activist investors, Argo Group, Avangardco, binary outcomes, Carl Icahn, catalyst, Daniel Loeb, Expected Value, government regulation, Herbalife, IRR, junk bonds, litigation, major sale, NAV discount, Risk Arbitrage, Robert Chapman, share buyback, shareholder activism
Continued from here.
iv) Activist Investors are my next catalyst. Obviously, there’s no specific timetable here, but since most activists are performance-driven hedge funds, a 6 mth to 2 yr timeline is reasonable. Activists in the UK usually target asset discounts & realizations (so investment trusts/companies are ideal), while European/US activists are perhaps more biased towards operational change (which may require a longer investment horizon).
Most activists prefer to agitate for change behind the scenes, but some prefer to be more public: Carl Icahn (I read King Icahn at least once a year) is the king of the activists – he’s 77 now, but is more of top of his game today than he was 30 yrs ago! Other notorious activists (& 13D filers) are Dan Loeb of Third Point (and here, though he claims he’s mellowed now!) & Robert Chapman, who (presumably!?) introduced the first ‘fuck‘ in an SEC filing. More in-depth reading material includes ‘Risk Arbitrage‘ by Wyser-Pratte, ‘Extreme Value Hedging‘ by Orol, and certain chapters of ‘Free Capital‘ by Guy Thomas.
Activists are impatient & aggressive, they’re seeking high returns, and they’ve got the muscle to achieve their goals. This fire-power covers a host of tactics: Sometimes it’s simply sheer size (they become the largest shareholder), but it also includes nominating directors, conducting proxy fights, deposing/appointing management, recommending operational changes & asset/business sales, finding bidders for the company (or even bidding themselves), demanding strategic reviews or even wind-downs/liquidations, etc. One catalyst may quickly lead to others..!
So, how do you keep track of these guys? Mostly by just surfing the usual financial/investing websites & blogs every day. Tackle the SEC EDGAR website to track US filings, and Investegate & LSE for the UK. Always check the major shareholders of any company that interests you. The WAM board on ADVFN UK tracks many UK activists. And here’s a specific list of activists you may want to keep track of:
Ireland: IIU (The Kaiser – Dermot Desmond), Focus Investments (Davy Stockbrokers), Kevin Anderson (the world’s oldest activist?!), and Farringdon Capital all keep a low profile, but I suspect they occasionally indulge in some low-key activism. Ray French (Strongbow Capital) & Pageant Holdings are more obvious/control-oriented activists. Similar activism would make sense for TVC Holdings (TVCH:ID) re their UTV Media (UTV:LN) stake (or other stakes, if they ever get ’round to buying anything else).
UK: Laxey, Weiss (Brookdale), QVT, Damille, and Principle Capital are mainly interested in investment trusts/companies & other asset situations. Julian Treger (Audley Capital) is now mostly focused on natural resource stocks. Sherborne Investors & Crystal Amber have an operational focus. Hanover Investors and North Atlantic/Harwood Capital have a distressed/private equity perspective. Individual investors to look out for are Nigel Wray, Bob Morton (Southwind), Peter Gyllenhammar (Bronsstadet/Union Discount), Joe Lewis, Jim Mellon, Andrew Perloff of Panther Securities (PNS:LN) (just read his Chairman’s Supplementary Ramblings!), Vincent Tchenguiz & Jack Petchey (Trefick).
[Perhaps I may humbly point to my own activist stirrings (in the UK): First, with Avangardo (AVGR:LI) – this letter was quickly followed by news of EU export approval. The share price has, rather absurdly, gone full-circle since then (a 14% retracement in the past mth) – again, this presents a (last?) chance to buy back shares at a substantial discount to intrinsic value.
And second, here & here with Argo Group (ARGO:LN), culminating in a much more specific proposal to return capital to shareholders. The intrinsic value here is even more obvious – the company’s market cap is at a substantial discount to its net cash/investments. Argo’s results should be released within a few weeks – I look forward to an update on operational progress & AUM, the balance sheet, and (of course) the company’s response to this proposal].
Europe: Wyser-Pratte, Knight Vinke, Pardus, Cevian Capital (quite exceptionally, Carl Icahn invested with them), Vincent Bollore & Algebris (seeded by Chris Cooper-Hohn (TCI), who’s now mostly US-focused).
US: Well, there’s far too many activists to list them all..! Let’s stick to the biggest/brightest: Carl Icahn, Harbinger Capital (Philip Falcone – perhaps on his last legs?!), Third Point (Dan Loeb), Eddie Lampert (ESL – focus on his other/successful investments, not Sears Holdings (SHLD:US)), Bill Ackman (Pershing Square), Relational Investors (Ralph Whitworth), Bulldog Investors (Phillip Goldstein), Trian Fund (Nelson Peltz), Jana Partners, Elliott Management, ValueAct Capital, and Steel Partners (SPLP:US) (Warren Lichtenstein).
[C’mon, you knew it was inevitable I’d mention Herbalife (HLF:US) at least once..?! Actually, HLF’s most definitely not a normal activist situation, but it’s another reminder of the recent resurgence of activists (& the accompanying media interest). It’s early days yet, but that makes me a little nervous – with hindsight, the sheer dominance of activists in 2007 was a classic signal of a market top. Which puzzled me for some time after… Surely activists are a harbinger of a market bottom, when assets/businesses are trading (on average) at substantially larger discounts? In reality, that’s not the case:
Most (larger) activist effort implies: a) A gearing-up of a company’s balance sheet (to fund a share buyback/tender, special dividends, and/or an accelerated growth/acquisition strategy), or b) a sale of key assets/divisions, or the entire company. These strategies, above all else, are dependent on the market’s risk appetite for funding/junk bonds – so, perversely, the greatest interest & success in activist investing inevitably arrives at the top of the market…]
Now, I’m not suggesting you throw all your efforts & portfolio into coat-tailing activists! Their risk profile & perspective may be v different from yours – by definition, they often take on poorly performing companies & equally poor management, which certainly isn’t for the faint-hearted... And you only get to see their stock entries/exits after the event (sometimes on a delayed basis), while you’ve probably no idea what other hedges, shorts or other offsets they may have within their portfolios.
I think it’s better to stick with activists as a catalyst. Use them wisely (and profitably) to cherry pick and/or endorse your conviction stock picks. That’s not to say you can’t let them do some heavy lifting in your portfolio. Here’s a selection of US/UK/European activist (& arbitrage) funds in which you can easily invest. If you prefer to consider individual stocks that are (possible) activist targets, here’s a selection of stocks which I monitor, or have a shareholding. [If you’re interested, be sure to peruse all subsequent commentary & news! For example, Joe Lewis has swooped in on Timeweave (TMW:LN) since, albeit at a piss-poor price].
v) A Major Sale is another catalyst to highlight. In fact, a major purchase may (in theory) be a catalyst too – but in reality, acquisitions almost always fall short of management’s rosy promises. And, of course, companies sell divisions/businesses regularly – most of the time, there’s no catalyst implied. But occasionally, a major sale offers a true catalyst in terms of value (realization). So, how exactly do we separate the exceptional from the pedestrian? Broadly, my rule of thumb is:
A sale amounting to at least 50% of the current market cap, and/or causing a P&L increase of at least 50% (or a flip into profitability!), may offer a significant catalyst.
This type of sale doesn’t necessarily increase intrinsic value. But:
– It can transform the balance sheet. Elimination or reduction of debt (to non-risky levels) is often the only way to reverse a leverage-induced share price spiral.
– If a company’s assets are intangible/have an underlying permanent value, but current profitability’s weak, the market’s often a poor judge of value. Think of luxury brands, natural resources, forestry, media, technology/patents, etc., or even a company ploughing profits back into its growth strategy. A sale may be the only way to highlight/capture this underlying intrinsic value.
– Even if value’s supported by hard assets, the market can sometimes ignore it for a v long time. That’s much harder to do when assets are converted to cold hard cash… And follow-up actions (like special/increased dividends, buybacks & tender offers) can reinforce/increase this inherent value.
– And the sale of a loss-making division can radically revise a company’s P&L – particularly true of small companies with proportionately higher fixed costs (which really leverages their profitability). Companies, somewhat bizarrely, often do a poor job of communicating this step-change in their prospects.
Here’s another selection of individual stocks which have a major sale as an actual/potential catalyst (again, please research subsequent news & commentary on these stocks).
vi) Litigation/Regulation is my final catalyst. Without a doubt, it’s the most difficult to exploit (NB: I tackled catalysts in reverse order of difficulty) – you may even want to forget this one… First, most litigation/regulation risk/events are simply part & parcel of normal corporate activity. Second, some sectors are almost permanently targeted (by politicians, for example). These risks often amount to noise, and are routinely priced in anyway – they’re not catalysts.
But occasionally, you see a real game changer: A lawsuit, or a (potential) regulatory action, that could prompt a major change in a company’s intrinsic value, and/or a rapid/significant adjustment in its market cap. How exactly do we identify such a catalyst? A similar approach (to a major sale) seems sensible:
A litigation/regulation risk or event that may cause at least a 30-50% change in the intrinsic value and/or market cap. of a company may offer a significant catalyst.
Of course, this kind of threat/opportunity is difficult to handicap. Even for the company itself, which may prefer denial, or to simply leave its shareholders uninformed about the risks & complexities involved. And, regardless of the depth of your analysis, the outcome’s always going to be binary – leading to v different financial results. The correct approach, of course, is to use an expected value approach: Identify each outcome, try to handicap its probability, evaluate the potential financial impact, and repeat... Once you’ve covered the spectrum of possibilities, you can calculate the resulting expected value of the financial impact & consider it in relation to the current market cap.
If you’re a smart & consistent handicapper, you can expect to make good money over time. In the short term, though, you can’t escape that actual binary result – which may be the worst outcome…which can really hurt! But remember, many investors (even institutional) just can’t cope with this kind of situation – they end up pricing it in binary fashion:
i) They completely ignore the risk, forget the risk, or simply refuse to price in the risk, or
ii) They just go completely overboard, and price in the majority (or even 100%) of the risk!
When investors simply forget a risk, or forget to use an expected value approach, this often presents a lower risk opportunity, ideally within an accelerated timeline… Yep, it’s a catalyst! And they turn up much more frequently than you might imagine – I’m often amazed at the value on offer pre/post-catalyst. Some examples are definitely the best way to illustrate this catalyst: Here’s a final selection of stocks that suffer/enjoy a litigation/regulation catalyst.
In closing, let’s revisit my original definition:
A catalyst is any kind of transaction/fact/event/etc., actual or potential, that offers the opportunity for a full/partial realization of value in a stock, within a (reasonably) accelerated timescale.
So, the real benefit of a catalyst isn’t necessarily about a change in valuation, it’s just as much about realizing that value in a (reasonably) accelerated fashion. Which can vastly improve your IRR & the general risk/reward equation of your investments. But don’t forget, a catalyst doesn’t assure investment salvation either – and it becomes that much less valuable the more it’s priced in. Then risk increases, upside decreases, and it simply becomes another part of a stock’s price & story.
But the beauty of catalysts is how often they’re ignored – investors don’t pick up on them, or their potential impact, in the first place! Or they’re simply forgotten – investors pop the stock & then it drifts right back down once they get bored and move on… As I mentioned above (re activists), in general catalysts are perhaps most powerfully employed if you use them wisely (and profitably) to cherry pick & endorse your high-conviction stock picks.
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Alan Stopford said:
Phenomenal piece of work. Great insight. Thank you.
Thks, Alan – yes, catalysts have proved a really popular idea on the blog – people v quickly grasp how they can help stack the deck in your favour when selecting/buying a stock.