Thursday, October 05, 2006
Hedge Funds: Game Over, Part II…When “It” Girls Don’t Read the Fine Print
There’s a company with which I’m familiar that’s been around a long time. It has good management and a nice portfolio of products generating reasonable sales growth at healthy margins, year after year.
On top of that, the business throws off more cash than it requires for plant and equipment, so the management team does what it has been doing for decades: it finds businesses or individual product lines that fit the existing franchise, and buys them at prices which make sense. And if the company can’t find the right fit at the right price, the company doesn’t buy.
Since the stock of this company is owned by the founding family as well as public shareholders, management isn't pressured to do the wrong thing for a short-term pop in the stock: instead, it has the leisure to think about, and act on, the company’s long-term interest.
So it was a bit of a head-scratcher when a hedge fund showed up a couple of quarters ago suddenly owning almost 10% of the company’s stock and presenting itself as one of those ‘activist’ shareholders who stirs things up by prodding management into making stock-moving business decisions for the benefit of public shareholders.
After all, ‘activist’ hedge funds tend to target woefully mismanaged companies whose executives spend money egregiously on themselves or their own pet projects at the expense of public shareholders. They don't tend to go after good companies with happy shareholders.
My own view of ‘activist’ hedge funds is that they are—aside from a handful that have been doing it very well for many years (my old pal at Third Point, Dan Loeb, comes to mind on that score)—the “It” Girls of Finance in the Year 2006.
Seems anybody with a billion dollars of nervous, we-will-withdraw-in-a-heartbeat-if-you-have-two-bad-days-in-a-row money, a Bloomberg terminal and a publicist can be an activist hedge fund nowadays.
And, indeed, the shallowness behind the bluster of the activists agitating for change at the company in question was amply demonstrated on the company’s very next earnings call, when the “It” Girl’s Chief Activist queried management what it planned to do about the company’s “incredibly unleveraged” balance sheet.
For those of you not fluent in the code of activist phraseology, “incredibly unleveraged” means the balance sheet is simply too healthy.
The most obvious way to fix this apparent deficiency, in most activists' playbooks, would be for the company to act like a private equity owner by loading the balance sheet with debt in order to return cash to the shareholders via a share buyback at a fancy price well above the activist’s cost, leaving the company with a crippled balance sheet and reduced growth prospects while the “It” Girl moves on to the next “incredibly unleveraged” target.
Sort of like being a Miami condo flipper, until that game ended last fall.
The only problem in this particular “It” Girl’s case is that the company in question has a Class A/B stock, in which one class of shares has voting power while the other class does not.
Guess which stock the founding family controls? That’s right: the voting shares.
Apparently our “It” Girl activist friends never read the fine print. Or, if they did, they decided that the current environment is so activist-friendly that their powers of persuasion and displays of righteous indignation would cause management to throw forty years of careful stewardship out the window for the sake of a brief pop in the stock and the opportunity for the knuckleheads in question to sell out and move on to the next “incredibly unleveraged”—i.e. healthy—company.
They were wrong.
And having been proved wrong, they are, according to my Bloomberg, selling.
Maybe they'll read the fine print next time.
I Am Not Making This Up
© 2006 Jeff Matthews
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.
Posted by Jeff Matthews at 7:55 AM