But few investment firms solicited by the Goldman Sachs bankers who are shopping it have shown much interest in what is one of the industry’s more successful trading firms.
The main stumbling block is not the price — Lehman wants $550 million to $800 million for the stake, according to people briefed on the matter, including some who considered bidding on it. Rather, it is the terms of ownership that were negotiated by Lehman in the spring of 2007, these people said.
The deal with D. E. Shaw treats Lehman as a passive owner that collects a percentage of the firm’s profits but has no board seat. The fund’s consent is required to sell the stake, according to filings in the bankruptcy proceeding.
Before the financial crisis, these terms were not unusual. Morgan Stanley, for instance, is said to have negotiated a similar arrangement for its 20 percent stake in the Avenue Capital Group, the $14 billion hedge fund founded by Marc Lasry and his sister, Sonia Gardner. In 2006, Morgan Stanley also bought a 19.8 percent stake in Lansdowne Partners, a London hedge fund co-founded by Steve Heinz.
These passive ownership deals negotiated by Wall Street banks were often motivated by a desire to build a long-term relationship with the hedge fund in case the firm ever went public — something that a number of hedge funds were considering before the financial crisis hit.
Today, however, few hedge funds talk about going public. Deals negotiated before the crisis are now seen as too restrictive to attract buyers who are looking for some say in how a firm operates — or seeking more favorable income-sharing arrangements — in return for their investment.
One hedge fund manager with knowledge of the arrangements who spoke on condition of anonymity, said precrisis deals assumed a higher valuation than many of the funds were now worth. The manager said those deals assumed that a hedge fund was worth 15 times as much as its revenue. Now, a single-digit multiple is more realistic.
And firms like D. E. Shaw, which manages $32 billion across all its investment funds, have little incentive to renegotiate the terms of such lucrative deals.
A spokesman for D. E. Shaw declined to comment.
The only firm that continues to show interest in acquiring the stake is the Affiliated Managers Group, an investment firm based in Boston that specializes in buying stakes in hedge funds and private equity firms. But no deal with Affiliated Managers, which owns minority stakes in the hedge fund BlueMountain Capital Management and the private equity firm EIG Global EnergyPartners, is imminent, people briefed on the matter said.
Other investment firms approached by Goldman about buying the Lehman stake include the Blackstone Group and Dyal Capital Partners, a private equity unit of the Neuberger Berman Group.
Officials with Goldman, Blackstone, Dyal Capital Partners and Affiliated Managers all declined to discuss the bidding process.
Matthew Cantor, the general counsel for Lehman Brothers Holdings, which manages the remaining assets of the former investment bank, did not return phone calls seeking comment.
In 2007, Lehman paid around $800 million and a contingency based on future performance for the hedge fund stake. The deal was structured to require Lehman to make a big upfront payment and additional payments in 2009 and 2012. In a regulatory filing at the end of 2013, Lehman gave a value of $675 million for ARS Holdings II, the entity that controls the D. E. Shaw investment.
The hedge fund firm, founded by David E. Shaw, is known for its quantitative trading strategies and for having once employedLawrence H. Summers, who later became President Obama’s top economic policy adviser. (Mr. Shaw has stepped down from an active role in the operation of the firm and is now its chief scientist.)
Its funds have made better-than-average returns over the last several years, after a lackluster performance in 2010. The firm responded to its 2010 results by reducing the fees it had charged investors. In 2011, D. E. Shaw cut its asset management fee to 2.5 percent from 3 percent and cut the performance fee it charges most investors to 25 percent from 30 percent.
Since then, the firm’s performance has mainly outperformed the rest of the $2.7 trillion hedge fund industry. This year, D. E. Shaw’s flagship multistrategy fund — called the Composite Fund — was up 4.2 percent in the first quarter, according to a person knowledgeable about the numbers, which are not reported publicly. This compares with a 1.1 percent gain across the Hedge Fund Research Index, one of the broadest performance gauges in the industry. Last year, the Composite Fund returned about 11 percent, compared with a 9.3 percent return for the entire industry.
The Lehman estate does not appear to be under any deadline to make a deal. To keep the investment in place and prevent Lehman from defaulting on the terms of the original deal, Judge James Peck of the United States Bankruptcy Court in Manhattan approved a payment of $134 million to D. E. Shaw in 2009.
More broadly, the corporate debt of Lehman has proved to be a good investment for hedge funds like Paulson & Company and other investors who bought the bonds at distressed prices after the firm filed for bankruptcy in September 2008. The bonds have since risen in value as Lehman has proved more capable in selling assets and collecting on claims. This year, John Paulson told his investors that Lehman was an investment that “keeps on giving.”
The D. E. Shaw stake, though, is shaping up as something of a waiting game.
As one interested bidder who walked away from the deal, speaking on condition of anonymity, said: “You don’t want to be wearing someone else’s underwear.”
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