Vulture venture

Leap Wireless emerged from bankruptcy with hedge funds snapping up the debt

Sun., Apr 06 - San Diego Union-Tribune [excerpt]

Vulture venture

Leap Wireless emerged from bankruptcy with hedge funds snapping up the debt

By Jonathan Sidener
April 6, 2008

When Leap Wireless emerged from bankruptcy in 2004, the San Diego company issued a news release listing new board members and mentioning two likely future directors, Mark Rachesky and James Dondero.

Despite the casual treatment, Rachesky and Dondero were key players in the reorganization of the Qualcomm spinoff best known for its Cricket fixed-price cell phone service. The two are Wall Street hedge fund managers who parlayed high-risk purchases of debt from Leap's bankruptcy - a practice called vulture investing - into top stakes in the reorganized company.

Rachesky, a protégé of corporate raider Carl Icahn and founder of MHR Fund Management, controlled 18 percent of Leap's shares. Dondero, founder of Highland Capital Management, owned about 7 percent.

Without further word from the PR department, Rachesky took over as Leap chairman.

The interest of the two hedge funds in the bankrupt Leap was a sign of things to come. Today, eight hedge funds control slightly more that half of the wireless company's shares, and the funds are four of Leap's five largest owners.

It's unusual for hedge funds to hold a majority stake in a single company and likely points to a couple of things about Leap, industry observers say: The company has value not reflected in its stock price, probably its wireless spectrum and networks, and savvy investors believe there's a way to tap into that value.

"Typically, what you find with the companies hedge funds invest in is that the financial health is bad, but the product is fantastic," said Walter Schubert, chair of the Finance Department at La Salle University in Philadelphia. Unlike venture capitalists, who swing for the fences and strike out a lot, hedge funds don't strike out as much, Schubert said.

"These are guys who want to win on average," he said. "They expect to win."

Last year, Leap was in and out of merger talks with MetroPCS, which offers a similar flat-rate service. The two companies' networks have very little overlap, and a merger would essentially create a fifth national network. Analysts say a merger makes sense for both companies.

In December, Rachesky bought 3 million Leap shares, bringing his total to 22.6 percent. Also that month, hedge fund Harbert Management bought more than 1 million shares, raising its ownership to nearly 15 percent. In the latest move, Owl Creek Asset Management raised its stake to slightly more than 9 percent.

"You're seeing several funds increasing their bets on a merger," said Pacific Crest Securities analyst Steve Clement. "The stock was very cheap, below $40. I think the funds are saying there's a decent argument that the (MetroPCS) offer was too low and they think the merger will happen."

Perhaps because of their roots in the corporate raiding of previous decades and perhaps because some embrace terms such as vulture investing, there is a stigma surrounding hedge funds and debate about whether that notoriety is deserved.

Defenders say the funds push undervalued companies to take their medicine, which puts them on the road to health. Others say the funds dwell in the fringes of financial regulation as they seek big, quick payoffs. Their moves can create big waves that buffet little investors.

"There certainly is a stigma among the general public, and I think it's undeserved," said Craig Asche, executive director of the Chartered Alternative Investment Analyst Association, which provides education and certification in several alternative investment areas, including hedge funds.

"Ninety-nine percent of the funds are run by extremely professional, ethical, very well-trained people," he said.

Asche said hedge funds have become mainstream investment tools, managing the assets of public retirement funds and university endowments.

"This is a relatively new area," he said. "Fifteen years ago, a hedge fund was often two guys in a garage with a couple of Bloomberg machines. Today, hedge funds have trillions under management."