Jeffrey Gates and Gates Capital’s Amazing Performance

Gates Capital Management is a New York–based hedge fund that was founded in 1996 by Jeffrey Gates, who currently serves as President and Portfolio Manager. After obtaining a BS in finance from Kansas State University in 1984, Gates started working as a high yield bond research analyst at Kidder, Peabody & Company. In 1988, Gates graduated from the Wharton School of the University of Pennsylvania with an MBA and started working at Schroder, again as a high yield bond research analyst. Between 1990 and 1995, Gates worked as a highyield salesperson at Schroder & Co., and between 1995 and 1996 he served as a Director at the same company.  Throughout his 25+ years of career, Gates specialized mainly in high yield bond research.

The Gap Inc.

According to the latest 13F, Gates Capital manages a portfolio valued at $725 million as of March 31, 2011. Here are Gates Capital’s most recent reported activities as of 1Q2011:

Security Ticker Value (x$1000) Activity Return
Gap Inc GPS $7,835 -73% -18.8%
Copart Inc CPRT $47,397 -35% 8.7%
Geomet Inc GMET $1,783 -31% -29.3%
Lorillard Inc LO $24,352 -23% 16.3%
Zimmer Holdings Inc ZMH $27,996 -13% 5.1%
Darling International Inc DAR $30,568 -12% 8.4%
Shuffle Master Inc SHFL $6,130 -9% -11.6%
Davita Inc DVA $25,760 1% 1.8%
Blount International Inc BLT $51,708 4% 12.7%
Vishay Precision Group Inc VPG $18,879 4% 5.5%
Flotek Industries Inc FTK $15,042 4% 2.9%
Bed Bath & Beyond Inc BBBY $30,019 6% 21.7%
Solutia Inc SOA $70,009 7% -10.1%
Snap On Inc SNA $43,116 14% 4.5%
Interval Leisure Group Inc IILG $36,281 15% -14.6%
Mcgraw Hill Cos Inc MHP $29,759 21% 8.6%
Flotek Industries IncBOND FTK $25,527 27% 2.9%
Coca Cola Enterprises Inc CCE $35,148 31% 8.5%
Grace W R & Co Del New GRA $39,119 39% 20.9%
Quanex Building NX $28,464 40% -17.7%
Kar Auction Services KAR $41,406 43% 23.5%
Bard C R Inc BCR $34,159 New 11.0%
Masco Corp MAS $23,424 New -12.7%
Ashland Inc New ASH $15,193 New 13.9%
Richardson Electronics Ltd RELL $6,334 New 4.8%
Dover Downs Gaming & Ent DDE $10,094 No Chg. -9.3%
Domtar Corp UFS $0 Sold Out 7.7%
Eagle Materials Inc EXP $0 Sold Out -9.0%
Methanex Corp MEOH $0 Sold Out 2.0%
Advance Auto Parts Inc AAP $0 Sold Out -11.6%

We see some significant trim offs in Gates’ portfolio in the first quarter of this year. He trimmed more than 70% of his holdings at Gap Inc. (selling about 940K shares) and time proved him to be right as the stock lost almost 19% in value since the end of March. Neverthless, according to the latest filing, Gates continues to hold almost 350K shares of Gap and still incurred a painful loss, despite the smaller share Gap constitutes on his portfolio. Robert Jaffe’s Force Capital and Edward Lampert’s ESL Investments were among the funds that were bullish on Gap but that got disappointed with the stock’s performance since the end of March.

There are a couple of other stocks that Gates decided to reduce his share in but he probably regrets that he did so as these securities performed relatively well since the end of March. Copart and Lorillard have returned 8.7% and 16.3%, respectively. Gates sold about 600K shares in CPRT and 76K shares in LO during the first quarter of 2011. Unlike in Gap, Robert Jaffe’s Force Capital got his reward for his bullish stand on CPRT as he had increased his position in CPRT by about 4% in the first quarter of this year. Jean-Marie Eveillard’s First Eagle Investment Management must have enjoyed the return on LO as the fund increased its position by about 28% during the first quarter of 2011 and held roughly 2.2 million shares valued at $211 million on March 31, 2011.

Among the securities that Gates was bullish about in the first quarter of 2011, he performed generally well. Gates decided to increase his portfolio by 43% in Kar Auction Services and bought about 800K new shares in the first quarter of 2011. The stock returned 23.5% since the end of March. Joshua  Friedman’s Canyon Capital Advisors and Jay Petschek’s Corsair Capital Management have acccompanied Gates Capital in enjoying the return on KAR.

Another security that generated above 20% return for Gates was W R Grace and just like KAR, Gates added new GRA shares onto his portfolio and increased his holdings by about 39% since 4Q2010. Jonathan Auerbach’s Hound Partners , Scott McLellan’s Marble Arch Investments , and Rehan Jaffer’s H Partners Management were probably all happy with the return.

Gates has also performed well with his new stock picks with the exception of Masco Corp. The stock had a negative return of 12.7% since March-end. On the contrary, BCR and ASH have both generated above 10% returns, thereby more than compensating the loss incurred at MAS.

A major disappointment for Gates, however, has been Solutia Inc. (SOA), where about 10% of the fund’s money is parked. Gates increased his position by about 7% in the first quarter of 2011, however, the stock had a heartbreaking performance of negative 10% since the end of March. Eric Bannasch’s Cadian Capital was also disappointed with the stock’s performance as it had increased its position by about 82% in the first quarter of 2011.

Overall, out of the 14 securities where Gates increased his long positions, he had positive returns in 11 of them, ranging from 1.8% to 23.5%. Out of the 4 securities where Gates took new positions, he had positive returns on 3 of them, ranging from 4.8% to 13.9%. Gates has been performing extremely well overall as his fund generated almost 5% return since the end of March. His 10 stock picks that are constituents of the S&P 500 index returned 6.1% during the second quarter. Investors imitating Gates’ stock picks beat the S&P 500 index by 6 percentage points.

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