Hedge fund activism: Participants
ACTIVIST HEDGE FUNDS are losing in the popularity stakes. Last month, the latest funds to suffer a public backlash were London-based Centaurus Capital and US-based Paulson & Co. The two funds, with a combined stake of 31.4% in Dutch conglomerate Stork, continued to press for a management change, and a break-up of the company’s business units. Their case: that the firm would unlock more value for all shareholders if it focused solely on its main business, aerospace. Minority shareholders Robeco and ABP, the Dutch pension fund, have publicly rejected the hedge funds’ proposal, and management of Stork has allegedly tried to dilute the managers’ stake of almost one-third by issuing preference shares. The result: a pending court investigation into the allegations.
Also in the headlines recently has been Eric Knight, of Knight Vinke Asset Management. Knight has fought a public battle as he has campaigned as a shareholder for the break-up of French utility Suez, into a water business and an energy business. With recent reports that French billionaire François Pinault is exploring a bid for the two businesses separately, Knight might finally see his ambitions for the firm fulfilled but it will not be as a result of his fight for shareholder value.
In the US, Carl Icahn is the most noted name among activist hedge funds. In 2005 and 2006 he entered into a public battle with the US’s largest media company, Time Warner Cable, as he fought for cost cuts, management changes, a $20 billion stock buyback and a break up of the business units.
Such publicly fought battles, whether intended or not, between activist hedge fund managers and management of some of the world’s largest companies have resulted in the activist segment of the hedge fund community being branded as antagonistic and troublesome.
There are an estimated 125 dedicated activist hedge fund managers, with many more hedge funds thought to be applying an active approach in conjunction with their main strategy, be that event-driven, distressed, long/short equity or merger arbitrage.
It is a growing number but often their roles in creating shareholder value and working with management go unmentioned – because they are without conflict.
Euromoney asked a selection of hedge fund managers that would be perceived as activists to discuss how they approach activism, what shareholders and indeed management can gain from their involvement, and where they see their segment of the hedge fund industry going.
BC: Activism can mean many things to different investors, ranging from nasty, confrontational letters to quietly working alongside management on strategic decisions and capital allocation. Can each of you define your approach to activist investing?
DM: We’re always active but not always activist. We’re looking for undervalued situations and will get as active as necessary. We want to be friendly activists and work with the company and the board to unlock value. In extreme cases though, we are not afraid to get much more aggressive. As shareholders, we own a piece of the business. We won’t back down when we see that the management is not doing the right thing for shareholders.
MF: The dictionary definition of activism has an adversarial connotation to it. Our style is to think and act like owners. We want to be involved with management that already gets it and that we can work with. We don’t always agree with our companies but we virtually always agree with the strategy and the business model that they’re pursuing. If you’re an owner and you’re acting like an owner, why would you put your money with someone that you thought was going to be a poor steward for your capital?
CL: Here’s the distinction between passive investing and active investing: if we don’t like what’s going on, we don’t just simply sell the stock, what people call “voting with your feet”. We get involved. Ours is a private equity mentality, so we take a view as if we’re another private equity sponsor who will do whatever it takes to make sure value is realized.
KR: We do ownership investing. Many activists just complain to the management but we try to work with them. We’ll bring in consultants, bankers, people and resources that can unlock value in the situation. Almost any company could be doing something better. Sometimes we fight with management, but we leave that in the boardroom. You’ll never see us in a public letter-writing campaign. That’s dangerous to your franchise. We’ve actually run into problems just by having the word “active” on our website. We’ve changed it to the word “ownership”, because a lot of people who call themselves active have left a bad taste in managements’ mouths.
JL: This notion of constructive activism and trying to work with a company is particularly germane to our strategy. We have found it the most efficient path to value over our 11 years in the business.
BC: Perhaps the most fundamental part of a successful activist strategy is superior security selection and accurate valuation analysis. Most activists are stock-pickers who have a true passion for their craft. How do you go about sourcing opportunities?
KR: Superior security selection is probably 70% to 80% of the game, while the unlocking of value probably gets the other 20% to 30%. If you pick a lousy company at a bad valuation, you can get them to put in a dividend but you’re going to lose money. So we always start with finding a good business. These ideas can come from trade journals, our analysts that follow certain industries, or relationships with management over time. A lot of ideas come from the due diligence you do on others. We look for industries that have recurring revenue, high return on invested capital, longevity of management and generate positive free cashflows over time. From the valuation standpoint, we look for 10% cash on cash yield, and the company has to be growing 5% a year. That will mean we double the value of our investment in five years if they do nothing else. But of course we want to help them increase the stock price, improve margins, grow faster or return capital to shareholders.