Category Archives: activist investing

Ackman, Actavis, Allergan and Valeant

November 25, 2014 By in activist investing, mergers and acquisitions, stock market Tags: , , , , , , , , Leave a comment

This is a situation I didn’t pay much attention to while it was going on but which I think has interesting implications for merger and acquisition activity in the future.  It doesn’t seem to me, however, that investors in general understand exactly what went on.

The bare bones:  Bill Ackman, of Pershing Square fame (and J C Penney infamy) bought just under 10% of Allergan, the maker of botox, and urged the company to put itself up for sale.  Ackman then allied himself with serial pharma acquirer Valeant to make a joint hostile (meaning against the wishes of the target) bid for Allergan.  Actavis, a third pharma company, emerged as a “white knight” to rescue Allergan from Valeant’s clutches with a bid that topped Valeant’s offer by about 15%.  Valeant conceded defeat.

 

This is the latest enactment of one of the oldest dramas on Wall Street.  A “black knight” makes a hostile bid for a vulnerable company.  The target firm, realizing that it is now in play, understands that at the end of the day it will most likely be acquired.  The only choice that remains to the target is to choose who the acquirer will be.  Invariably, it determines to join with anyone but the black knight that has caused all this trouble.  That’s why hostile bids fail as often as not.

For this reason, one of the bigger problems in the m&a game is that no one really wants to be the black knight.  Once the villain has appeared, however, there’s usually no trouble in finding someone willing to ride to the rescue.  In most cases there’s at least one potential acquirer hoping against hope that someone else will make the first move.

 

The Ackman innovation: in February, when he and Valeant became co-bidders for Allergan, he agreed to pay Valeant 15% of his Allergan profits if a third-party ended up acquiring Allergan.  This created a win-win situation for Valeant, which would either come away with Allergan or with several hundred million dollars for having played the black knight role.

Issues:

–what was the Allergan price at which Valeant shifted from hoping to acquire the company to wanting to collect a fee from Ackman?;

— did Valeant ever really expect to own Allergan?;

–most important, will this maneuver work again?

I don’t know  …but the answer to question #3 depends a lot, I think, on the answer to #2.

 

analyzing sales rather than earnings (ii)

September 12, 2014 By in activist investing, capitalizing vs. expensing, sales/share vs. earnings/share, stock market Tags: , , , , , Leave a comment

The answer the Bloomberg Radio reporter gave to the question, “Why sales, not earnings?” was that sales are harder for a less-than-honest company to manipulate.  In some highly abstract and technical way this might be true, but in any practical sense the reply is ridiculous.  Stuffing the channel is a time-honored, easy to do way of inflating sales.

Still, there are instances where an investor will want to look at sales rather than earnings.

1.  Value investors looking for turnaround situations will seek out companies with lots of sales but little in the way of earnings.  They’ll benchmark the poorly performing firm against a healthy rival in the same industry.  They figure that if the two firms have comparable plant, equipment and intellectual property, then a change of management should enable the weaker firm to achieve results that are at least close to what the stronger one is posting now.

As I see it, this mindset is what separates value investors from their growth counterparts.  The latter, myself included, begin to salivate when they see a strong bottom line; the former are magnetically attracted to big sales/no profits firms instead.

2.  Especially in the tech world, companies often go public before they become profitable.  AMZN, which didn’t report black ink for eight years after its IPO, is the poster child for this phenomenon.

Potential investors routinely look at the size of the market a given firm is addressing and the rate of its sales growth as a way of gauging its potential value.  This is a tricky thing to do, since it requires us to decide how much of the money the company is now spending is akin to capital spending–one-time foundation laying that won’t recur–and how much is spending that’s needed to generate each new sale.  Put a different way, it’s a decision on what is SG&A and what is cost of goods.  As AMZN illustrated, there’s huge scope for error here.

(An aside:  I attended an AMZN IPO roadshow presentation.  Management mostly said that during the PC era investors could have bought then-obscure companies like MSFT and CSCO and made a fortune.  The internet age was dawning and AMZN offered a similar chance.  Nothing but concept.)

3.  A simpler variation on #1  + #2, which is currently being worked vigorously by activist investors at the present time, is to find companies that may not break out results by line of business but which in fact operate in two different areas.  In the most favorable case for activists, the target firm will look like nothing special but have one high-growth, high-profit area whose strong performance is being obscured by a low-growth low/no-profit sibling.  The activist forces a separation, after which growth investors bid up the price of one area, value investors the other.

 

Obviously, no one uses just one metric.  But the way I look at it, the only persuasive case for using sales as the keystone to analysis is the value investor use I outlines in #1.

 

the Market Basket saga: taking Arthur S’s position

August 29, 2014 By in activist investing, activist invstors, book value, family owned companies, mergers and acquisitions, supermarkets Tags: , , , , Leave a comment

Market Basket is a privately held New England discount grocery chain controlled by two third-generation branches of the founding family.  One branch, owning 50.5% of MB, is led by Arthur S. and has no role–other than being on the board of directors–in the day-to-day running of the firm.  The other is led by the largest single shareholder, Arthur T.

MB recently deposed Arthur T. as CEO and replaced him with two non-family members.  Warehouse and delivery workers struck when they heard the news (with the encouragement of Arthur T., some have suggested), preventing the 71 stores from restocking and effectively hamstringing the firm.  Recently, the Arthur S. branch has agreed to sell its shares of MB to Arthur T. for $1.5 billion.

Throughout this highly public dispute, Arthur T. has been portrayed as a benevolent retail genius, creating an immensely successful business with fanatically devoted employees and extremely loyal customers.  Arthur S., on the other hand, has been seen as a money-grubbing child of privilege who wants to fund his yacht and string of polo ponies by pillaging the workers’ retirement plans.

A lot of this may be true, for all I know.  And the issues rocking MB are all pretty routine third-generation family owned company stuff (see my earlier post on MB).  But in the feel-good story line being taken by the media, one fact is being overlooked.  From what little has been in the press about MB’s profits, it doesn’t appear to be a particularly well-run company.  Arthur S. is probably right that Arthur T. isn’t a good manager.

the case for Arthur S.

Let’s say I’m a member of the Arthur S family and I hold 5% of MB’s outstanding stock.  I receive a yearly dividend of $5 million.  My genetic good fortune is significantly better even than winning the Megamillions jackpot.  So in one sense I should have no complaints.

On the other hand, my share of the assets of MB is worth about $175 million.  Therefore, my annual return on that asset value is 2.9%.  That’s about half the return on assets that Kroger achieves.  It’s also just over a third of what Wal-Mart generates, but I’m confident MB doesn’t aspire to be WMT.

I presumably also know that good supermarket locations are extremely hard to find in New England and that those MB has established over prior generations are immensely valuable.  It’s conceivable that if MB were to conceptually divide itself into two parts, a property owning one and a supermarket operating one, and have the property arm charge market rents to the stores, MB would see that the supermarket operations lose money and are only kept afloat by subsidies from the property arm.  (This situation is more common than you’d think.  It was, for example, the rationale behind the hedge fund attack on J C Penney.  That fact that inept activists botched the retail turnaround doesn’t mean the underlying strategy was incorrect.)

Even back-of-the-envelope numbers suggest something is very wrong with the way MB is being run.  Personally, my guess is that the inefficiency has little to do with employee compensation or with merchandise pricing, although the former has apparently been the focus of the AS’s discontent.  I’d bet it’s in sourcing and in how shelf space is allocated.

At the same time, Arthur T is presumably blocking my every attempt at finding stuff out and is rebuffing board suggestions that he bring in help to analyze why his returns are so low.  If MB were a publicly traded company, I could sell my shares and reinvest in a higher-return business.  I’m probably not able to do this with MB.  Even if I were, the public intra-family feuding would suggest the stock wouldn’t fetch a high price.

I have two choices, then.  I can accept the status quo, or I can try to create a consensus for the family to sell the firm.  That latter is what Arthur S. chose to do.

Signet (SIG) buying Zales (ZLC): a takeover scorecard

June 3, 2014 By in activist investing, activist invstors, mergers and acquisitions, stock market, takeover rules Tags: , , , , , , , , Leave a comment

Last week, shareholders of mall jewelry company Zales (ZLC) voted to approve the takeover of the firm by its rival Signet (SIG).  SIG, a UK-listed company owns Kay and the more upscale Jared, as well as a number of (much less interesting, in my view) UK brand names.  The acquisition price is $21 a ZLC share, or about $670 million.

When I was working I liked luxury goods in general and the jewelry business in particular.  My portfolios contained Tiffany (TIF) and SIG more often than not, and Bulgari (now a part of LVMH) from time to time.  ZLC never.

What I’m primarily interested in today is to outline ownership percentages that are important in any US-based takeover.

1.  at 80% ownership, the acquirer can file a consolidated tax return, meaning losses in one part of the company can be used to offset otherwise taxable income in another.  As well, funds can pass freely from one part of the combined company to another without being considered (taxable) dividends.

2.  at 90% ownership, under the law in Delaware (where virtually every publicly traded US company is domiciled) the acquirer can force the other 10% to tender their shares.  Not having a minority interest makes running the combined company much easier administratively.  Specifically, the firm doesn’t have to concern itself with a tiny number of shareholders whose sole aim may be to become enough of a nuisance to be bought out at a higher price.

3.  at 90% ownership, dissenting shareholders do have the right to appeal to the Delaware Court of Chancery.  There, they can argue that they–but not the vast majority who have accepted the takeover offer–deserve a higher price.  Whatever the outcome, they are still compelled to sell their shares.

The process can be time-consuming.  It’s also risky.  The dissenters’ funds are tied up while the appeal is being heard–and if they lose, they’ll end up with the takeover price, less their legal expenses and will get the money maybe two years from now.

4.  SIG and ZLC are in the same industry.  If I understand US tax law correctly (a big “if”), this fact makes the accumulated tax losses of ZLC more readily available to SIG than would normally be the case.  This could be important, since my cursory reading of the ZLC 10-k suggests ZLC lost just under $500 million in the US during 2009-2012.  Those losses would be worth around $140 million to SIG if they could be used immediately, even if ZLC already used some of them in 2009 to recapture earlier taxes paid.

this may well be an interesting chancery court case

Several large institutional owners of ZLC shares have voiced their intention not to tender all/some of their shares to SIG and to seek a higher price in chancery court.  This may simply be bluster.  If not, I think the case will be an interesting one.

SIG has said that it expects to improve ZLC’s operating results by $50 million a year by using the SIG sourcing apparatus and by another $20 million by plugging ZLC into SIG’s administrative structure.  It expects a final $30 million from sales growth and repairs.  Then, of course, there’s that $140 million in potential tax benefits.

What I find interesting is that just about all this extra value is created by the fact that SIG is the new owner.  A private equity buyout, for example, wouldn’t have anything like the same positive effect, since it wouldn’t have the appropriate sourcing and repair infrastructure (I’ve visited the SIG diamond vault, by the way).  And their use of ZLC tax losses would be far more restricted.

Are minorities entitled to share in value being created solely from intellectual any physical property owned by SIG?  If it come to chancery court, the argument should be interesting.

 

 

 

 

 

value investing, American-style–riskier than it seems

March 5, 2014 By in activist investing, activist invstors, book value, Current Market Thoughts, distressed assets, growth vs value Tags: , , , , , 2 Comments

First, my usual caveat when I write on this subject.  I’m a dyed-in-the-wool growth stock investor.  But I my initial training was as a value investor.  And I practiced that craft for my first eight years in the business.  (Then I began to research mid-cap Pacific Basin stocks in earnest.  They had, at the time, a unique combination of extremely low valuations and unusually high growth.  After a couple of years of owning these hybrids I woke up one day and realized I had morphed into a growth stock investor.) Since that time, I’ve worked side by side with value colleagues for most of the rest of my career, though.

Growth investing is all about finding situations where a company is likely to expand its profits much faster than the consensus expects, and/or at an above average rate for much longer than the consensus believes.  It’s about where the company is going, not where it is now.

value investing

Value investing, in contrast, is all about where the company is now.   It’s about finding companies whose equities have been beaten down excessively by overemotional holders who have abandoned ship because of temporary earnings disappointment.  This disappointment can come from any number of causes.  Common ones include:  highly cyclical companies entering the down part of their business cycle, a big misstep by a normally competent management, or flat-out terrible corporate managers.

As an astute former value colleague put it, “There are no bad businesses, only bad managers.”  Put another way, there is enduring worth in a company’s tangible (think:  factories and inventories) and intangible (think: brand names, market positioning) assets that persists despite whatever earnings disappointments the firm may be experiencing at present.

In the first two causes I cite, time will cure the earnings deficiency.  Wayward shareholders will rediscover their zeal for the name and bid the stock price up aggressively.

But what if the management is genuinely awful?  In this case, value investors believe that the incompetents will be shown the door and be replaced by more highly skilled individuals.  The board of directors may do this, because, after all, that’s their job.  Or shareholders may demand a change.  (Fat chance of either of these happening, in my view.)  Or–and this is particularly American–either activist investors or hostile acquirers will swoop in and force a change.

two risks

As far as I can see, this last American idea–that justice will be served and the bad management tossed out–is valid in the US, but almost nowhere else.  Just look at the experience of activist value investors over the past quarter century in Japan or in continental Europe.  Yet, oddly enough, otherwise rational American value investors try the same tactic over and over, each time in the expectation of a different result.

This risk has been around for a long time.  The second hasn’t.

One of the deep underlying assumptions of value investing is that a company’s assets have an enduring economic worth, despite current headwinds.  All we need is some spark, some catalyst that will enable this worth to shine through.  And we can wait, since the value of accumulated assets is unlikely to deteriorate.

This is the sense behind the observation that a stock is trading at a discount to book value–that is, to the total sum of the assets the company owns, after subtracting out anything it owes to the rest of the world.  Calculations of “book” are based on the actual historical cost of acquiring the assets, which very often understates (usually by a lot) what it would cost to replace them.

Two new, still poorly understood, threats to this view:  the internet and Millennials.

Take suburban shopping malls as an example.  Millennials, at least more affluent ones, seem to like to live in cities, not the suburbs.  Internet shopping has reached the point where retailers are openly saying (they’ve probably secretly know this for much longer) that they have too much mall retail space.  Who to sell it to?

In other words, demographic/technological change is accelerating.  This increases the chance that balance sheet assets are writeoffs waiting to happen rather than “straw hats in winter,” needing only a change of season to flower.