Thursday, September 28, 2006


Another Hedge Fund in TROUBLE

Pirate Capital Loses Its Swagger

Hedge Fund Hits Uneven Patch
With Its 'Activist' Strategy;
Some Investments Drop Sharply
September 27, 2006; Page C1

When Pirate Capital LLC rented a 200-foot yacht for a cocktail party with investors and prospective clients for a ride around Manhattan last week, the weather was unsettled.

That's a bit like Pirate's recent performance. The $1.8 billion hedge fund has hit a rough patch lately employing an "activist" strategy of buying stocks and attempting to prod management of target companies to take steps to boost their stock prices.

Some of Pirate's investments are down sharply this year; its overall return is roughly 3%, according to hedge-fund industry advisers, less than an average of about 7% for activist funds in general. The Securities and Exchange Commission is investigating whether Pirate ran afoul of securities law by failing to timely disclose it had sold stocks, a person close to the situation says. Pirate says the regulatory matter was a misunderstanding that it has sought to rectify.

Pirate's stumble reflects a growing problem faced by hedge funds these days. Many of these funds -- private pools of money catering to wealthy investors and institutions -- are jam-packed into stocks with other hedge funds pursuing similar investment strategies. When the strategy falters, fast-money traders rush for the exits, dragging the stocks down further and faster than they would have had hedge funds not plowed in.

Not long ago, Pirate's swashbuckling stance with the managers of the companies whose shares it owned seemed like a winner. The fund's literature for investors is packed with pirate-themed references and it takes its investors on an annual boat ride. In its Norwalk, Conn., offices stands a life-size pirate figure.

The fund is run by Thomas R. Hudson Jr., 40 years old, a former distressed-debt trader at Goldman Sachs Group Inc. who left the big securities firm in 1999 after failing to report a relationship with a subordinate as required by Goldman's policies, a person close to the situation says. Mr. Hudson sued Goldman in 2000 in a New York state court, alleging breach of contract, wrongful termination and slander, seeking more than $100 million in damages. The suit was dismissed. Later, Mr. Hudson worked as a distressed-debt trader at Amroc Investments LLC, a private investment firm.

Mr. Hudson didn't return phone calls.

In recent months, the fund has been marketing heavily to investors and it ballooned to $1.8 billion at the end of June from $300 million at the end of 2004, according to Ken Squire, who runs 13D Monitor, a research firm that tracks regulatory documents detailing corporate stakes by investors. At least two marketing managers have recently left Pirate, say people close to the situation.

But Pirate's infusion of capital may turn out to have been a double-edged sword. At the end of 2005, Pirate had $930 million in investments, according to SEC filings. At the end of June, that number had jumped to $1.7 billion. Finding enough promising "activist" investments in which to deploy such a large amount of capital is difficult, says Mr. Squire.

"That is a lot of money to put to work in one quarter," he says. "I don't see many guys increasing, or doubling their position" in such a short time frame.

Among the activist investments Pirate made this year is OSI Restaurant Partners Inc. That position was down 33.6% at the end of June. Pirate sold its stake in OSI, which owns Outback Steakhouse, between July 27 and Aug. 14. As part of its investigation, the SEC is looking at whether Pirate complied with SEC rules when it disclosed the OSI sale in a Sept. 13 filing. In general, investors are required to report a material change in their positions within a few days if they own 5% of a stock, according to an SEC spokesman.

Pirate says the regulatory matter is a misunderstanding. In a statement, Mr. Hudson, the fund's founder and portfolio manager, said Pirate had believed that the SEC "did not require" the firm to reveal its stock sales "under those circumstances." He said "Pirate believes it had a sound basis for its position," but "determined to comply" with an SEC notification on Sept. 12, and "amended" its regulatory files the next day.

Since the beginning of the year, Pirate also bought shares of Pep Boys-Manny Moe & Jack, an auto-parts retailer, a position that was down 1.9% at the end of June, according to an analysis by Mr. Squire.

Some of the stocks targeted by Pirate are small, thinly traded shares, which fall even harder when the selling starts. The lack of "liquidity," or ease of trading, in their holdings is a problem being confronted by many hedge funds these days, says David Kostin, a Goldman analyst, in a recent report.

"The most concentrated hedge-fund positions have dropped 10.6% since March 31 versus a 1.3% gain for the S&P 500" stock-market index, Mr. Kostin notes.

Not all of Pirate's investments have fared poorly. John Q. Hammons Hotels Inc., a lodging company, was up nearly 60% at the end of June, and Cornell Cos., a security and protection-services company, was up nearly 40% in the same period.

Among Pirate's worst-performing activist investments are James River Coal Co., which is down 73%, and GenCorp Inc., a conglomerate, down 24%. Pirate's holding of shares of Cutter & Buck Inc., a textile and clothing company, sank 14.6%, while Allied Defense Group Inc., an aerospace and defense company, was down 23%, Mr. Squire says.

--Anita Raghavan contributed to this article.

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