Ex-Fairholme Chief Raises His Own Barn

Nov 28 2012 | 12:44pm ET

Charles Fernandez, the former president of Fairholme Capital Management, always wanted to hang out his own shingle—and now he has.

His Barnstar Opportunities Fund, a long-bias hedge fund that aims to exploit market dislocations created by regulatory, legal or financial circumstances, debuted earlier this month. It was named, Fernandez told FINalternatives, for a symbol found “on almost all barns in the United States,” one that stands for “good luck, working together and organic growth.”

While the Florida-based fund is an event-driven vehicle, Fernandez argues the term is widely misunderstood.

“What a lot of people don't understand about event-driven is, we come in once the event has occurred," he said. "A deep-value investor, for example, will say, 'You know, XYZ stock is today trading at $6 a share and will produce a dollar of cash flow and it should trade at $10 a share.' That's not what we do.”

Instead, he said, they scan the universe of public, regulated entities, mostly American, in search of those in financial, legal or regulatory difficulties (difficulties which, he says, often “bleed into” one another.)

“We focus on companies that are regulated entities, because when you have a regulated entitity, when they get a dislocation there's a lot of publicly available information and there are a lot of professionals that you can engage to analyze, and there's a lot of transparency if you can really get the right people to analyze how much damage there is. Is it going to put the company out of business? Is it something the company can recover from? Is it something that spending a certain amount of money, such as to pay taxes, fees and other things, and restitution can fix?”

Once a target company has been identified, Fernandez assembles a team of regulatory and legal experts to conduct due diligence—he says he can call in as many as 15 to 20 experts for a process that “never takes less than about three weeks to a month” and “could take as long as six months.”

The team determines whether or not an investment is warranted and whether that investment has an opportunity for a 50% upside with “significant downside protection” from assets and/or cash flows.  These conditions met, Barnstar will participate in a recapitalization or restructuring process with the company, while determining the best part of the capital structure for its own investment.

Fernandez says the opportunities Barnstar seeks out are the kind of opportunities that are out there “all the time.”

“A lot of people assume that these things only happen when the market is bad. Right now, there has been, with the fiscal cliff coming, a lot of talk about the market and what's going on, but it doesn't really matter because there are dislocations related to regulatory, financial or legal issues all the time. When things are bad there is a lot of inventory out there, a lot of low-hanging fruit. But when things are good, companies sometimes get too aggressive to try to make earnings and they get themselves in regulatory problems. So there are opportunities on both sides and people make mistakes all the time.”

Barnstar Opportunities will hold four to six core positions, accounting for 40% of its portfolio, with no one position accounting for more than 15% on a cost basis, said Fernandez. Another “15 or so positions” will account for the remaining 60%:

“These 15 positions are companies that have dislocations that aren't major dislocations which require an enormous amount of research and time, not perhaps as severe as, 'Is the company going to go into bankrutpcy? Is the company going to be put out of business? Is the company going to lose its license to operate and have to sell its assets?' They're not going to be those kind of dislocations.”

The fund will be roughly 95% U.S. stocks, 5% Canadian and Australian—Fernandez said this is because his team is familiar with the U.S. legal system and U.S. regulatory bodies, less so with those of foreign countries.

Fernandez has invested his own money in the venture and has already attracted some outside money,  although he would not reveal the fund's current assets under administration. He says the minimum investment is $3 million and he thinks their “sweet spot” would be about $1 billion.

Among those who have sat up and taken notice of the new fund is Goldman Sachs, which is acting as Barnstar's custodian and has assigned a capital introduction team to work with it.

“I think they see the future,” said Fernandez of Goldman's unusual interest. “They see that this is a very unique opportunity and there is a need out there for it and it's not the typical long/short hedge fund.”

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