Baker Street Capital v Kerr “Stupid is as stupid does”

We don’t have a particular strong opinion on the following, but we would agree that it does seem that the young guns at Baker Street Capital in Los Angles were stuffed into the agee jar by the experienced deal maker, George Kerr. The information put forward to us does make it clear that it is an uneven match.

Before we share the basic details around Baker Street we will take a moment to visit the deal Kerr struck with Baker Street.

Background

According to press reports Kerr first learned about Baker Street when it showed up on the PGC shareholder list. There was no prior connection, which sounds plausible although it has not been verified. Baker Street quickly built its stake to 19.78% and then shortly after Kerr struck a deal with Baker Street. Kerr at that point controlled 14.1%

Deal

The details of the deal or Limited Partner Agreement that Kerr and Baker Street struck can be found on page 25 of appendix 1 to the offer agreement which can be found here

You can read it below at your convenience.

1.        What stands out for us is where Baker Street owned 19.78% of PGC before the offer it will own virtually the same (20%) of the vehicle, which sole asset will be PGC, after the deal. So Baker Street’s economic interest will not change.
2.        The general partner, which controls the partnership, is again controlled by George Kerr and as you can see from the details of the agreement below, it is made quite clear the Kerr has all the control.
3.        The agreement has a lifespan of seven years.

Why?

The obvious questions are,

1.       Why would Baker Street give up control to a vehicle without increasing its economic interest?
2.       Why would Baker Street commit to an investment period when a) it is itself is funded by investors with a different time frame and b) its own investment horizon is generally significantly shorter?

Explanation

We have listened to a lot of opinions on why Baker Street would negotiate such a bad contract for Baker Street investors when it clearly was negotiating from a position of strength.

In our view there is no substitute for experience and of that Kerr has a lot and Baker Street little. The most plausible scenario to us is very simple. Baker Street was out negotiated; very quickly and very effectively or as one shareholder put it, quoting from the flick Forest Gump, “Stupid is as stupid does”. We have seen this kind of flick before and unless Baker Street pulls out it will most likely end badly for Baker Street investors.

The devil is in the details

How does Kerr stack up against Baker Street?

Kerr

George Kerr is no stranger to the readers of this blog and is antics are very well covered by the New Zealand press, to which you can refer.

Baker Street

Very little is known about Baker Street in New Zealand, but we asked around and came up with the following.

According to our latest information, Baker Street Capital Management is a limited liability company based in Wilshire Boulevard, Los Angeles California. The founder and chief investment officer Vadim Perelman is 30 years old and assisted by Jeff O’Donohue and since Jeff only has about 2 years work experience the decisions effectively all fall to young Vadim. Baker Street uses small and unknown auditors and legal advisers and an online broker, Interactive Brokers Corp, to take care of its investments. 

Baker Street was founded in Sep 2009 and by 2010 had US$45m assets under management (AUM); the assets under management seems to be similar today. The AUM was on the back of an outstanding 73% investment return in its first year of operation, but the Sep 2010 – Sep 2011 period suggests that the markets have been less kind to Baker Street investors.

Although Baker Street claims to be modeled on the partnerships managed by Warren Buffett it also puts its “time horizon” at “12 to 24 months”. The last point clearly presents a problem for Baker Street, because it signed up to a partnership agreement with Kerr for 7 years and Kerr himself claimed the PGC investment horizon is up to 20 years. It does not reconcile well with an investment horizon of 12-24 months. This is also not small change for Baker Street, because on a cost basis of $0.38 it sunk about 30% of its assets under management into a very illiquid situation. Readers also have to consider that Baker Street specializes in investments like Hollywood Media Corp, Daniel Leather, Unilens Vision, etc which are in itself very illiquid situations. Therefore the argument that some have put forward to us, which is that the situation got away from Baker Street, does seem to hold water. Why else would it sign all power away to Kerr? Also, it does not participate in the current buying. Why not? Probably because it cannot, because it cannot afford or have extra cash to sink into PGC. 

Add to that the following from Baker Street’s “Core Strategy” and it does seem that Baker Street got itself into a pickle,

“Focus on simple, predictable, underfollowed companies at very attractive valuations:

– Shareholder-oriented managers with incentives in place to maximize shareholder value

– High barriers to entry and returns on equity, with an ability to profitably reinvest capital

– Limited dependence on debt financing, especially short-term, recourse debt

– Free optionality from “hidden” assets (e.g. unencumbered real estate, stakes in private companies, NOLs, etc)”
We struggle to see how PGC fits into the above mold.

We understand Baobab identified PGC as an investment candidate when PGC filed to spin off Heartland and it is plausible that Baker Street did the same. Baker Street claims it is “heavily research driven”, a process it explains as follows,

“Heavily research-driven approach to investing

- Focus on extensive primary research as a key driver of investment insight

- Discussions with employees, customers, competitors, suppliers and other primary sources

- Thorough due diligence on the integrity of key stakeholders (senior management, board members, large shareholders)

- Stay up-to-date on industry events: attend trade shows, read trade publications”

We cannot reconcile the above with claims by Mogridge, Kerr and other PGC/Heartland stakeholders that they never heard of Baker Street until Baker Street started filing with the stock exchange. So it is plausible that Baker Street did not do sufficient research on PGC and the person who it got into bed with, George Kerr.

It is clear from the following that Vadim Perelman cannot match Kerr’s experience. Perelman got his first job in the investment industry, only in 2007 as a junior analyst at Force Capital. Force was founded by Robert Jaffe who is experienced; ex director of research at Stephen Cohen’s notorious SAC Capital and an ex associate at Steinhardt partners. After two years at Force, Perelman founded Baker Street in 2009.

So to us it is clear that the scale is heavily tilted towards Kerr. We do however think that Baker Street should not to be dismissed; if you read about the investment opportunities which Perelman has been able to dig out, in the Baker Street presentation below then it is clear to us it would be a mistake to simply dismiss him. Strangely enough we think Kerr, especially, should not feel to smug. Baker Street could very well see a way out, especially if we assume that it would have figured out by now that it there are more to Kerr than its cursory research showed. 
Kerr and his merchant banker friend, Steve Walker is doing the rounds telling all existing shareholders that a dilutive rights issue is on its way. The questions is, what does it mean for Baker Street which is already holding a very concentrated position? Is it ready and able to back its faith and trust in Kerr up with even more investment funds?

If not, then Baker Street might indeed be plotting alternative strategies as we speak and we will not be surprised to see Kerr excluded from those.  Kerr of all people should ensure its relationship with young Vadim stays cozy and warm even if it just so he can have him for lunch!

Cheerio!

 jA

LP Agreement between Baker Street Capital Management and George Kerr

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