A 'Reputational Risk' Worth Taking

Tom Marsico played the late 1990s mutual fund bubble so perfectly, I counted him among the smartest money managers I'd ever interviewed.

He was a superstar at Denver-based Janus mutual funds -- not only handsome and well-spoken, as superstars ought to be, but reliably cranking out 20%-plus annualized returns for his shareholders.

Marsico left in late 1997 over what Janus termed "philosophical differences." But Marsico knew it was time to move on.

He immediately started Marsico Capital Management. He marketed his stellar growth stock- picking record and amassed billions from investors in six namesake mutual funds. He then sold the entire shop to Bank Of America Corp. (NYSE:BAC) for $1.1 billion and continued his work there.

What most mutual-fund mavens needed decades to accomplish, Marsico pulled off in a couple years. And mind you, this was back in the day when $1.1 billion was a lot of money. More amazing: He did all this before the Internet bubble burst, sticking Bank of America with the top-of-the-market price.

It was full-throttle financial genius, and a wonder to behold. But then came 2007, and what did Marsico do before the next big crash? He bought back his namesake company from Bank of America for nearly $2.7 billion.

He put down $100 million of his own money. His associates put down another $50 million. And they borrowed the rest by issuing junk bonds. They had just made the biggest leveraged bets of their bold financial lives just before the Great Depression, Part II.

The assets Marsico's firm manages peaked at $110 billion in October 2007 and fell to $43.4 billion in August before recovering to $50.5 billion today. Mutual-fund companies generate revenue as a percentage of assets under management. So the firm's revenue couldn't support its junk-bond payments, and Marsico was headed for a big default.

So goes the story of just about every leveraged deal of 2007.

Marsico, however, succeeded in restructuring about $2.7 billion in debt on Nov. 10. The restructuring reduced the firm's debt to $1.6 billion as it gave a 49% equity stake to bondholders. But Marsico and his associates still call the shots with a combined 51% stake.

Nobody got laid off. Salaries weren't cut. And the investment team is riding a choppy market back to success. But analysts are justifiably taking shots now that the mighty Marsico has stumbled.

Standard & Poor's Financial Services writes: "Marsico's ability to service its debt remains weak."

Then there's something financial types dub "reputational risk."

"They probably figured out pretty quickly it was the wrong time to buy back the firm," said Morningstar analyst Karin Anderson. "It's probably going to make it harder for them to attract new money, and also maintain their current sub-advisory business, which makes up a big chunk of their business."

How could Marsico have been so right about selling to Bank of America just before the Internet bust, yet so wrong about buying it back before the mortgage bust?

Marsico, being the stand-up guy that he is, gave me his answer.

"The reasons why I have made certain changes in my career always have to do with the clients," he said in a telephone interview on Wednesday. "It always has to be for the clients first, then the employees, the stakeholders, and last the equity-holders.

"In December 2006, given what's happened to Bank of America and to other institutions, I really felt it was in the client's best interest for me to buy the firm back."

Without getting into details, Marsico said he was concerned about what he considered "policy errors" at Bank of America. "I didn't foresee the calamity that took place to the extent that it did," he said. "This was for the clients."

At 55, Marisco has been managing money for more than 30 years.

"This is my love. This is what I like to do," he said. "And frankly, I think it's a little too early to call what will be the success or the failure of the acquisition of the company back to us."

While growth in the U.S. remains slow, Marsico is shifting to stocks in China and other growing economies.

"Everyone is running into bond funds like they used to run into Internet funds," he said. "We think now is the time to get into equities."

Marsico stands beside his shareholders as the largest investor in all of his funds. When they lose, he loses. He said he also owned some of the very bonds he was forced to restructure.

And if he hadn't bought his company back, he'd still be a part of Bank of America. Can you imagine being owned by this bailed-out nightmare of a bank?

"Reputational risk" from having to restructure $2.7 billion in junk bond debt may be nothing compared to that. I say Marsico is still one of the smartest guys I've ever interviewed.