Activist investing continues to gain advocates — and capital; according to Hedge Fund Research, activist funds’ assets under management have more than quintupled since 2008, from a level of $32 billion to $176 billion as of year-end 2016. New data for 2017 is expected out soon, notes Stephen Biggar, editor of Argus Research.
Why are assets growing? Activists are achieving successful results. In 2016, activists were able to get management to address their demands 58% of the time, up from 53% in 2014-15, according to the Activist Insight annual review of 2016.
The activists use a variety of strategies to generate alpha. Typically, they go after board seats, push for M&A activity, target the excess cash (or lack of it) on the balance sheet or demand operational improvements.
In recent years, as activists have achieved increased success and gained credibility, the size of their targets has grown. Indeed, blue-chip mega-cap companies such as General Electric and Procter & Gamble are now working with (under pressure from, perhaps) activist investors to turn around their fortunes.
In the past, activists announced their presence by amassing 5% of a company and filing a form 13-D with the U.S. Securities and Exchange Commission. Today, they may hold a smaller stake but still convince other investors to take their side through the use of shrewd media exposure, shareholder letter/whitepaper publications, or high-profile proxy fights.
To isolate the impact of activism, we maintain a dynamic list of major activist investors in the database from Vickers Stock Research, which includes more than 9,000 institutional portfolios. The list has been compiled through a systematic survey of 13-D filings, hedge fund databases, news stories and Argus team of analysts. On average, our top-ranked activists own a concentrated portfolio of 36 stocks in their $6.6 billion portfolio.
Interestingly, some of the recent research on activist investing has concluded that these funds often take a long-term or even collaborative approach. A paper published by professors from Duke University and Columbia University titled “The Long-Term Effects of Hedge Fund Activism” argued that activist investing not only increases value around the time of investment, but for as many as five years following the investment.
We also have noticed a trend in which activists are becoming more collaborative and are working with management teams, as opposed to the historic corporate raider mentality associated with the genesis of the strategy back in the 1980s, or the slash-and-burn campaigns in the early 2000s.
Lastly, announcements by passive investment management organizations now indicate that they are beginning to lean toward activism. BlackRock CEO Lawrence Fink recently sent a letter to the CEOs of the firms in which his $6 trillion invests suggesting they consider the “social purpose” they are serving. He commented that companies “must not only deliver financial performance but also … (make) a positive contribution to society.”
Passive-management voting patterns are changing as well. In mid-2017, both BlackRock and Vanguard pushed ExxonMobil (XOM) to provide annual climate-risk reporting. Further, data from Barron’s showed that the largest passive fund managers are increasingly voting against management on topics such as director elections and shareholder rights.
We keep a close eye on the activists and the stocks they like. The analysts at Argus Research, teamed with the data analysts and programmers at Vickers Stock Research, as well as the portfolio strategists at Argus Investors Counsel, have designed an analytical process that identifies value stocks which may be poised for outperformance because activist investors have built substantial positions in the companies.
The process starts with the stocks in the S&P 1500. We first cut the index into its three constituents: the S&P 500 of large-caps; the S&P 600 of small-caps; and the S&P 400 index of mid-cap stocks. For each index, we sorted for bottom performers by sector. These value screens deliver a list of 450-470 deep-value names.
The next step is to analyze the activists. Activist investing is an important trend in the financial markets, particularly in the wake of the Great Recession and Bear Market of 2007-2009.
Investors such as Icahn, Peltz, Jeffrey Ubben of ValueAct Holdings and William Ackman of Pershing Square, among others, have raised tens of billions of dollars from institutional investors in support of their strategies to enhance shareholder value.
At times using the media, they have successfully pushed for improved shareholder returns by calling for new management, board members or asset sales and restructurings at large- and small-cap companies.
Once we gather the portfolios of these investors from Vickers, we then rank the stocks (more than 850 of them) on activist criteria. We focus on:
• Depth of ownership: Does an activist investor have “skin in the game”? How much skin?
• Breadth of ownership: Are several activists working together for change?
• Timeliness of ownership: Have activists been buying the stock recently?
We then combined the two lists to arrive at a final group of stocks that exhibit potentially powerful characteristics for stock performance: attractive valuations with an activist trigger for outperformance. The stocks that met both criteria are currently included in the Argus Turnaround Portfolio.
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Chipotle Mexican Grill Inc. (CMG)
*_Activist Investor Pershing Square began acquiring shares of Chipotle in September 2016. Pershing currently holds $950 million of Chipotle shares, which is the fund’s third-largest positon.
*_Pershing Square bought Chipotle after the company’s reputation had been ruptured due to food-safety issues that occurred at the beginning of 4Q15. This incident caused a 36% decline in average unit sales. In 4Q16, even after the sales began to recover, average unit volumes were still about 19% below peak levels.
*_Pershing Square has helped Chipotle take a number of initiatives in order to get sales back to their peak. Some of these include the appointment of a sole CEO, a new focus on operations, strengthening of the leadership team, and new menu items. Pershing Square also pushed for pro-consumer aspects such as mobile and digital ordering as well as catering.
Mattel Inc. (MAT)
*_Southeastern Asset Management has held Mattel since October 2017. The fund initiated a position valued at $178 million as of the last 13-F filing.
*_Mattel has struggled to stay up to date with current toy trends. One of their main products was Barbie, which is no longer a popular toy. Another issue is that competitor Hasbro has double the market size. Since the bankruptcy of Toys “R” Us, gross sales have decreased.
*_Southeastern Asset Management plans to help sales recover. They also plan to place a large portion of cost savings towards reinvestment in e-commerce, IT, and gaming through the years of 2018-2020. Mattel has eliminated the dividend to conserve cash.
Hain Celestial Group Inc. (HAIN)
*_Engaged Capital is a new activist on our list. The fund has held Hain Celestial Group since June 2017. Hain is its top holding, with a stake valued at $410 million as of the latest 13-F.
*_Engaged Capital believes Hain, with its focus on natural and organic foods, has great potential compared to most consumer-packaged goods companies.
*_Engaged Capital’s main focus is on innovation. Hain’s largest consumer group is Millennials, and the company is looking to introduce new products and packaging to Hain’s large Millennial consumer base.
Procter & Gamble Co. (PG)
*_Trian Partners is one of the largest ($13.4 billion in AUM) and most-concentrated (eight stocks) activist investors.
*_Trian started buying PG shares in November 2016. At $3.5 billion, the Procter & Gamble shares are now the largest holding in Trian’s portfolio.
*_Trian believes P&G fits the profile of their investments, as they are an industry leader, hold a substantial market cap, and have significant free cash flow. They believe in P&G’s potential, but think the company is held back by excessive costs and lack of administration.
*_In July 2017, Trian filed for the election of Nelson Peltz to P&G’s board of directors. He joined the board in December 2017.
*_Since 2016, P&G has increased investment in research and development, which has helped reduce manufacturing costs and boost organic growth. The dividend of P&G continues to increase, showing growth in free cash flow.
Hess Corp. (HES)
*_Elliott Management has held a stake in in Hess since 2013. Currently, the $1.1 billion investment in Hess is the fund’s third-largest holding.
*_Hess has always been a smaller energy company. Its main problem is that it uses an integrated model for business, so it is not a pure refiner like some competitors — leading to an underperformance.
*_Currently, Elliot wants Hess to sell assets in Southeast Asia and to turn the focus to share buybacks instead of dividends.
Allergan plc (AGN)
*_HealthCor Management has held Allergan since early 2017, and invested more in November 2017. The Allergan shares are a top 10 holding for the $2.9 billion fund.
*_HealthCor places a strong emphasis on the balance sheet and on cash flow to grow shareholder value. They believed AGN management was weak and had potential to meet higher demand.
*_On February 5, Allergan appointed a new CFO, Matthew Walsh.
*_HealthCor is helping AGN grow revenue, increase efficiency in operations, and deploy capital to repurchase stock.
Baxter International Inc. (BAX)
*_Third Point LLC has held Baxter since August 2015.
*_Third Point looks to identify situations where potential value exists. They believe better management and operations teams are needed at Baxter.
*_Third Point helped Baxter select a new CEO. They plan to transform the business to focus on outcomes for patients, investors and stakeholders in order to increase the value of the company.
*_Since the election of the new CEO, the Baxter shares have risen 52%.
*_The BAX stake remains the top holding of the fund.
Merck & Co Inc. (MRK)
*_Healthcor Management is new to Merck, and has held Merck & Co. since November 2017.
*_In June 2017, Merck experienced a cyberattack that resulted in a huge lost in sales and additional expenses. This greatly impacted 3Q17 earnings.
*_In our view, Merck could renew its focus on R&D spending and also consider M&A activity to strengthen its pipeline.
Mylan N.V. (MYL)
*_Greenlight Capital has held Mylan since December 2015.
*_Currently, Greenlight is trying to increase earnings so that Mylan can further research and develop.
*_On January 16, Greenlight announced their fourth-quarter results. Mylan was their top-performer and Greenlight believes much of their earnings were due to the FDA approval for generic Copaxone. Greenlight believes Mylan’s market value will continue to increase along with earnings through 2018.
Itron Inc. (ITRI)
*_Marcato Capital Management has held Itron since August 2017.
*_The fund believes Itron’s operations are underperforming and that the company needs to look at potential strategic alternatives.
*_Recently, Itron acquired Silver Spring Networks, a provider of internet-connectivity platforms and solutions for utilities and cities. This new technology is expected to help efficiency within the company while adding value to its services and outcomes.
