NFV NEWS

[September 03, 2006]

High intensity pays off for Highland Capital: Dallas firm is active ? whether it's hiring, investing or litigating

(Dallas Morning News, The (KRT) Via Thomson Dialog NewsEdge) Sep. 3--At first glance, James Dondero is like lots of Texas money men. He lives in a $2 million home, drives a year-old Porsche 997 hardtop and enjoys downhill skiing and big-game hunting.

But he and his Dallas-based Highland Capital Management LP are anything but typical.

Tucked away on three floors of a Galleria office tower, Highland is a unique combination of high-yield loan manager, distressed debt investor, private equity firm, mutual fund manager and hedge fund.

Highland's phenomenal growth has gone hand in hand with a tough work ethic, including a rigorous hiring process and mandatory 60-hour workweeks. The firm is also known for its aggressive legal tactics.

Named after the enclave where Mr. Dondero and many of his 75 investment professionals live, Highland makes money in a number of different ways, including earning fees for managing high-yield debt.

One of its strategies is to buy the debt of struggling companies and convert it into equity if the firms falter. Using this method, known in financial circles as "loan to own," Highland has taken control of several businesses, including Home Interiors & Gifts Inc. of Carrollton, the largest direct seller of home decor products in North America.

Highland's legal strategies -- filing numerous lawsuits and forcing troubled companies into involuntary bankruptcy -- have drawn some criticism. Christopher Downie, executive vice president of Motient Corp., whose management won a proxy fight against Highland in July, said, "It appears to us that Highland attempts to use litigation to wear down its adversaries."

Highland disputes this accusation. "We're not litigious," Mr. Dondero, 44, Highland's president and majority owner, said in a telephone interview.

Very little is known about the increasingly powerful sector of alternative asset managers like Highland because they're private, largely unregulated and usually shun publicity.

But interviews with Highland's executives, investors and others -- as well as a review of numerous lawsuits -- provide a rare look at Mr. Dondero and his 13-year-old firm.

More than a thousand miles from Wall Street, Mr. Dondero and his longtime business partner, Mark Okada, have assembled a team of hard-charging financial analysts and portfolio managers who often can be found at their desks dressed in Hawaiian shirts, shorts and flip flops.

Mr. Dondero cultivates a taste for the unusual. Pressed about rumors that he has hunted giraffes, he would only admit, "Giraffe makes very tasty jerky."

With $30 billion in assets under management, the firm manages a portfolio of more than 1,000 investments, from the parent of the Tony Roma's restaurant chain to telecommunications companies.

Distressed-debt investors like Highland are expected to take on a bigger role in reshaping the business landscape in coming years because of changing market conditions.

Next year, experts are predicting a sharp rise in the number of loan defaults. The current buyout frenzy has saddled a widening list of companies with heavy debt loads.

"We'll continue to expand," Mr. Dondero said.

Long, hard hours

At Highland, Mr. Dondero has fostered a culture that treasures hard work. Employment contracts mandate the extra-long workweeks. Caterers bring in meals so employees don't have to leave their desks. And everybody must log into a software program that tracks work hours.

"You have to be committed and passionate every day," said Paul Adkins, chief executive of Moll Industries Inc., a Dallas-based custom injection molder controlled by Highland.

"Nobody's thinking about compensation," he said. "You're in it because of ego, you're in it because of intellect, you're in it because your desire to win forces you to."

He works at least six days a week, sometimes seven. Even on Father's Day, Mr. Adkins, a father of one, was in Michigan visiting a customer.

Mr. Dondero credits hard work for the firm's growth.

"This business is populated by a fair number of our competitors who have more of a rock star approach and a vacation approach," he said. "We've had more of a 'try to work as hard as any of our investors would work' attitude.

"We make 15 to 20 employees a year millionaires," he added. "It's a high-intensity environment. It's not for everyone."

Highland gives job applicants a few days to complete a case study. The assignment enables the firm to assess candidates' analytical capabilities and writing and financial modeling skills, said Jack Yang, Highland's head of business development.

Highland views its Dallas location as a benefit, allowing it to attract a more diverse group of people than the average New York investment firm. Besides Wall Street finance whizzes, it has hired engineers, lawyers and military officers.

Those who know Highland regard the firm's large research team with 45 analysts as one of its key strengths.

"They have an ability to discern value where others don't," said Michael Kelly, a Highland investor. "They're intense, they're smart and they're driven."

Mr. Dondero is viewed as the strategist and visionary, while the soft-spoken Mr. Okada serves as trusted lieutenant.

"We complement each other well," said Mr. Okada, 44. "I help him [Mr. Dondero] get it done."

Don Pollard, the head of leveraged finance at Credit Suisse in New York, said that during meetings, Mr. Okada is often attending to investor and banking relationships, telling jokes and keeping the environment positive, while Mr. Dondero is thinking of business issues and opportunities that are two or three steps ahead of where everyone else seems to be.

"Mark is kind of the glue that holds the place together," he said.

Mr. Yang described the partners' relationship as similar to the way the left and right sides of the brain function. While Mr. Dondero is thinking about opportunities and where to go, Mr. Okada is focused on the risks and how to get there, he said.

Both Mr. Dondero and Mr. Okada fiercely guard their privacy. For this story, both agreed to be interviewed only by telephone. They declined to be photographed and shied away from questions about their families.

Forming a bond

The two men bonded while working in the late 1980s at a Los Angeles firm that was a joint venture between Don Boulanger, now a senior adviser at investment bank Chanin Capital Partners, and Protective Life Corp., an Alabama-based provider of insurance and investment products.

It specialized in managing high-yield bonds and leveraged loans for 401(k) plans and hired Mr. Dondero as its chief investment officer. Mr. Dondero owned 4.5 percent of the firm, worth $1.5 million. After Mr. Boulanger sold his shares to Protective, Mr. Dondero used his stake to form his own high-yield debt management firm in a joint venture with Protective.

In 1994, Mr. Dondero and Mr. Okada moved the firm to Dallas to be closer to Protective's headquarters. Three years later, they bought out Protective's interest.

"Jim had a business owner's mentality from Day One," said Mr. Boulanger, recalling how Mr. Dondero used to own only one tie, despite his sizable income. "Jim is a very no-nonsense kind of guy."

Today Mr. Dondero works 70-hour weeks and sometimes goes months without leaving Dallas. His days are filled with board and investor meetings, company strategy sessions and constant monitoring and adjusting of the firm's portfolios.

To stay a step ahead, the certified public accountant devours many industry publications.

"I enjoy building a business," he said. "It's interesting and it's fun. On the personality tests, I test out as the carpenter."

Highland displays a softer side outside the business world. It's been a sponsor of the American Cancer Society's annual Cattle Baron's Ball in Dallas and last year received the organization's "Caring Spirit Award." It also supports local fundraising races for the National Multiple Sclerosis Society and other groups.

Mr. Okada serves as chairman of the board at Common Grace Ministries, a Dallas nonprofit organization that, among other things, helps low-income people with food, rent and English lessons.

Highland and Mr. Okada fund Common Grace's $400,000 operating budget, said Martin Hironaga, the organization's director.

Mr. Okada "is not a power monger kind of guy," he said, noting that Highland's chief investment officer sometimes arrives for Saturday breakfasts at a La Madeleine cafe on a skateboard. "I consider him a brother."

Leveraged loans

On Wall Street, Highland has become one of the biggest players in the growing market for collateralized loan obligations, securities backed by a diversified portfolio of leveraged loans. According to Standard & Poor's, so far this year investors have funneled $329 billion into leveraged loans, which is essentially debt owed by non-investment-grade companies.

Though it has branched out into other investment areas, the firm's primary income still comes from fees it earns managing portfolios of leveraged loans. Two-thirds of Highland's assets under management consist of leveraged loans, Mr. Okada said. The management fees vary but are lower than those charged by private equity firms and hedge funds, he added.

Highland has more than 250 institutional investors, such as banks, insurance companies, pension funds and foundations.

"Highland Capital has built a sizable team of investment professionals and has provided its investors attractive investment returns," said Peter Koops, a spokesman for the $2 billion Houston Municipal Employees Pension System, which this spring invested $10 million in one of Highland's funds.

The latest data from the California Public Employees' Retirement System, the nation's largest public pension fund, shows that its investment in one of Highland's funds had generated a three-year return of 28.7 percent, vastly outperforming three other external high-yield debt funds also in the pension fund's portfolio.

Armed with its expertise in the high-yield debt market, it wasn't a big leap for Highland to start investing in the debt of troubled companies.

Besides Home Interior & Gifts and Moll Industries, other Texas firms it controls are Romacorp Inc., which owns Tony Roma's, and Trussway Ltd., the largest U.S. manufacturer of trusses, a structural building product, for apartments.

Not every "loan to own" play has turned into a success. In the fall of 2004, Hedstrom Corp., an Illinois-based seller of outdoor children's play equipment, closed six plants, laid off 800 employees and filed for Chapter 11 bankruptcy reorganization. Managers have since created a new toy company using the Hedstrom name.

And Indiana auto supplier Amcast Industrial Corp. has been selling off all of its assets after entering Chapter 11 bankruptcy for a second time late last year.

Taking on Motient

Such setbacks haven't deterred Highland. For more than a year, the firm has been in a bitter clash with the management and board of Motient, one of its biggest investments.

Currently Motient's second-largest shareholder, Highland sought to elect its own slate of directors to the unprofitable company with potentially valuable assets. Illinois-based Motient aims to offer voice, data and video services using satellite and land-based technology.

Disagreements arose over the company's direction. And though Mr. Dondero had sat on Motient's board, Highland accused some Motient executives and directors of engaging in conflicts of interest, maintaining weak internal financial controls and other misdeeds, according to letters made public in regulatory filings. Motient denied all the allegations.

Mr. Dondero launched a barrage of shareholder letters filled with these claims, prompting Motient executives to fire back with their own missives. Highland and its affiliates also filed six lawsuits against Motient, some of its directors and affiliated parties. Motient's executives fought back, suing Mr. Dondero and notifying shareholders in letters that he and his firm had been involved in more than 50 lawsuits since the late 1990s.

Motient has estimated that Highland's lawsuits cost it more than $2 million in legal fees. Though Highland lost the proxy fight, Motient replaced nearly its entire board.

That didn't satisfy Highland. In mid-July after the proxy fight ended, it warned Motient that it's considering various plans such as seeking to acquire the company or buying additional shares.

"It's been painful," Mr. Dondero said of the battle. "No one's ever suggested that Highland has ever done anything inappropriate.

"Proxy fights are very difficult to win period. Very few are successful," he added. "We'd like to maximize returns for our investors and we'd like to protect our investors from any inappropriate actions."

Tenacious

This kind of tenacity isn't unusual for Highland. When a lawsuit doesn't go its way, the firm usually appeals.

For example, as a debt holder, Highland sued over a bankruptcy judge's approval of a reorganization plan for American HomePatient Inc., one of the country's largest home health care providers.

It lost the lawsuit and appealed to a higher court but didn't win there either.

Yet Highland didn't give up. As a major shareholder of American HomePatient, it tried to acquire the Tennessee company this past spring, amend its bylaws and nominate a director to its board. These efforts were later withdrawn, but Highland warned it could take other actions in the future.

"We are not passive in terms of our investments," Mr. Yang said.

Some of the lawsuits filed against Highland and Mr. Dondero also show how tough the firm can be. In one of them, Joshua Wheelock, a trader of collateralized debt obligations at UBS Securities, alleged that he lost his job because of Mr. Dondero.

According to the lawsuit, Mr. Wheelock wouldn't tell Mr. Dondero that UBS had won an auction for a collateralized debt obligation product. That allegedly prompted Mr. Dondero to tell UBS that it would pull its business unless Mr. Wheelock was fired.

The lawsuit also claims that Mr. Dondero told one or more of Mr. Wheelock's prospective employers that Highland would withdraw its business from them if they hired him.

In court documents, Mr. Dondero and Highland denied Mr. Wheelock's allegations. The lawsuit, which sought $7.5 million in compensatory damages, was ultimately dismissed.

"It was a meritless lawsuit," Mr. Yang said. Mr. Wheelock declined to comment.

Hard on its own firms

Though Highland can be demanding in its dealings with outsiders, it is equally as hard on its own companies.

"They expect excellence 24 hours a day," said Bill Adams, chief executive of Trussway, the Houston truss manufacturer. "They are very decisive. They are risk takers. They are not shy."

Highland expects Trussway to make continuous improvements, Mr. Adams said. Even though it's "blowing past its financial objectives, you'll never be off the hook with Highland," he said.

His counterpart at Moll Industries, Mr. Adkins, compared working with Highland to being part of a Formula 1 auto racing team.

"They're actively involved with the tuning of every aspect of the high performance machine," he said. "They interrogate everything at all times."

Highland employees assist Moll executives with tactical planning and budget issues, Mr. Adkins said. Highland hopes to expand the plastics manufacturer into a billion-dollar company from half that level now and take it public in five years, he added.

Even Mr. Dondero has gotten involved. Every so often, he drops by Mr. Adkins' office for a detailed briefing of Moll's business. He's pushed Mr. Adkins to experiment with new ideas by forming a Skunk Works project and given him management books to read.

Mr. Adkins likens Highland's president to an Olympic sprint coach.

"He always finds a way to show someone that they can hit a higher ground," he said.

E-mail kyung@dallasnews.com

HIGHLAND CAPITAL MANAGEMENT

Highland Capital Management is an investment firm with more than $30 billion in assets under management.

Founded: 1993

Offices: Dallas and New York

Management: James Dondero and Mark Okada, managing partners

Staff: 75 investment professionals, including 45 analysts covering 30 industries; a 15-person private equity restructuring team; and a 10-person trading desk

Investments: $20 billion in leveraged loans; $6 billion in retail mutual funds; the remainder in hedge funds, distressed debt, private equity investments and real estate

Portfolio companies in Texas: Home Interiors & Gifts Inc., Moll Industries Inc., Trussway Ltd. and Romacorp Inc.

JAMES DONDERO

President, managing partner and co-founder of Highland Capital Management LP

Age: 44

Experience: Chief investment officer of Protective Life Corp.'s guaranteed investment contracts subsidiary, 1989-93. Managed $1 billion in fixed-income funds for American Express, 1985-89.

Education: Accounting and finance degrees from the University of Virginia

Family: Married with one child

MARK OKADA

Chief investment officer, managing partner and co-founder of Highland Capital Management LP

Age: 44

Experience: Manager of fixed income for Protective Life Corp.'s guaranteed investment contracts subsidiary, 1990-93. Vice president for Hibernia National Bank, managing more than $1 billion in high-yield bank loans, 1986-90.

Education: Degrees in economics and psychology from the University of California at Los Angeles

Family: Married with five children

SOURCE: Highland Capital Management

Copyright (c) 2006, The Dallas Morning News
Distributed by McClatchy-Tribune Business News.
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