O'Leary Fund promises to share the wealth and wisdom

At noon today, retail stockbrokers and their clients will have the chance to munch on salad and sandwiches at Toronto’s King Edward Hotel while they wait to hear about the latest TSX initial public offering. But this isn’t just any roadshow booking. This is a life event. Brokers will share the air with a real television personality. [Warning to readers – this piece falls into the category of an “opinion” piece and should be taken as such]

None other than BNN’s Terence Kevin O’Leary, in fact. The Simon Cowell of Canadian television.

And as far as I’m concerned, investors should look very closely at this unique investment opportunity. “KO”, as he’s known to his friends, might be well positioned to make you a great deal of money. He certainly appears to have done better financially than most of us, so for that reason alone he might be a wealth creation machine for all of the retail investment community.

According to a recent SEDAR filing, Mr. O’Leary is launching his own equity fund. It would appear that he’s grown a tad bored of his multifaceted role as BNN broadcaster, CBC Dragon, corporate director, and all ’round international investor. Rather than merely make what he claims are bags of money for himself, Mr. O’Leary seems prepared to share his many gifts with Canadian retail investors.

The vehicle is being called the “O’Leary Global Equity Income Fund”, and the investment thesis being pitched to retail stockbrokers is this, for just $12 per Unit:

– �Capitalize on the knowledge and capabilities of Kevin O�Leary and Stanton Asset Management�
– �Get Paid While You Wait approach is designed to provide yield, growth and global diversification�
– �Access an actively managed, globally diversified portfolio compromised primarily of dividend-paying common and preferred shares of public issuers�
– �Seek unique yield-oriented private investments comprising up to 20% of total assets�
– �Attractive initial target distribution of 5% per annum, paid monthly�
– �Unique opportunity to benefit from the knowledge and capabilities of O�Leary and Stanton�
– �Kevin O�Leary is an entrepreneur and investor who travels extensively investigating, reporting and investing in global opportunities�
– �O�Leary is a known business television personality, whose work and relationships provide him global access and insight, which is shared with investors in his daily dialogue on national broadcast television�

Much of that requires translation, and that’ll come in a moment. But first, here’s the O’Leary resume being shared with stockbrokers:

– “Investigates, reports and invests in global opportunities”
– “Co-host: Squeeze Play, BNN”
– “Cast member: Dragon’s Den, Fortune Hunters, CBC”
– “Strategic Advisory Board member of Genstar ($3 billion private equity firm)”
– “Co-founder & President of Softkey (later The Learning Company), which sold to Mattel in 1999 for $4.2 billion”
– “Founding investor/director of Global BPO Services Corp., a $250 million Special Purpose Acquisition Corporation”
– “Investment Committee of Boston’s 107 year-old Hamilton Trust”

Curiously, there’s no mention of Mr. O’Leary’s time as a managing partner at Boston-based North Coast Capital LLC. For years, Mr. O’Leary’s resume was focused on his prior experience at The Learning Company (more on that below), but his full time job was as a partner at North Coast Capital. Mr. O’Leary told his public that North Coast was in the business of management-led leveraged buyouts, which is similar to what Genstar is also up to. North Coast Capital may no longer be active as it has neither a telephone number in Boston, nor does it have an easily found corporate website. You can find a reference to his 2006 political contributions, but nothing else on the North Coast front. Not even Factiva has heard of it, and that web service tracks hundreds of publications. Perhaps it was a secretive firm and never announced its closed deals, but that wouldn’t mirror Mr. O’Leary’s well-honed self-promotion machine.

Investors will want to know what became of North Coast and the Tibbar Fund, on the basis that prior investment performance may help predict future returns. And unlike Eric Sprott’s IPO prospectus, none of Mr. O’Leary’s investing track record or IRR data is being shared.

Retail investors will want to understand how appearing on The Dragon’s Den or call-in shows on BNN Television will generate fantastic investment opportunities. As the O’Leary Fund is 80% geared towards public companies with market caps of $1 billion and higher, the start-up stage entrepreneurs on CBC Television aren’t an appropriate feeder network, obviously.

The overarching investment message is clear for retail investors and their investment advisors. You’ve seen Mr. O’Leary on television. You’ve heard him brag about his huge investment wins. And now is your chance to get his special talents working for you and your retirement account. Rather than just watching Mr. O’Leary, why not be Mr. O’Leary, Porsche 911 and all?

If 911s aren’t your thing, there’s always the cottage getaway, as featured in a 2005 New York Times Story:

For anyone casually acquainted with Muskoka, what passes for a cottage these days may come as quite a shock. Take the home of Kevin and Linda O’Leary, a couple from Boston who built a cottage on Lake Joseph five years ago. Now, rising like a wedding cake from the lakeshore, is a periwinkle-blue structure with white trim, wraparound cedar decks, three boat slips and a second-floor sun deck that is larger than some marinas here.

And that is just the boathouse.

Behind it, perched on a huge slab of pink-and-gray granite, is the 9,000-square-foot main house with seven bedrooms, four stone fireplaces, a wine cellar carved into the native rock and a lofty sweep of terraces.

“This is a very typical room in Muskoka,” Ms. O’Leary, 41, said during a tour of her cottage earlier this month. The room had 30-foot cathedral ceilings and a wet bar. In a restaurant-grade kitchen, a staff of three was preparing sweetbreads and lobster for 17 people, including colleagues from her husband’s former software company. “I wanted this to have a country cottage feel,” she said.

As investment strategies go, the IPO prospectus makes great hay about Mr. O’Leary’s personal investment approach. To quote, “the ‘get paid while you wait’ investment approach is a theme espoused by Kevin O’Leary on regular television appearances and through daily dialogue with investors through national broadcast television.”

As a concept, the “Get Paid While You Wait” investment strategy isn’t a novel one. A variety of investment firms and business publications promote the exact same theme. Motley Fool has been on that bandwagon for years (2003, 2006), for example. A.G. Edwards also likes the phrase (2006). Estate Planners use it in the context of investing in a mutual fund built on dividend-paying stocks (www.grandparents.com). USA Today stock pickers referred to it back in 2001. And there was Fortune in 1993…

At any rate, you get the point. Buying dividend stocks in the hopes they’ll also appreciate in value is a good idea, even if Mr. O’Leary is jumping on someone else’s bandwagon.

Leaving aside the lack of novelty regarding the investment strategy, what exactly will Mr. O’Leary do with the capital should Canadian investors decide to give him their life savings? According to Mr. O’Leary’s bumf, there are many global companies “that will be among those considered by the Manager”. The list includes:

Manitoba Telecom
Portugal Telecom
Babcock & Brown
China Steel
Pages Jaunes
Total Gabon
Arcelor Mittal
Fletcher Building
Tata
British Telecom
Fosters

As you’ll have noticed, these global stocks are all available for individual sale to retail investors today, without Mr. O’Leary’s 1.5% annual management and 0.40% servicing fees. If you’d like to buy a diversified group of stocks for a fee, there are a host of money managers out there with existing, seasoned global dividend funds: Acuity, AGF, Dynamic, Fidelity, RBC, TD, etc. These funds have a track record, and they’re already invested in the market.

Mind you, the O’Leary Fund offers the promise of two things that traditional money managers don’t, whatever the fee: the ability to invest up to 20% of capital in private companies, and the notion that a Trust structure is an efficient way to invest capital for the purposes of buying and selling securities.

As someone who has plenty of experience in the world of private companies, it seems to me that he’ll have a tough time finding more than a few firms at acceptable valuations that would throw off enough free cash flow to generate the type of 5%-8% annual after tax yields that Mr. O’Leary is proposing. With hundreds of billions of dollars of merchant banking money also focused on private, profitable, cashflow positive opportunities, there’ll be plenty of competition. In the USA alone, there are about 2,000 mid market merchant banks and family offices currently scouring the earth for the same private deals that fit the O’Leary profile.

To make matters worse, it’s often tough to sell a private company when things aren’t going well. With a public company position, all the institutional fund manager has to do is call a brokerage firm and hit the sell button – even when the stock is falling like a knife. At least you can exit a public position. With an illiquid private, O’Leary’s investors might “be stuck on the bus” if things don’t go well at a private co. investment, to use a Bay Street turn of phrase.

The Genstar merchant bank, which Mr. O’Leary includes as part of his resume by virture of an “advisory board member” role, has a similar private company investment strategy. Genstar hunts for profitable, mid-market private companies to invest in. It will be interesting to see how Mr. O’Leary navigates that relationship: who does he owe a duty to when Genstar pitches him on an investment idea in his capacity as a Strategic Advisory Board member? Genstar’s limited partners or the unit holders of the O’Leary Fund? Cross-border relationships can be a good generator of deal flow, but a Fund manager can only serve one master.

O’Leary’s Fund mandate also plans on using the 20% private company basket to swing the bat in “private equity, leveraged buyout equity participation, mezzanine debt, distressed debt and venture capital”. Can you imagine the size of the team and the expertise required to be proficient in so many different investment specialties. We play in the mezz and VC world, but that’s all we do. Firms such as Onex and Blackstone focus on private equity and LBOs. Ventures West, VenGrowth, VentureLink and JLA Ventures are examples of Canadian VC funds, and Kensington Capital has a vehicle that retail investors can use if they want non-Labour Sponsored exposure to VC funds.

But to do it all? Play in every investment vertical known to humankind, in every region of the world? With a single brain? Crammed in between filming a daily TV show, a weekly TV show, several boards, etc. Amazing!

The O’Leary Fund is also hoping to take advantage of the recent market correction. In O’Leary’s view, “the recent market selloff has provided an attractive entry point in a variety of high quality public securities. Financial institutions have been forced to sell high quality securities due to significant writedowns…[and] many sellers and few buyers have pushed prices down.”

Many sellers and few buyers? I thought that we all understood that for every seller there was a buyer.

This “many high quality stocks are available cheap” investment thesis is illogical, of course, as whatever securities that have been “forced” onto the market over the past 8 months are anything but “high quality”. When Citigroup or Bear Stearns sold a package of subprime or leveraged loans, are those the securities that Mr. O’Leary is referring to? According to Mr. O’Leary’s target investment list above, he’s planning to buy international telephone and infrastructure companies. I try to read many a great business publication, and I haven’t seen a single piece of news regarding “financial institutions [being] forced to sell high quality securities due to significant writedowns”.

The Canadian ABCP and U.S. subprime mayhem has had an impact on the overall stock market, this is true. But so has the fear of a U.S. and Canadian recession.

If Citigroup’s retail mutual funds held Manitoba Telecom (16x EPS) or Portugal Telecom (12x EPS), Citigroup’s $50 billion of subprime writeoffs wouldn’t have had an impact on their mutual fund portfolio in any event. They’ve been unloading underperforming loans, which isn’t what the O’Leary Fund is proposing to acquire on your behalf.

The stock market might be undervalued right now, and perhaps it isn’t. Warren Buffet hasn’t been that active buying public company stocks in 2008, but perhaps Mr. O’Leary has found some gems. I don’t doubt that he has, and that may be a perfect reason to invest in this new Fund.

Ok, you might say: The investment thesis isn’t novel. I can buy all of the same stocks myself if I wanted to. And the story that large financial institutions have thrown high quality stock positions out the top floor window of their Wall Street HQ at cheap prices is a pockerful one.

But what of Mr. O’Leary’s experience? Don’t I want that on my side? Absolutely you do. He’s certainly built himself what appears to be a sizable fortune, and his lauded track record has provided a forum for views that are sought by people the world over, courtesy of Jack Fleishman’s love for his television schtick.

Well, let’s look back at that track record.

We’ll ignore for now the zany 2004 recommendation that we buy every crappy and broken down Income Trust:

“When you look at an investment like a trust, when so much of the valuation is on management’s ability to generate cash, you can have remarkable changes in value if you get rid of the management if you put new teams in,” he says. “I am looking, as an individual investor, for the corporate governance issues to kick in here and, over time, for these boards to replace the idiots that are running these companies.”

Invest in companies run by people who you believe are idiots? Now that IS a new investment approach; but we’ll move on.

That Mr. O’Leary is focused on corporate governance at investee companies is a good thing, of course. Track his 2005/06 SEDI filings as a corporate director of EnGlobe. Mr. O’Leary wanted to do some tax-loss selling, and the fact that the company was going through a material $30MM refinancing and was in the 3rd last day of its financial quarter wasn’t a barrier; the company’s lawyers and compliance officer gave him approval to do the trade. No harm, no foul, all approved. Mr. O’Leary bought back the same 300,000 share position on February 1, 2006 at 36.5 cents (Revenue Canada requires a 30 period before you can repurchase a position after a tax loss trade), and the stock closed at 38 cents yesterday.

But should corporate directors engage in tax loss selling while sitting on public boards? Now that’s a question for investment advisors to ponder.

The big kahuna win has to be the 1999 US$3.5 billion sale of TLC to Mattel. As President of The Learning Company, Mr. O’Leary was a hero. Huge exit price, and the original investors reaped massive rewards for their ownership positions. It probably matters not that Mr. O’Leary departed Mattel in 2000, soon after The Learning Company’s results had slumped and the new owner began to figure out that the worm had turned.

What does matter is that Mattel was losing US$1.5 million a day on TLC. What had been “worth” US$3.5 billion the year before was, suddenly, an unprofitable business. In April, less than a year after the acquisition, Mattel announced that it would be selling the division. Analysts initially estimated that Mattel would get US$400 million for it, but in October 2000, when Gores Technology Fund finally agreed to acquire it, Mattel handed it to them for free – with the promise by Gores that Mattel could share in some future upside should things improve dramatically.

That US$3.5 billion dot.com creation? That incredible feat of business building and entreprenurialism? Apparently worthless in less than 18 months. Either Mattel screwed up a perfectly good company, or else they were sold a pig in a poke as some Mattel investors charged. Class action lawsuits were naturally filed by Mattel shareholders. It was settled by Mattel for US$122 million in 2002.

Another two class action lawsuits were also filed when former Broderbund shareholders sued Mattel (as successor to The Learning Company) and the former directors of Learning Company (Broderbund investors received shares of The Learning Company in connection with the Learning Company-Broderbund merger on August 31, 1998): “The complaints in those actions generally alleged that Learning Company misstated its financial results prior to the time it was acquired by Mattel.”

Former directors of The Learning Company denied all claims.

Many investors made a killing in the NASDAQ’s run to 6,000. Some of the firms were sustainable, real businesses and others weren’t. Mark Cuban, for example, took his winnings and started all over again.

But selling a business to Mattel at the height of the dot.com boom isn’t a guaranteed recipie for future stock-picking prowess, whether they be dividend paying stocks or high tech growth names.

Investors and their financial advisors might make a some good Alpha from Mr. O’Leary’s proposed fund. And they’ll certainly get a kick out of his TV persona, if that’s their thing. Even an invite to his Lake Joseph cottage if they place enough Units.

But if retail investors are looking for a superstar to manage their investments, there are plenty of people out there with established track records, through bear and bull markets, recessions and expansion economies. Warren Buffet (BRK.B:NYSE), Hal and Duncan Jackman (ELF:TSX, UNC:TSX, EVT:TSX), and the Desmarais Family (POW:TSX) are but three that come to mind.

Until Mr. O’Leary matches Eric Sprott’s IPO disclosure and gives investors the details of his personal investing prowess since 2000, none of which is disclosed in the O’Leary Fund IPO prospectus, we are left to wonder why this is the right vehicle for the times.

At noon today, Toronto investors will have their chance to find out, first hand, why this is a sensible vehicle for their needs. KO will wow the crowd, that is assured. The proof will be in the pudding once the Funds’ investment returns are published a year or two from now.

If you’re not so sure, there’s always the “sleepy” Scotiabank (BNS:TSX). The 25 year compounded annual return is something like 14.8% if you reinvested the dividends, which BNS allows you to do on their own website — free of charge.

Most dividend fund managers would be tickled at that type of sustainable return, KO included.

[Don’t forget to vote on the Globe and Mail’s 25 Best Business Blogs]

MRM
(disclosure – this post, like all blogs, is an Opinion Piece; we own BNS in our household; WF Fund II holds warrants in EG)