Dec. 28 (Bloomberg) -- Nick Zito needs nothing more than a glance at the yearling to size up the potential behind a chestnut coat that glows burnt orange in Lexington, Kentucky's morning light.
``Stands great; good balance,'' he mutters as he scribbles notes into a frayed, 959-page auction catalog while a barn hand keeps the thoroughbred steady on a dirt path.
Zito, a Brooklyn, New York, native who trained two Kentucky Derby winners, has already consulted an equine geneticist. With an eye for undervalued talent and a budget of about $4 million from client Robert LaPenta, co-founder of defense contractor L-3 Communications Holdings Inc., Zito is ready to make his move.
The next day, he outlasts other bidders at the Keeneland Association Inc. auction, paying $200,000 for the one-year-old, labeled simply number 787.
Zito, 59, and LaPenta, 62, are bullish speculators in a market for racehorses that has been breaking sales records for the past four years. In their trading niche, a once-obscure art called ``pinhooking'' that's drawing investment like never before, average returns are beating those of hedge funds. Among the reasons: More oil money is flowing in from Dubai.
If their buy-and-flip strategy works, Zito and LaPenta will never see their young acquisition bolt from a starting gate. Instead, they'll board and train the horse in Florida for half a year, then sell -- or pinhook -- him at an auction of two-year- olds, pocketing a tidy profit.
`High Risk, High Reward'
``It's a very volatile part of our market that's developing dramatically,'' says Geoffrey Russell, director of sales at Keeneland. Pinhooking isn't for the fainthearted, he says. ``You have to wear long pants to play in this industry. You need to understand that it's a high-risk, high-reward business. But it's a very fun aspect of the business.''
The $200,000 that the Zito-LaPenta team paid for No. 787 is a fraction of the $1 million-plus bids drawn by 32 other yearlings sold in September at Keeneland.
``Nick has an unbelievable eye for young horses,'' says LaPenta, now chief executive officer of Stamford, Connecticut- based L-1 Identity Solutions Inc., which makes fingerprint- and face-screening software. Asked how much he's made since teaming up with Zito six years ago, LaPenta belts out a deep laugh. ``Let's just say I'm not unhappy.''
Buying and flipping horses before they reach the racing circuit for two-year-olds can be lucrative, though unforeseen training costs and injuries can take a toll on even the most wily trader. The average return on a thoroughbred purchased as a one-year-old, or yearling, and sold as a two-year-old climbed to 47 percent in 2007 from 30 percent in 1999, according to TBH MarketWatch, an industry newsletter put out by the publishers of The Blood-Horse magazine, based in Lexington.
Outperforming Hedge Funds
By comparison, hedge funds globally gained an average of 13 percent in 2006 and 8.8 percent in the first three quarters of 2007, according to Chicago-based Hedge Fund Research Inc.
Together, Zito and LaPenta have made pinhooking history. In 2004, they flipped a horse named Fusaichi Samurai for a then record $4.5 million, almost 17 times the $270,000 they paid. In 2007, they flipped 11 horses for $2.4 million, almost double the $1.3 million paid.
Horsemen spent about $600 million in the 2006 yearling auctions across the U.S., anchored by sales in Kentucky, Maryland and New York. Pinhookers accounted for at least $71 million of those purchases, according to data compiled by TBH MarketWatch, up from at least $44 million in 1999. They spend millions more each year on horses just seven to nine months old, weanlings they look to flip the next year.
Dubai Oil Money
Horse values are rising across all age ranges and types. The biggest buyer of thoroughbreds in the world, Sheikh Mohammed bin Rashid al-Maktoum, the billionaire ruler of Dubai, went on a spending spree this year to strengthen his breeding operation. He bought Street Sense and Hard Spun, the first two finishers in the 2007 Kentucky Derby, an event for three-year-olds that is the most prestigious horse race in the U.S. He also purchased the eighth-place finisher, Any Given Saturday.
All three horses, bought in private transactions for undisclosed amounts, will stand as sires at Sheikh Mohammed's Lexington farm. In a November auction, the ruler outbid his main rival, Irish breeder John Magnier, by plunking down a record $10.5 million for a female horse he'll use for breeding.
The two horsemen also helped drive up values for two-year- olds, benefiting pinhookers. Sheikh Mohammed and Magnier had made a practice of focusing on the annual yearling sales to find potential Kentucky Derby winners. They began buying more at the auctions for two-year-olds after two horses discovered in those sales went on to victory in the Derby: Silver Charm in 1997 and Monarchos in 2001.
Soaring Revenue
``That success attracted a better quality of horseman to the sales, both on the buying and selling side, and caused the whole thing to steamroll,'' says Terry Finley, president of West Point Thoroughbreds Inc., a partnership based in Mount Laurel, New Jersey, that invests in thoroughbreds to race and pinhook.
Revenue at North American auctions for two-year-olds rose to a record $217 million in 2006 from $127 million in 2001, according to The Blood-Horse, the primary source of industry sales data.
Success in pinhooking lies in that rare ability to spot racing talent in an undeveloped yearling. The young horses don't gallop at auctions; buyers won't see them run until months later at the sales for two-year-olds.
``With a yearling, you just visualize it,'' says James Scatuorchio, who retired as head of equity trading at New York- based Donaldson, Lufkin & Jenrette in 1998 to start a racing business.
Steinbrenner, Whitney
That's why LaPenta needed an expert like Zito to even consider the pinhooking game. One of the best-known U.S. horsemen, Zito broke in as a groom's assistant at age 16 and eventually trained horses for Barnes & Noble Inc. Chairman Leonard Riggio; New York Yankees principal owner George Steinbrenner; and Marylou Whitney, the widow of airline, mining and thoroughbred investor Cornelius Vanderbilt Whitney. Zito was inducted into the National Museum of Racing and Hall of Fame in Saratoga Springs, New York, in 2005.
At Keeneland, Zito sees defects in an instant as he scans yearlings from the side and head-on: ``Body didn't meet his legs;'' ``he toes out a little in the left;'' ``needed more bone.'' Those that make his list are ``powerful'' or have a ``great walk'' or ``presence.'' He comes to a verdict on most in about 30 seconds.
Chace's Eye
Zito has few peers in measuring raw potential. One is Baden Powell ``Buzz'' Chace, the buyer for West Point Thoroughbreds. The son of a mill laborer and an electrical worker, Chace, 66, has known nothing but horses since 1950, when he took a job cleaning stalls for 50 cents a day at a riding school near his home in Somerset, Massachusetts.
He's been a groom, rider, trainer, veterinary assistant, equine dentist and, for the past two decades, bloodstock agent - - a broker of sorts who picks out horses for clients.
Chace has bought racehorses for Barry Schwartz, co-founder of Calvin Klein Inc.; Oregon timber baron Aaron Jones; and Leon Hess, the late chairman of refiner and oil explorer Amerada Hess Corp., now known as Hess Corp.
``He's got a reputation that's unbelievable,'' says Boyd Browning Jr., executive vice president at Lexington-based auction house Fasig-Tipton Co.
During the eight days he spends at Keeneland's September sales amid the sweeping green hills and white rail fences of central Kentucky, Chace inspects some 1,500 horses, about a third of the total that go through the auction ring. Fewer than 100 impress him enough -- and pass a veterinarian's examination -- to make West Point's pinhook candidates list.
`Loose, Smooth, Graceful'
Like Zito, Chace knows within seconds whether he likes a yearling. ``Sometimes as soon as they come out of the stall,'' he says in a deep voice tinged with a Jack Nicholson inflection, the result of a five-decade smoking habit that started when he picked up a pack of Chesterfields at age 12. He often removes his glasses -- ``I see better without them,'' he says laughing - - before taking in every inch of a horse with a piercing stare that sweeps up and down, left and right. His ideal: ``a loose, smooth, graceful type of horse.''
Chace seeks the ``beautiful head and big eye,'' features he says indicate intelligence. He touches the horses on the head to gauge their reaction. A yearling that pins its ears back flat is a ``sour'' horse that may prove tough to train. A kind, intelligent horse will prick its ears forward.
Bout of Nerves
Chace gives yearlings a final look as they arrive at the first of three walking rings that lead to a passage into the sales pavilion. He watches how they handle the stress of being surrounded by hundreds of people and bombarded by the auctioneer's jackhammer-like call, which is piped throughout the Keeneland grounds. A horse that spooks in an auction ring may not stand up to the pressures of racing.
On the third day of the Keeneland sale, Chace saunters back to the outer ring early to check out a young male, or colt, he had been impressed by days earlier. ``A nice, physical-looking horse,'' he says.
Now, though, No. 542 is all nerves, rearing up and whinnying in fear. The brown colt throws its head up high again and again, trying to escape the pull of the handler's chain. Chace slides into the ring -- to within a foot of the horse -- for a closer look.
``He's acting a little silly out here,'' Chace says. ``I'd like to see him drop his head and walk like a horse should.''
When the bout of nerves reaches two minutes, Chace scales back the $300,000 price ceiling Finley had allotted for the colt, a move he knows will put it out of reach. ``There's plenty of other horses,'' he says.
Davy Crockett
Chace, who collects a 5 percent commission on all purchases, ends up buying eight horses for Finley at the Keeneland sales. The cost: $1.5 million. In all, West Point loaded up on 26 pinhook prospects in 2007 compared with an average of 12 during the previous three years.
The term pinhooking springs from the lexicon of the American farmer, where a pinhooker was a ``small-time speculator, especially in tobacco,'' according to the Dictionary of American Regional English. Pinhook first appears, as an adjective meaning petty, in the 1834 autobiography of frontiersman Davy Crockett.
In the world of thoroughbreds, pinhooking's perils abound. Costs accrue quickly between the yearling sale and auction for two-year-olds. The trailer ride alone from Lexington to Ocala, Florida, the biggest yearling racehorse training center in the U.S., costs about $1,000. Pinhook trainers charge as much as $65 a day.
Bucked Shins, Bone Chips
Throw in vet, dentist and blacksmith bills, insurance, shoes, feed additives and GastroGard, an anti-ulcer medication, and the cost climbs to at least $15,000, says Josh Cooper, West Point's chief financial officer.
Dozens of prospects are derailed every year by injury as they start to train, suffering bucked shins, an inflammation of the tissue membrane that surrounds a leg bone; strained ligaments; bone chips; and sore feet. Young horses can break an ankle kicking a wall or get loose on the track and flip over a rail.
If they make it to the auction as a two-year-old, that event can add another $3,000 or so in costs. The pinhook trainer, who sells on consignment for a private owner, typically gets a 5 percent cut, and the auction house slices off another 5 percent.
Hundreds of horses fall short of the minimum sale price, or reserve, set by pinhookers. In all, about 40 percent of pinhook prospects fail to sell at the auctions, says Finley, 43, an Army retiree who started the West Point partnership in 1991 and named it after the site of his alma mater, the U.S. Military Academy.
`All or Nothing'
The laggards are sold in private deals afterward or are sent to the racetrack in a bid to impress potential buyers.
Risks like those can prove costly to neophytes. And with more investors crowding in, old-time pinhookers such as Niall Brennan are feeling the squeeze. Brennan, a 46-year-old Irishman who has run his company out of Ocala since 1992, says growth in the industry's average returns is distorted by a handful of big scores every year, such as LaPenta's $4.5 million sale of Fusaichi Samurai and a record $16 million sale to Magnier of a horse later named The Green Monkey.
Strip those out, Brennan says, and margins are down. Horses that don't sell at the auctions for two-year-olds run up thousands of dollars in additional maintenance costs, he says.
``It's all or nothing,'' Brennan says as he takes a break from scouting horses during a rain-soaked opening day at the Keeneland sales. He says his pinhook partnerships, which buy some 30 thoroughbreds a year, have returned less than 5 percent annually during the past two years, down from an average of 36 percent a year in the previous decade.
Pitino's Partnership
``Because of the success of pinhookers, everybody started looking at the business and said, `I can do that,''' says Brennan, who managed Steinbrenner's Florida thoroughbred farm in the late 1980s. ``So end-users who we'd normally be selling to in the two-year-old sales became our competitors.''
Among the end-users was LaPenta. He shifted to pinhooking in 2001 after dabbling in horse racing in the 1990s, taking a stake in a thoroughbred partnership run by his friend Rick Pitino. An itinerant basketball guru, Pitino, 55, has coached pro teams (the New York Knicks and Boston Celtics) and several major college teams, including two in Kentucky (the University of Kentucky and the University of Louisville). Zito trains horses for Pitino.
5 Percent Commission
LaPenta pays Zito a flat fee to work the yearling auctions and cuts him a 5 percent commission when a horse sells for a profit. Clients who interfere in the purchasing process can bog him down, the gravelly voiced Zito says. ```Why didn't you like this horse, or that horse?' I don't have time for that,'' he says. LaPenta obliges, Zito says. ``He's a businessman. He doesn't bother me.''
The only opinion Zito seeks at Keeneland is that of David Foye, a 63-year-old Cornell University-trained equine geneticist. Foye pores over breeding data to help Zito identify yearlings with potential and takes no part in the physical inspection. The two met in 1991 just before Zito won his first Kentucky Derby with Strike the Gold, a powerful chestnut colt produced from a Kentucky mating planned by Foye.
Zito's gray hair and crooked nose are famous in Kentucky, where his Derby victories have made him something of a legend (after Strike the Gold, he trained 1994 winner Go for Gin). Everywhere he walks at Keeneland, the sound of ``Hey, Nicky!'' follows.
`The Master'
``He's the master,'' says Foye, who looks the part of a scientist, wearing big, round glasses and toting pens and index cards in his breast pocket. ``He has what I call a genetic eye. He can scrutinize a lot of these genetic oddities -- they can be positive or negative. It's a God-given talent, much like a painter.''
Time is crucial when trying to examine hundreds of horses in a week. Zito is obsessive about not straying from his list of purchase candidates. ``If you ain't on the list, I got to keep going,'' he says to one consignor who tries to get him to look at his horses. Later, Zito snaps at Foye for having a salesman bring out a horse he didn't want to see. ``Dave, we're wasting time,'' he says.
Within days of purchase, LaPenta and Finley ship their horses to farms in and around Ocala, where they're introduced to a rider for the first time, pushed for speed and muscled up on protein and additives such as Body Builder, which, according to the product Web site, contains rice bran oil extract.
Auction Sprints
A yearling that arrives weighing 500 pounds (227 kilograms) can grow to 900 pounds by the time it goes for sale as a two- year-old some six months later, says David Scanlon, who breaks yearlings for LaPenta and Finley as well as Sheikh Mohammed and Magnier.
The auction season for two-year-olds kicks off on Feb. 12 at the Ocala Breeders' Sales Co. and runs until June, swinging through Miami and Lexington as well as Pomona, California; Timonium, Maryland; and Grand Prairie, Texas.
Before bidding, buyers get to watch the two-year-olds sprint, under the urging of a jockey, for distances ranging from an eighth of a mile (200 meters) to three-eighths. The fastest cover an eighth of a mile in about 10 seconds.
That additional information has a price. Two-year-olds sold in public auctions from 2004 to 2006 cost an average of $62,999, 15 percent more than the $54,946 average for yearlings during the same period, according to The Blood-Horse. As the spread widens, pinhookers profit.
Cash Cow
Chace cemented his reputation in 1994 when he pulled a gray yearling out of a Saratoga Springs auction ring for $200,000. His client, Ernie Paragallo, a former Goldman Sachs Group Inc. and Deutsche Bank AG executive, pinhooked the horse for a then record $1.4 million, only to see the Japanese buyer, businessman Hiroshi Fujita, return the horse, saying X-rays revealed an ankle injury.
Paragallo named him Unbridled's Song and sent him to the racetrack, where he won the 1995 Breeders' Cup Juvenile, the richest race in the U.S. for two-year-olds, and two key prep races ahead of the 1996 Kentucky Derby. Hobbled by a cracked hoof, he ran fifth in the Derby. Zito, who trained the colt for six months, calls him the most talented horse he ever had.
Lately, Unbridled's Song has been a moneymaking machine, generating about $20 million annually in stud fees. Chace pockets 7.5 percent of the revenue, thanks to a stake Paragallo gave him after the pinhook deal fell through. ``Ernie's a great guy,'' Chace says as he sips coffee at a Keeneland barbecue. ``Guys in this game just don't do what he did.''
War Pass
Chace could retire today -- ``I don't hustle clients,'' he says -- but thoroughbreds are his life. So he travels from auction to auction across the country, searching for horses he calls ``runners.''
``We're all looking for the big hits, for the one or two that will pay for everything,'' Brennan says in his thick Irish accent.
Mention a big hit named War Pass, and Brennan says the horse has made the entire year for LaPenta. Then Brennan corrects himself: ``He's made a few years.''
The story is a pinhooker's dream.
Zito picked out the yearling for LaPenta, who paid $180,000 in 2006 but had to hold him out of the 2007 auctions for two- year-olds because of injury. LaPenta sent the horse off for ankle surgery and turned him over to Zito to train and race -- their plan B when a pinhook prospect falters.
Under Zito's tutelage, War Pass went undefeated in four starts this year, including a 4 3/4-length romp in the $2 million Breeders' Cup Juvenile in October. That stamped him as the favorite to win the 2008 Kentucky Derby, scheduled for May 3.
Bill Oppenheim, a breeding and auction market columnist at the Thoroughbred Daily News, estimates War Pass's value at about $20 million. That's a return of more than 10,000 percent. Try making that trading stocks and bonds.
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I have always said to myself, if people put the same r esources into horse racing sales and hell even handicapping as they have into stocks, they would make more money. besides a few results, I have never been bella impressed with stock returns. the real money in stocks is IPO's. I keep stocks but I like the dividend checks more than an ything.
I'm getting off the point. I do think this article is a little misleading. thye named what... 7-8 horses? how many horses are there on the first 3 days of the sale? 600ish? should have been more balanced.. the 9 million dollar storm cat in dubai, the 11.2 million dollar kingmambo (Medayan City I think is the name) that we havne't seen yet, the green monkey, etc.
all in all it was a pretty good read
