This Firm Wins Even if Knight Ridder Loses

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By Allan Sloan
Tuesday, November 29, 2005

Bruce Sherman, the money manager who has forced the Knight Ridder newspaper chain to put itself up for sale because its stock performance has been crummy, has performance issues of his own.

In an irony that's simply wonderful, Sherman and his associates, whose firm is Knight Ridder's biggest shareholder, are virtually certain to get a $300 million performance bonus next summer even though their recent performance for investors has been well below par. That's because their performance payments don't depend on how well Sherman's firm, Private Capital Management, performs for its investors. It depends on how Private Capital performs for its owner -- the Legg Mason money management company, which purchased it in 2001.

Barring a catastrophic collapse in the amount of assets that Private Capital has under management, the firm will easily meet the revenue target called for in its contract with Legg Mason, which will fork over the $300 million next August.

I'm basing all this on public records, because neither Sherman nor Legg Mason would comment.

Before we proceed, some disclosures. I'm a former employee of Knight Ridder, in which I own a token two shares. I have very large (for me) stock holdings in several of the newspaper companies in which Private Capital Management has very large stakes. Finally, while I'm a big fan of shareholder rights, I think the proposed breakup of Knight Ridder will be bad for journalism, which is my life's work. New owners will almost certainly depopulate newsrooms even more than Knight Ridder already has, accelerating the decline of its papers.

Back to the main event. If you read the Private Capital-Legg Mason sales contract, which Legg filed with the Securities and Exchange Commission on Aug. 10, 2001, you see that Sherman's performance payments are based on the revenues that Private Capital generates for Legg Mason, not on how well Private Capital performs for its investors.

That's typical for a sale of a money management company because the buyer wants to make sure the assets stick around (and continue to generate fees.) Private Capital (minimum initial investment: $2.5 million) operates like a mutual fund, whose fees are based on the amount of assets it holds, rather than like a hedge fund, whose managers typically get a share of investors' profits as well as a percentage of the assets.

Sherman and his partners got $682 million from Legg Mason for their firm in 2001 and got a $400 million performance payment in 2004. Now they stand to get a final performance payment of up to $300 million.

Let me give you the short version of what Private Capital must do to earn that money and why I think it's a sure thing that has nothing to do with the price of Knight Ridder stock. Private Capital's revenue target is a bit over $200 million for the year that will end on July 31, 2006. Private Capital currently has about $30 billion under management and charges fees of around 1 percent a year. That works out to $300 million, well above the target level. Since a third of that year is already over, Private Capital will earn the performance bonus unless close to half its assets leave by next summer -- which I consider inconceivable.

That being the case, the timing of Sherman's campaign against Knight Ridder, which became public on Nov. 1, has nothing to do with performance targets. Rather, I think, it has to do with Knight Ridder's bylaws, which had a late November deadline for nominating dissident candidates for the company's board. On Nov. 13, the company changed its bylaws and made the deadlines much later, a victory for Sherman.

Sherman has had an excellent long-term performance record for investors, even after subtracting his fees. Private Capital says its returns after fees have beaten the Standard & Poor's 500 by more than 8 points since 1987, when it set up shop. But this year, Sherman has been strictly from blahsville. As of Sept. 30, his portfolio was down 0.6 percent (after fees) for the year, while the S&P 500 had returned 2.8 percent.

While Private Capital's assets under management have been stagnant for a year, according to its SEC filings, they've quadrupled since Legg Mason bought it. That's made Private Capital a lucrative deal for Legg Mason, even though lately Private Capital hasn't been very lucrative for Private Capital's investors.

Sherman's performance may rebound, as it has on several occasions in the past, but he'll have his money either way.

You have to love it. Knight Ridder, once a great company and a fine stock, is takeover bait because its current performance hasn't lived up to its past.

Sherman, who put the company in play, hasn't lived up to his past, either, at least this year, but he's headed for a huge payday because of the assets he's attracted based on the performance he used to have. Isn't Wall Street a wonderful place?

Sloan is Newsweek's Wall Street editor. His e-mail issloan@panix.com.


© 2005 The Washington Post Company

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