To anyone who cares about bonds, Bill Gross, the chief investment officer of Pimco Advisors, is a living god. Gross, 55, runs the biggest bond fund in the country, Pimco Total Return, and his uncanny knack for calling twists and turns in the bond market has attracted tons of private-account bond money. Gross's reputation has made Pimco the biggest bond manager in the United States. "He's the king of bond funds," says Ed Rosenbaum, research chief at Lipper Analytical Services Inc.
But despite Gross's high-bondwidth profile, Pimco Advisors has had almost no profile. Which is fine with those of us who realized that you could buy a piece of this very profitable outfit on the New York Stock Exchange. But rather than buying shares in a corporation, you're buying units in a limited partnership. Owning Pimco units gives you a piece of Gross's action without having to invest in bonds. Pretty nice.
But our happy little unit-holder world got kicked over recently when Pimco agreed to be taken over by a giant German insurance company, Allianz AG. Normally investors love it when their company sells out. But for investors in Pimco, there's not much to love in the deal on the table. The price seems low, the biggest stockholder isn't selling, the managers are getting new employment contracts. This raises questions about the conflicting roles of big holders, small holders and managers. Guess who gets the short end here? Hint: It's not the big holders or the managers.
Before we proceed, disclosures. I own 250 Pimco units and would normally never write about this deal because I'm a party at interest. But I think there are points here that someone ought to raise. So I'll buy my way out of the conflict. If Allianz raises its price or another buyer emerges within a year, I'll donate to charity anything I get over $38.75 a unit, the price Allianz is offering.
And now to the main event.
There's been talk about how $38.75 is a great price because Pimco was trading in the 20s before takeover news leaked, it's 13 times Pimco's operating profit and so on. But let's look at cash, which is always preferable to statistics. Pimco pays holders $2.40 a unit per year, a payout that's rising as Pimco's cash flow rises.
Here's the math: Borrow $38.75 at 6 percent, cover the interest and buy Pimco with its own cash flow. Future cash-flow increases are a nice bonus. As is the tax break, spotted by Robert Willens of Lehman Brothers Inc., that would save a buyer about $850 million over 15 years.
The tax break, if you're interested, consists of Allianz (or any cash buyer) being able to deduct the entire purchase price in excess of $12 or $13 a share because Pimco Advisors is a limited partnership. (The $12-to-$13 number, which comes from Pimco, is based on all sorts of complicated calculations.)
The deal calls for Allianz to pay $3.3 billion for its Pimco stake. Around two-thirds of that--call it $2.2 billion--would be deductible over the aforementioned 15-year period. Multiply the deduction by Allianz's U.S. tax rate of 40 percent or so and you get an $880 million saving, which I've rounded down to be conservative.
So why do the math-literate and honorable folks at Pimco buy into this? Like everything about Pimco, it's complicated. Kenneth Poovey, its chief operating officer, says Pimco has to expand internationally to avoid dwindling into a small, niche player. But its partnership structure makes big purchases difficult, Poovey says, and its own forays abroad haven't produced much.
Hence the idea to hook up with a big foreign player. Poovey says Pimco first proposed buying Allianz's money-management business by issuing new partnership units to Allianz, but Allianz insisted on majority ownership and operating control.
Enter Pacific Life Insurance Co., Pimco's biggest holder, with a 34 percent stake. It didn't want to sell. So for Allianz to get its majority, it had to buy out Pimco's managers (who own 22 percent) and public investors (44 percent).
The Pimco managers are getting the same $38.75 a unit the public will get--but they can cash in stock options, they get new employment deals, they get $100 billion-plus of Allianz's money to manage. So they receive the same price public holders do, but in a different deal.
Although Pacific Life wouldn't talk to me, it's clear why it doesn't want to sell. After paying capital gains tax, it wouldn't have enough money left to generate anything like the annual income its Pimco stake produces.
Fair enough. But why did Pacific Life approve a deal it wants outsiders to take but is unwilling to accept itself? The company says I should wait to read the proxy statement describing the deal--which isn't out yet.
Pimco's Poovey says, "For me, personally, I would have been happy just going on holding my units," but Allianz wouldn't go along. "If you want cash, this is a good deal," he says.
A pretty big "if." Poovey says public investors can choose to vote the deal down when it comes up for their approval next year. I'll vote no, but I don't expect to win. Nor do I expect much--other than lawyers' paydays--from the suits that have been filed. So it looks like we'll have to invest in Bill Gross's funds to buy a piece of him. Hmm. Maybe I can learn to love bonds.
Anjali Arora contributed to this column. Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org.