Friday, September 05, 2008

Mini-case on Cerberus from NY Times

Investments Are Faltering in Chrysler and GMAC -
"...for Cerberus, named after the mythological three-headed dog who guards the gates of hell, the news keeps getting worse.

On Wednesday, Chrysler, which owns the Jeep and Dodge brands, said its sales in the United States fell by a third in August ....The same day, GMAC, in which Cerberus holds a 51 percent stake, said it was trying to stanch the bleeding from a business that was supposed to be immune to the ups and downs of the car industry: home mortgage lending. GMAC and its home loan unit, Residential Capital, announced that they would dismiss 5,000 employees, or 60 percent of the unit’s staff, and close all 200 of its retail mortgage branches....

A Cerberus spokesman said in a statement on Wednesday that it remained confident in its management of Chrysler and GMAC. “No one is pleased with current market conditions,” he said. “However, Cerberus is a patient investor and not a market timer, and we take a long-term view of our investments. Our funds are structured accordingly.”

Class discussion questions: Some ideas for a class discussion.

1. What does this say about the limitations of diversification? Notice how even though Cerberus seemed diversified, bets that were at first glance uncorrelated (mortgages and car sales) both turned against them at the same time.

2. What does it say about long term vs short-term investment strategies. For instance the article states :

"Over the years, Cerberus excelled by gaining control of companies in bankruptcy and nursing them back to financial health....Top executives at Cerberus have said they are determined to fix the company and that their $7.4 billion investment will pay off.

What risks does a firm incur when holding onto an investment that turns bad? What is the risk of selling now? (i.e. losing out on return if they turn it around). Can you think of anything from own life that was like that?

3. Upper level class? try this. What does this type of strategy suggest about returns to private equity funds? How is this related to the "survivorship" bias problem?

SBU note: the on campus fitness center is in large part the result of a multi-million dollar donation by Bill Richter who is a founding partner of Cerberus, so there is a higher degree of interest in Cerberus on campus.

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