Chapter 5
The Fearless First Mover
We keep our cool when others don’t. The point is, markets adapt. People adapt. Don’t listen to all the crap out there.
—David Tepper, May 2010 Ira Sohn Investment Conference speech
David Tepper had had enough. It was late 1992, and the 35-year-old had just been passed over for the coveted role of partner at Goldman Sachs for the second time. Tepper had risen through the ranks as a junk bond trader, raking in millions of dollars for the venerated financial institution, year after year. He had worked so hard, and thought to himself, damn it, it just wasn’t fair. But at least this year’s snub wasn’t a mystery. Tepper knew the reason very well, which was why it was time to leave.
When he landed at Goldman in April 1985 after leaving his job as an analyst at Keystone Mutual Funds, he was 27 and thought he had hit the jackpot. Goldman was starting its new high yield group, and Tepper had signed on as a credit analyst for the team. From behind his gargantuan mahogany desk in his office in Short Hills, New Jersey, the now 54-year-old Tepper recalls how he soon realized he didn’t want to be an analyst, but wanted to be in the hot seat, trading. “I really wanted to learn about this trading business, and the guy running the desk at the time was not really a corporate guy,” says Tepper, who, at a stocky six feet tall with bright, baby blue eyes, looks more like a linebacker than a human calculator. “He wasn’t good at understanding companies and was more familiar with how interest rates moved so he wasn’t really right for the job.” Within six months, Tepper earned the right to move up.
Tepper had worked like a dog while he was a credit analyst at Keystone, but when he made the move to Goldman Sachs he did not exactly receive an enthusiastic welcome from his colleagues. Travelers Corp. had acquired Keystone in 1979, and, he says with a chuckle, “Travelers cut Goldman off when they hired me. It was a bit hard going in there because a few of the salesmen were so pissed off at me that Travelers wouldn’t do business with them. But, by the end of the year, they decided to make me a trader because they thought I knew what I was doing,” he says. That wasn’t the only surprise for Tepper that year. He had signed on to the job in April 1985 for a salary of $150,000, far more than he had been making at Keystone. “My boss called me off the trading floor into his office for my year-end review and told me they were going to give me the entire $150,000. I was ecstatic,” he remembers. “I thought they were just going to prorate it and had no idea how the place worked or anything about bonuses. I was just happy, you know—just stupid.”
The following year, Tepper made even more money for Goldman and became the head junk bond trader. Around bonus time, Tepper was again ecstatic. “They paid me some amount which was so low for what I was doing but I had no idea—I couldn’t be happier.” He was anxious to get home to tell his wife Marlene the good news, but first he had to make a stop at the local 7–11 to buy sugar wafers for their celebration. The $600,000 paycheck was the largest he had ever received in his life. “I didn’t know that I was still underpaid!” he roars. The next year he continued his winning streak, making more money for the firm during the stock market crash of 1987. “Going into the crash I had set up my entire portfolio as just short—I had no long positions. I made a fortune during and after the crash,” he says with a chuckle. “It was very cool.” Unfortunately, the rest of the firm didn’t do as well. “I still got a raise but not as much as I should have.”
Despite his stellar track record, Tepper wasn’t the best-liked person in the department—mainly because he wasn’t afraid to stand up to others who weren’t 100 percent focused on the job. Eighteen-year-old chess prodigy Boaz Weinstein (who went on to develop the credit-derivatives department of Deutsche Bank and now runs $5 billion Saba Capital) was an intern on the trading floor with Tepper under David Delucia. Weinstein had a stroke of luck after stopping by Goldman one afternoon to visit his sister, Ilana. Weinstein had been trying to get an internship at the firm without success. After being told there was nothing available, he stopped in a bathroom on the way out and ran into Delucia, then the head of corporate bond trading. Delucia, who was ranked an expert by the U.S. Chess Federation, had played Weinstein, who already ranked a master, many times. He arranged for a series of interviews until Weinstein got an internship on a Goldman trading desk.
“I don’t really even think he was an intern,” says Tepper about Weinstein. “I think he was just there to play chess with Delucia and I didn’t understand it so I just gave them both so much shit about it. I used to be like, ‘What the hell’s this guy doin’ here? Why’s he hangin’ around?’ ” he remembers. To kill time, some days Tepper would shout out trivia questions like, “Guys, guess how many synagogues there are in Michigan?” and it would be Weinstein’s job to look it up. “This was before there was Google,” he laughs. “But I would still always be right. I used to be very good at history.”
Tepper remembers a few occasions when he even argued with the late Fischer Black, the prominent economist who co-authored the famous Black-Scholes option pricing formula. Occasionally, Black would go down to Tepper’s office and question certain positions he was taking. Black advised Tepper that the debt was overpriced and that he should buy the equity instead. Tepper remembers responding, “Fischer, if I listen to you, I’m gonna be fired. You’re probably right over the longer term. But in the next three months, I don’t think you’re right. If I listen to you, I’m gonna get killed.”
Tepper’s instincts were impeccable. He continued to pull in millions for the firm and was up for partner in 1988 and then again in 1990. By 1990, at the age of 33, being passed over for partner was very upsetting. “I kept making the firm so much money.”
Case in point: the 1990 savings and loan crisis. Tepper bought the holding company paper of troubled financial institutions like Republic Bank and MCorp. He understood that even though the failing banks were being seized by the government and reopened under new owners, the bank holding companies were in great shape, with billions of dollars in cash and other nonbranch assets. Tepper realized that the government couldn’t break into the holding companies to take those assets.
But at the same that Tepper was raking in big profits at Goldman, the P&Ls of other books across the bank were just managing to stay in the black. Also, when he joined the junk bond group, Tepper took bankruptcy investments away from the risk arbitrage desk and became caught in a turf war. But his bigger fights were with the corporate finance team over trading for an internal fund investing for Goldman. Tepper thought some of the trades they were asking him to make were inappropriate, and so he notified the legal department, a move that seriously angered the finance team. “I just didn’t give a shit,” he says. “What was I going to do? Trade for them when I think they’re doing something that’s wrong? And then not see my kids again because I’ll get blamed for the trades? So I didn’t do the trades, but I didn’t get made partner either.”
Even Tepper’s mentor Robert Rubin couldn’t help him make partner. The legendary head of Goldman’s international risk arbitrage desk had left the department by the late 1980s and served as co-chairman of the firm from 1990 to 1992, when he left Goldman to join President Clinton’s economics team, first as the director of the National Economic Council, then as the Secretary of the Treasury. After Rubin moved on, Tepper continued to turn to him for advice, which didn’t sit well with Jon Corzine, the new co-head of the fixed income department. “I think that’s pretty public,” says Tepper. “People say that I basically kept going to Rubin instead of Corzine but it wasn’t for political reasons. It was just because Rubin knew what was going on with equities and Corzine was a Treasury guy that didn’t know corporates. I wasn’t disloyal to him, but I wasn’t one of his boys,” he says. “I was stupid because I was just working hard and wanted answers and to be as efficient as possible. I wasn’t trying to screw or not screw anybody.”
Tepper knew by then that he was ready to strike out on his own, and so by early 1993, after eight years at Goldman Sachs, he made his move. With the assistance of mutual fund legend Michael Price, who had been a Goldman client, Tepper started trading aggressively for his own account off of a borrowed desk at Price’s office, hoping to raise enough money to start a fund. Just a few months later he was ready to launch with partner Jack Walton, a former senior portfolio manager for Goldman Sachs Asset Management. They had collected $57 million in assets from fund of funds, insurers, and investors they met at Goldman.
Tepper and Walton only needed the perfect name for their new venture. Greek mythology was popular at the time and they first decided on Pegasus, the flying horse, before discovering it was already taken. So Walton went to the library and came back with a book on horses. They knew they needed a name that started with “A” to be first to receive faxes on trades, which was how orders were processed back then. They had learned well from their stints at Goldman that two minutes could make or break you. The first name they came across was “Achaikos,” but they found it too hard to pronounce. So they skipped ahead and settled on “Appaloosa.” And the fund was born.
Growing up, Tepper always wanted to be a millionaire by the time he was 30. “Like many kids, growing up without much money was inspiration enough to do well,” he says. Barely into his early 30s, Tepper was on the brink of building a business that would go on to earn him billions, making him one of the richest men in the world before his fiftieth birthday.
David Alan Tepper was born on September 11, 1957, the second of three children. He had a lower-middle-class upbringing in a four-bedroom brick row house in the Stanton Heights neighborhood in the East End of Pittsburgh, Pennsylvania. His father, Harry, worked as an accountant (not a CPA, Tepper specifies). His mother, Roberta, was an elementary school teacher who taught in a number of different Pittsburgh public schools over the years. The son of “just” an accountant, Tepper was exceptional at math from a very young age. He was so remarkable that his older sister Sheryl brought him into her second-grade class for show-and-tell. “I was only four or five years old but I could already do multiplication and complex adding. I could barely even talk at the time but I could do math,” he says.
Tepper had been shy in grade school, but later he grew into the role of class clown and became active in sports. “I was a big kid and was quiet in the beginning, but as I got into football in high school I turned into a joker and was well liked,” he says. He spent time during his teen years with his maternal grandfather, Benjamin Tauberg, who shared with his grandson a love of baseball and the Pittsburgh Pirates. Tepper collected baseball cards as a kid: “I knew every player in the major leagues. You could pull a player’s card, and I could tell you the statistics.” Also an avid football fan, he fulfilled a lifelong dream when on September 25, 2009, Tepper signed a deal to purchase a 5 percent noncontrolling interest in the Pittsburgh Steelers. He reportedly flies on a private jet with four of his closest friends to attend every home game.
Tepper attended Peabody High School, an inner-city school in the East Liberty neighborhood near his family’s home. Tepper recalls that the school had a reputation for being “combative” and, during most of his sophomore year, fights would break out with other teams. Eventually, the school decided to bar all students from attending games.
Though Tepper was in the scholars program, he frequently found himself in the vice principal’s office. One such time, after his English teacher threw him out of class, the hall guard stopped him to ask what he was doing in the hallway. Tepper responded, “My English teacher threw me out of class. He told me to roam the halls and act like the animal I am. I’m doing the best I can.” He laughs at the memory, saying, “I wouldn’t say I was a bad kid, though, just bored.”
On another occasion, Tepper was sent to the office along with his friend Will Wanamaker after starting a fight in the hallways with squirt bottles from chemistry class. “I was just squirting water,” he says with a chuckle. The punishment for bad behavior at Peabody was either 10 days of suspension or 10 whacks with a wooden paddle. “I remember the paddle—it was square and had holes in it so it would hurt more because there was no wind resistance,” Tepper explains. He and his friend were sitting in the corner of the vice principal’s office contemplating which one was worse, when the fire alarm went off and Tepper and Will were shooed out of the office. “That was the only time I ever got close to that darn paddle,” he recalls. “I was questioning whether to tell my parents, which could have been worse. It was a really interesting choice. I think I was leaning toward the whacks.”
Even though he was in the scholars program in high school, Tepper wasn’t motivated to work hard and never earned an “A” in four years. Often, he would skip class and go to the seminary across the street. “I went there because they’d give you free pancakes,” he remembers. “Afterwards I’d hang out with the priests. I’m Jewish, but I still wanted the free pancakes!” he laughs. “It wasn’t like I was a bad student. I just didn’t take it seriously.” Some things in high school, however, he did take very seriously. During his senior year he won Peabody’s Best Actor award for his role as the father in Bye Bye Birdie and even received a standing ovation during the awards ceremony. By then, Tepper had surely gotten over his introversion. “You can’t be totally shy and get the best acting award in high school,” he points out cheekily.
Though his father was not the soft and cuddly type, Tepper used their shared love of numbers to learn about investing while growing up. “I remember my dad had made some small investments in a few companies, so I would track them and see how he was doing.” His dad wasn’t a great investor, but Tepper was intrigued and can remember talking to his high school teachers about the stock market. When he was a junior, he bought his first stock, Career Academies. He bought about 100 shares of the $2 stock, “but then the whole thing went bankrupt,” he shrugs. “It was a bad investment, but that didn’t deter me.” Years later, after Tepper started his career at Goldman Sachs, his father won the lottery, giving him $30,000 a year, what he calls his dad’s “pension.”
Things changed very quickly for Tepper when he entered college at the University of Pittsburgh. He sums it up in seven words: “I had to pay for it myself.” Having done very well on his SATs and earning 4’s and 5’s on his AP exams, he was able to get enough college credit to skip one semester and graduate in only three and a half years. “Since I had to pay for it all myself, that was really important to me. It was funny, in high school I never had an “A,” but in college I almost never didn’t have an A.” To pay his way through school, Tepper worked at the Frick Fine Arts Library on campus and took out loans.
After college and before graduate school, Tepper also began dabbling in trading. “I had some scheme going where I was taking advantage of small moves in the market by buying options. It was like clockwork. I would put in orders at a sixteenth of a point and sell at an eighth and pay a dollar or two for commission and come out way ahead. It was just a little anomaly in the market at the time, and it was a really steady income.” Until the stock market took a sharp turn in 1982, Tepper was able to make enough money to pay for his tuition and room and board, about $2,500 a semester. Despite, or perhaps because of, all the hard work Tepper put in, he remembers his college years fondly. “I wish I was still in college,” he says with a sigh. “I just remember it as a really fun time in my life.”
In 1978, Tepper graduated summa cum laude with an honors degree in economics and started as a credit and securities analyst in the Trust department of Equibank in Pittsburgh. Two years later, unsatisfied with his position, he enrolled in Carnegie Mellon University’s business school. “I was really nervous because Carnegie Mellon was such a good school. I thought I might not be as smart as some of the other people because I had only gone to Pitt, but that wasn’t the case.” His first year in business school he earned straight A’s. “So my grades actually got better with every level of education because I kept getting more serious—and school kept getting more expensive,” Tepper finishes with a laugh.
These days, Tepper gets boatloads of letters from kids asking him to pay their college tuition. “I’m gonna have somebody put together a form letter for that,” he told New York magazine when they did a profile of him in September 2010. “I think people should be self-reliant. You should work and be self-sufficient. That’s what I did,” he says.
By 1982 he earned his MBA, then known as an MSIA or master of science in industrial administration, and began his real education: two years in the treasury department at Ohio’s Republic Steel. There, he was introduced to the junk bond market by working on financings of non–investment grade debt. In 1984 he was recruited to Keystone Mutual Funds in Boston, where he met his wife, Marlene, while she was working at Wang Laboratories. He worked as an analyst for their junk bond group for about a year before being recruited by Goldman Sachs.
Through the years, Tepper has made several large donations to the University of Pittsburgh, including endowed undergraduate scholarships, university-run community outreach programs, and academic centers. In March 2004, a year after he had officially become a billionaire, Tepper announced that he would donate $55 million to the Carnegie Mellon Graduate School of Industrial Administration, after being encouraged by his former professor, Kenneth Dunn, who later went on to become dean of the school. As a result, the name of the school was changed to the David A. Tepper School of Business.
“I’m lazy competitive, if you know what I mean,” Tepper says one winter afternoon over lunch of spicy tuna rolls at Appaloosa’s offices across from the Hilton in Short Hills, New Jersey. His 30-person staff is predominantly male, and, at a glance, Appaloosa has the air of a very high-end frat house. But no matter how it appears to outsiders, Tepper is very focused on running a fierce and fearless operation. “The main thing that makes Appaloosa stand apart from the pack is the depth of our analysis and the fact that we’re not afraid to be the first one to act on our convictions. If you look at our history over the years, we are usually the first mover in a country or situation, time and time again,” says Tepper.
As of January 2012, Tepper’s firm had about $12 billion under management, divided into two separate funds: Appaloosa and Thoroughbred. After starting with $57 million in 1993, the funds grew quickly, and by 1996, it had already hit $700 million. What Tepper means when he describes himself as “lazy competitive” is that in his everyday life, he’s a pretty laid-back person. But in business, he likes to win. That’s why one of the most painful lessons Tepper learned over the years didn’t even involve huge dollars losses but rather a lost opportunity to “win big.” The takeaway: never listen to pushy investors. “It’s the manager’s decision to make the right calls for the portfolio,” he says, “not the investors.” What Tepper is referring to is a large short position on the Nasdaq in 2000, which he covered merely five weeks before the tech bubble crash due to constant investor pressure. Though he didn’t lose much money, he considers it one of the worst trades of his career. In fact, Tepper’s regret is that he missed the opportunity to make a fortune.
“So I have a combination of laid-back competitiveness on the field of play,” he explains. “You see that with some athletes that come in with earphones on and are hanging with the music. And then when you get them on the field, they’re focused and they’re fierce. So in the outside world, I’m that easygoing person. But if I’m on the field, I wanna win. And we win a lot,” he says, looking at me with a sideways smirk as he sips his orange soda.
Tepper is right. Besides having one of the best track records of any hedge fund manager in the business, returning an average of 28.5 percent net to the firm’s investors since 1993, his fund is consistently ahead of the industry on deals as well. Appaloosa stood at approximately $16 billion in total assets under management coming into 2011, following a stellar 2010 when the firm was up 28 percent net. But outshining both of these recent wins is its 2009 performance, when the fund was up 132 percent net and raked in almost $8 billion in profits betting on bank debt and stocks like Bank of America, AIG, Citigroup, and Wells Fargo when they were at their weakest.
Three times in the life of Appaloosa it has lost more than 20 percent: 1998 (down 29 percent), 2002 (down 25 percent), and 2008 (down 27 percent). And all three times, the firm made its high-water mark back in six months en route to a stellar year thereafter. Indeed, Tepper’s investors have been trained to look forward to down years at Appaloosa. The year after Tepper lost money in each of the three years he was down, he had record performances: up 61 percent net in 1999, up 149 percent net in 2003, and up 132 percent net in 2009. “This is a good place to be during a panic. If you came to our office when we were down 20 percent, you wouldn’t see a difference. It’s another day at Appaloosa. The best time to invest with me is when I’m down,” he told hedge fund publication AR+Alpha in February 2010.
There was no fear within Appaloosa’s walls during the 2008 financial crisis. Tepper says the crisis wasn’t a shock to Appaloosa; the team knew exactly how to handle it. “The recent crisis wasn’t so hard because we went through two others before this,” he says. “1998 was hard because that was the first one we really went through. We took our book down, raised cash, and did different things than we had ever done.” During the final quarter of 2008, Tepper bought cheap commercial mortgage-backed securities, credit card debt, and government-guaranteed student loans. That seemingly noxious stuff no one else wanted at the time ended up being a critical component of Appaloosa’s $8 billion gain the following year.
Appaloosa has no investment committees, no daily meetings. “The daily meeting is every second of every day of the year,” he told Bloomberg Markets magazine in February 2010. “There’s no place to hide at Appaloosa.” The firm’s $8 billion gain in 2009 resulted in a $4 billion payday for Tepper, reported to be one of the biggest single-year paydays for a hedge fund manager ever. Tepper has since trimmed the fund size by returning money to investors, bringing it down to $12 billion, closer to what he calls a hedge fund’s “ultimate sweet spot.” He says, “You have every advantage of being a big fund at $10 billion. Above that, it gets tough to manage.”
Tepper feels that what separates his firm from the pack and enables it to bang out such stellar returns is that they are not afraid to lose money. Besides the fact that Tepper and his partners own about 55 percent of the firm’s assets (the other 45 percent is owned by outside investors, including institutions, wealthy individuals, and foreigners), the firm is allowed to lock up 75 percent of the assets for a period of three years if need be, even though it has never put this into effect—and for good reason. This sets up a stability that leads to long-term clients rather than “hot money,” he says. “We’re value-oriented and performance-based like a lot of funds. But I think what differentiates us is that we’re not afraid of the downside of different situations when we’ve done the analysis. Some other people are very afraid of losing money, which keeps them from making money.”
Tepper thinks of his investment track record as something similar to a connect-the-dots game, except the puzzle is never finished and the prize is billions of dollars. “When I got to Goldman, I changed the way junk bonds were traded. It was pretty radical, moving the whole market to trades on sectors. It used to be traded by maturities, which helped perpetuate the monopoly held by Michael Milken at Drexel Burnham,” explains Tepper. This approach to the U.S. junk bond market would serve Appaloosa well in its pursuit of global opportunities.
Venturing into the world of emerging markets in the mid-1990s was like second nature to Tepper, who had been a key player in many “different capital markets and things that were happening around the world,” he says, from his time at Goldman. Tepper had sat next to guys who ran the emerging markets desk at the firm and learned a lot from them. It is just a different type of credit analysis, according to Tepper. He says: “You’re basically doing country analysis, which wasn’t really that hard for us to pick up. And then, it’s just like everything else—analyzing all kinds of investments. You’re trying to figure out that inflection point.”
Tepper remembers his first trip to France, which ended up being unforgettable, but not for the right reasons. In 1995, he was invited to Paris to meet with a custodian for the Getty family and a French bank. So Tepper and one of his partners boarded the Concorde jet, which could fly at twice the speed of a regular aircraft. Less than an hour into the flight, right after breakfast had been served in first class, Tepper heard an explosion at the back of the plane and turned around to see that the passengers were white as sheets. Tepper looked at his partner, Ronnie Goldstein, and said, “I think we’re in serious trouble here.” Ronnie responded, “If we’re going to die, I’m finishing my breakfast. I’m not dying without a full stomach,” Tepper recalls with a chuckle. “It was classic Ronnie.” One of the plane’s engines had died, but, miraculously, the pilot was able to turn around and get everyone back to JFK safely. “There was already another Concorde on the runway waiting for us, but only about five people reboarded, including me and Ronnie. We were told that we were lucky to have made it out alive. They offered us $500 apiece for our trouble. I couldn’t believe it.” By the time they reached Paris around midnight, they just wanted to head to the hotel and go to sleep. “But the French bank salesmen were still waiting to meet with us! We didn’t want to go, but in the end we decided to just do it. That’s when we knew we were getting big.”
Starting in 1995, Appaloosa made a lot of money during the Latin America crisis, as the firm held big positions in Argentina, Brazil, and Venezuela. Tepper saw that people had finally recognized the inflection point in Latin America, after which the market moved up. And that’s what the firm has done since in other countries. For example, in Argentina, they figured out they had to watch bank deposits. Tepper says: “As soon as money started coming back in the country, that market took off. So we were able to figure out the right variable, to look at the right thing to focus on. And when it changed, we were fairly early and we were able to make a lot of money.” Appaloosa’s fearlessness has served investors well. The firm was the first to buy Korean Treasuries in 1997. Tepper sent a handful of analysts to Korea to see what was going on in the country and was stunned by their findings. “We discovered the country was an export machine—a real industrial country. They were sacrificing their gold for the good of the country. We were frankly surprised by the level of sacrifice,” says Tepper.
In 1997, Tepper was scheduled to meet Russian investor Boris Jordan at the Renaissance Capital offices in Moscow, but when he arrived, Jordan was not there. Tepper and a colleague somehow ended up in the basement facing five men with machine guns. Tepper had learned some Russian in high school and managed to say, “We’re going upstairs!” He later received a call from Jordan’s assistant canceling the meeting because there was a bomb scare in the building. “I was like, ‘Are you kidding me? Why didn’t you tell us before bringing us into the middle of a death trap?’”
In retrospect, Tepper was just too long in Russia going into 1998. He had made a lot of money in 1996, but then miscalculated the risks. The Russian ruble had been devalued, and the country defaulted after an International Monetary Fund (IMF) deal. Tepper had thought that bond prices would go up, which they did for about a day and a half before going straight down. Appaloosa hadn’t realized how fast the markets were becoming illiquid, as Russia’s default brought on a near global financial meltdown. The firm was about $1.7 billion in assets at that time, and lost approximately 29 percent on the whole and $80 million on Russia.
“It was the definitely the biggest screw-up of my career,” says Tepper. “We had huge emerging market and junk positions that we sold down to avoid disaster, so we were able to act fast. Our biggest mistake was not realizing how illiquid markets could get so quickly. Many firms went out of business at the time, and at one point, I wondered if we would be able to survive. That was kind of an interesting lesson for a lot of people,” he says.
But Tepper bounced back in 1999—and with a 61 percent net gain, no less—as he bought back the Russian bonds post-default. The banks couldn’t get the bonds off their books fast enough, so Appaloosa was able to swoop in and collect the debt at five cents on the dollar. “It was like minting money,” he recalls. “It was almost worth all of the hell we had to go through,” he says with a laugh.
Tepper knows that his way of doing things invokes a certain degree of risk, but for the most part, it yields bar-none results. In 2001, Tepper generated a 67 percent net return by focusing on distressed bonds. He has made significant gains year after year by investing in under-the-radar stocks such as MCI, Mirant, and Marconi, leading to huge profits for the fund. His 2003 investment in Marconi Corporation was a prime example of how Appaloosa successfully jumps into the mix during a reorganization process and cherry-picks cheap assets ahead of the pack, which would only serve as a warm-up for the behemoth bankruptcies following on its heels. Tepper estimates that the Marconi investment added more than 5 percent to the flagship fund’s percentage gain that year. The bulk of the fund’s 2003 gains came from purchasing the distressed debt of three of the then-largest bankruptcies in corporate history: Enron, WorldCom, and insurance giant Conseco. When the companies emerged from bankruptcy and the debt appreciated, Appaloosa went up a whopping 149 percent net in 2003.
Former employee Alan Fournier, who now runs $6 billion Pennant Capital, sent Tepper a fitting present to celebrate his success: a pair of massive, veiny, brass testicles affixed to a plaque inscribed with the words The Most Valuable Set of All Time. Fournier says that every time Tepper is working on a big trade, he calls him up and screams into the phone: “I’m rubbing your balls for good luck!”
Tepper’s photographic memory is one of his most valued possessions. It’s also what brings him pain. Like a professional athlete after missing an important shot, Tepper replays his losses in his head. “It is the only way you learn from your mistakes,” he says. Appaloosa’s four-year struggle with Michigan-based auto parts manufacturer Delphi Corporation is one of those what-doesn’t-kill-you-makes-you-stronger events that has brought Tepper both pain and the opportunity to learn.
In October 2005, Delphi filed what was then the biggest bankruptcy in U.S. automotive history. Then, in March 2006, a U.S. bankruptcy judge granted a motion by one of Delphi’s largest shareholders to create a committee to represent the interests of stockowners in the auto parts maker’s reorganization. At that time, Appaloosa held 9.3 percent of Delphi shares and asked for a separate committee, claiming that Delphi overstated liabilities when it filed for bankruptcy in October.
But after two years of negotiation, the situation wasn’t getting any easier and Appaloosa couldn’t see a light at the end of the tunnel. Tepper decided he had had enough. “It wasn’t worth the time at that point,” he explains. “We’re known as people that will fight till the end but I’m not going to fight something just to fight something. I’ll fight if I have to, but I’m actually a lover and not a fighter at heart.” In the end, Appaloosa and the consortium were collectively ordered to pay Delphi $82.5 million in fees plus expenses.
“Delphi was a big investment commitment that we thought had significant upside potential at the time. But the situation soon became very aggravating,” Tepper admits. “We thought we did everything right.” Following the Appaloosa exit in 2009, Delphi CEO Rodney O’Neal picked up the phone and gave Tepper a call. “He thanked me for everything we did to help save the company. I thought that was interesting,” he says with a smile.
Throughout 2007, Appaloosa sought ways to continue to execute on its distressed strategy, looking for various exposures across many markets. In January 2007, Tepper was just starting to see a little bit of a crack in subprime—which was an indication of things unwinding in the financial sector. As the Appaloosa team began looking closely at opportunities, one bank in particular stood out to them as particularly exposed to mortgages: Washington Mutual. Appaloosa had been keeping a close eye on the company as part of the basket of financials it had identified at distressed levels.
The Seattle-based bank, which had been the nation’s largest savings and loan, saw its stock price sink from its 2007 high due to mounting losses on risky loans and subprime mortgages. By April 2008, a group of investors led by private equity firm TPG Capital stepped in with a rescue plan, offering the bank $7 billion of capital in an effort to stabilize the company. But rising delinquencies and mortgage losses caused the Office of Thrift Supervision to step in and take over Washington Mutual’s banking unit, putting it into receivership and selling the unit to J. P. Morgan for $1.9 billion. In September 2008, the company filed for bankruptcy with 2,200 branches and $188 billion in bank deposits, becoming the largest U.S. bank to fail.
Enter Appaloosa. “We had been following WaMu very closely,” says Tepper. “We knew there was still about $4 billion in cash from TPG sitting at the holding company—and it wasn’t going down to the bank. We also knew there would be a potential tax refund,” Tepper continues, referring to the company’s ability to apply operating losses to prior years’ income to reduce taxes. “We knew we would be rewarded if we’d just be patient.”
So Appaloosa started scooping up the senior debt at between 50 and 60 cents on the dollar just ahead of the bankruptcy. “And after the bankruptcy filing, we became the largest creditor of WaMu—we understood the capital structure and the details of the corporate structure, so we knew there were assets for a recovery,” Tepper says. “We believed there was a good probability of recovery at the holding company for the bonds versus the bonds at the bank level.”On February 17, 2012, Washington Mutual was awarded court approval for a $7 billion reorganization plan by U.S. Bankruptcy Judge Mary Walrath in Wilmington, Delaware. The creditors have rights to more than $7 billion in cash from bank deposits and tax refunds, with the first slice of monies payable as early as March 8, 2012. Appaloosa’s patience paid off handsomely, although Tepper remarked, “it was a really long and incredibly painful bankruptcy process.”
The extensive time the fund dedicated to Delphi during the rise of the credit crisis in 2006 and 2007 meant that Appaloosa, usually a first mover in the distressed space, missed out on one of the biggest paydays in history: shorting the subprime market. While hedge funds like Paulson & Co. and Harbinger Capital were quietly shorting the market, building positions and raking in gains of several billion apiece, Appaloosa’s usually sharp eye was distracted from the short side of subprime. “It wasn’t that we didn’t have the trade on ourselves,” Tepper explains. “But that we didn’t have the extra time it took to figure out the best way to play it. If we weren’t torn away with some of the Delphi crap, we definitely could have hit the subprime trade better.”
By February 2008, the financial crisis was accelerating—with bank stocks bearing the brunt of market pressures. Instead of panicking like much of the investing world by bolting into gold and cash, Appaloosa was preparing to dive into the very debt and equity of financial institutions. In addition, Tepper had just raised about $1.5 billion for the Thoroughbred Fund, which remained 90 percent in cash. Because the fund had stood back from the subprime market and missed profits, Appaloosa’s performance was up only 8 percent net in 2007 and down 27 percent in 2008.
But Tepper hadn’t yet broken a sweat; he was just getting ready to roll up his sleeves. “We were very liquid when September 2008 hit. It was a financial sector event,” he says. “We had been sitting there waiting for it to tell you the truth,” he shares. “I mean, like everybody else, we were a little taken aback by the size of the declines in the marketplace, but the nine months leading up to it were kind of frustrating. Spreads were very tight in the debt markets and we had just raised money for Thoroughbred, so we had a pretty big liquidity cushion. We just did our due diligence and made sure to read all the indentures and credit agreements we could get our hands on.”
Through its research, Appaloosa had been drawn to the attractiveness of the insurance business initially because of the belief that being senior in the capital structure assured the probability of loss was very small. So they bought a little piece of the last bond issue of AIG in 2008. But when spreads widened out on a fundamental basis, it caused a run on cash collateral at the company. Tepper believes it was a great early learning experience and set up for a big investment on the other side of AIG. “Some of our best positions were ones we initially lost money on,” he says. The ultimate position size of the AIG investment ended up being over 10 percent of the fund.
The underlying thesis regarding financials was twofold: extraordinary measures would have to be taken so the institutions could survive in some form. And in order to see the greatest upside, most of Appaloosa’s investments would initially be debt securities under the premise that as “credits”—rather than equity—the banks would most likely be all right. “So there was a skewed upside versus downside,” Tepper explains. “Everything in the markets, whether investors knew it or not, was a bet on financials at the time. It was the same bet regardless of what you bought.”
Then in February 2009, the U.S. Treasury put out a white paper and term sheet online for the government’s Capital Assistance Program. Connecting the dots, Tepper figured the government wasn’t positioning to nationalize the banks if it was putting out this paper, which signaled the time was right to buy. The conversion price the government was effectively investing at for common shares meant that Tepper could buy securities in the market for a steep discount: 37 percent in the case of Citigroup and 21 percent for Bank of America.
“When the white paper came out, the government tipped its hand,” says Tepper. “If the government was going to raise equity for the banks, it meant it was establishing a floor under the equity indicating at what price that floor was. Essentially the government was telling us that it wasn’t going to let the banks fail.”
So Appaloosa quickly began buying all the common, preferred, and junior subordinated debt it could get its hands on, paying as little as 5 cents on the dollar for securities of AIG, Bank of America, and Citigroup, in addition to Fifth Third Bancorp, Commerzbank AG, and Lloyds Banking Group. “There was a lot of paper available and we had a pretty high conviction that we were right,” says Tepper. “It was all so deeply discounted—it was crazy!” The financials ended up representing more than half of the entire portfolio in late 2008 through 2009. “We typically hold anywhere from 10 to 20 positions at a time that are really meaningful,” says Tepper. “And during 2008 and 2009, there was no trade more meaningful than financials.”
As the stocks soared through the end of the year, with Bank of America up more than 330 percent and Citigroup up more than 220 percent, the fund raked in more than a billion dollars on those two names. AIG would end up being the best single trade, topping off gains from financials with another billion dollars from that name alone. Following his 2009 record-making earnings, Tepper was recognized as the only hedge fund manager to make Vanity Fair’s Top 100 most influential people list for 2010, coming in at 76.
His conviction in selected financials still stands, even though he closed out of his position in Bank of America in the second quarter of 2011. Tepper believes Citigroup stock has the potential to go up more than 50 percent depending on how well the foreign businesses perform. “We still think it’s underappreciated just how big the emerging market business is within Citigroup,” he says.
Tepper’s hope for Appaloosa is that it never gets so big that it turns into an asset gatherer rather than an investor. Instead of thinking about how to get bigger, Tepper and his team strive to decrease the amount of assets. “We don’t want to be bigger than we can invest,” he says. “The question is what size gets you—except more fees for the manager. But it doesn’t necessarily make the investor more money.”
Tepper thinks that for most funds, growing over a certain amount doesn’t do anyone any good. “Fixed income funds should naturally be a little bit larger than, say, equity funds. You want to be big enough that you can see everything and small enough that you don’t kill yourself with size. So I think different sizes are right for different types of funds.”
He gives an example. “Say you want to buy 5 percent of a $2 billion company, and have it be meaningful. That means it’s a $100 million position, which is a 1 percent position in a $10 billion fund. So if you’re an equity fund, if you keep getting bigger and get to $20 billion, that means your position is now only a half percent position. The 1 percent position doesn’t do much for the fund and so the half percent position does half as much. So there’s an aspect to the business, in equity funds especially, that gets funky on size.”
By March 2011, Appaloosa’s funds had appreciated so substantially that Tepper decided to return $600 million to investors. For the Thoroughbred Fund, however, investors had committed money for three years. The fund opened in July 2008, with a mandate to invest 70 percent of assets in fixed-income securities. Thoroughbred gained 22 percent net in 2010, after soaring 96 percent net in 2009, according to investors. The lock-up period expired at the end of 2011.
Tepper reiterates that he’s in the game to make returns, not to have assets, and is looking to place some of his personal wealth with a select few other managers. But he has no desire to get out of the game. He says: “I have too much money to quit. I mean, somebody has to manage my money. I’ll also put some money out to other managers so it will be a sensible balance.” He rejects the worry that he’ll downsize so much that he’s only left with his money to manage. Tepper says: “That may happen at some point, but not in the near future. I love what I do and it’s good to have the discipline of outside investors.”
“The more I make, the more I’ll give away,” says Tepper, who continues to be devoted to reforming public school education in New Jersey with his B4NJKids nonprofit organization. He has been a generous contributor to the Food Bank and numerous Jewish causes, such as United Jewish Appeal. In fact, an orthodox rabbi is known to show up at Appaloosa’s offices every month for tefillin and prayer with Tepper and his colleagues. He looks out the window of his office as the sun sets in the distance.
“Listen, it’s a complicated world out there,” Tepper says. “Sometimes it’s time to make money, sometimes it’s time not to lose money. Last year was a time not to lose money; we’ll see what this year brings.”