2010, 10:04 p.m. EST
Operational activists’ work pays off
ValueAct, Cevian, Barington see big gains as
corporate revenue rebounds
Alistair Barr, MarketWatch
FRANCISCO (MarketWatch) — Operational activist hedge funds, which take
long-term stakes in companies and push for strategy changes, are reaping
rewards from hard work during the recession.
ValueAct Capital Management,
a $4.5 billion firm led by Jeff Ubben, was up roughly 35% this year, through
early November. That was on the back of a 40% gain in 2009.
Jeff Ubben, head of
ValueAct Capital Management.
Cevian Capital, Europe’s
largest activist investment firm headed by Christer Gardell and Lars Forberg,
gained almost 30% in the first 10 months of this year and returned 36% in
Read MarketWatch’s profile of Cevian here.
Barington Companies Equity
Partners, run by James Mitarotonda, returned almost 11% in September alone.
It was up more than 20% so far this year, through the middle of November,
after jumping over 52% in 2009.
“Operational activists have
accomplished a lot over the past two years with their portfolio companies,”
said Tony Lissuzzo of Lakeview Investment Manager, which invests in activist
hedge funds. “The market rally and some economic pickup has highlighted the
companies that used the recession to rationalize their businesses.”
“As I look at the companies
in our managers’ portfolios I see good values and coherent plans to realize
that value,” he added. “You cannot discount the work they’ve done through
the recession on some of their longer-term positions.”
Activist hedge funds often
take big stakes in companies and push for share buybacks, bigger dividends
and sales of divisions or the whole corporation through mergers and
James Mitarotonda, head of
Barington Capital Group.
Operational activists try to
differentiate themselves by holding stakes in companies for several years
and often becoming directors and even chairing boards. Instead of focusing
on buybacks, dividends and M&A, they attempt to change the way companies
work and come up with new strategies.
This approach produced heavy
losses during the 2008 financial crisis. As stocks swooned in the wake of
Lehman Brothers’ bankruptcy, the big positions held by operational activists
were hit hard.
Most of these firms don’t
short, so they were exposed as other investors panicked and sold stocks
indiscriminately. If managers are board members, they are subject to strict
trading limits, which may have reduced their ability to maneuver during the
Barington lost 46% in 2008,
while Cevian was down 32% and ValueAct shed 28%.
But the losses masked
changes underway at several companies backed by these investment firms.
For ValueAct, the financial
crisis was an opportunity to put companies’ cash flow to work, often in
attractively priced acquisitions.
ValueAct doesn’t short
stocks, but the firm’s hedge is its focus on ten to 15 high-quality
businesses that can generate cash in good times and bad.
”Our role in the boardroom
is allocating capital,” Ubben said in an interview with MarketWatch. “Down
markets are really opportunities. With these companies generating cash flow,
we were in the room and we could act when prices fell.”
ValueAct’s largest holding is Valeant Pharmaceuticals International Inc.
-0.07%), a position
the firm has held for a few years.
ValueAct partner G. Mason
Morfit joined Valeant’s board and the chief executive was replaced with a
former McKinsey & Co. partner J. Michael Pearson.
The company has shifted away
from developing new drugs in favor of an acquisition spree focused on
manufacturing branded generics, Ubben explained.
Valeant has made at least 14
acquisitions in recent years, helping annual earnings, before interest,
taxes, depreciation and amortization, jump from about $150 million to $850
million, Ubben added.
In September, Valeant merged
with Biovail in a $3.3 billion deal. Although this was a “big bite,” Ubben
reckons the company can make more acquisitions in the industry by focusing
on manufacturing, rather than the science.
Valeant shares lost
two-thirds of their value from the middle of 2007 to October 2008, in the
midst of the financial crisis. Since then, the stock has tripled.
Ubben said part of the
company’s success involved a potentially lucrative compensation package for
Pearson that aligned the CEO’s incentives with those of shareholders.
“We incented in the hell out
of him... Alignment of interests is very important to us,” Ubben said during
a presentation earlier this year.
“The stock has tripled. You
can’t pay him enough for that shareholder value,” Ubben added. “If he can’t
do it, you fire him.”
ValueAct’s second-largest position is U.K.-based software company Misys Plc
Misys acquired Allscripts in
October 2008, at the height of the financial crisis, then merged its health
care software business into the company, which specializes in electronic
The combined business,
Allscripts-Misys Healthcare Solutions, bought Eclipsys Corp. for $1.3
billion in stock earlier this year.
Misys sold its 54.6% stake in Allscripts
+1.76%) as part of
the deal. That raised about $1.3 billion. More than $1 billion of that money
was returned to Misys shareholders, including ValueAct.
“We made three times our
money,” Ubben said.
“With low-cost debt, willing
sellers and cash flowing, it was wonderful,” he added. “The last two years,
it’s been as good as it gets.”
‘Sense of urgency’
The deep recession gave
other operational activists the chance to push through changes that might
have been rejected in better times.
London-based partner at Cevian Capital.
“The crisis instilled a
sense of urgency among all stakeholders — managements, boards, other
shareholders, even unions,” said Harlan Zimmerman, a partner at Cevian.
“This meant we could walk in the door and start talking immediately about
what changes to make.”
In the midst of the crisis,
other investors in the stock market didn’t care about such changes, because
“they were even more skittish and short-term focused than they normally
are,” Zimmerman added.
“Recently, as the world has
started to normalize and revenues have started to come back, we’ve been
enjoying the payoff for the work that we’ve been doing over the last two
years,” he explained.
“The cost structures of our
companies have been cleaned up, and the companies have achieved a new level
of profitability,” Zimmerman said. “This has driven our strong returns this
year, and we expect that dynamic to continue as revenues get back to
Crane giant Demag Cranes AG
-1.21%), in which
Cevian unveiled a position earlier this year, has been shutting facilities
in high-cost countries. As manufacturing recovers, they are opening
factories in lower-cost areas, improving profitability, Lakeview’s Lissuzzo
Barington’s Mitarotonda said
the recession forced many U.S. companies to make painful cuts that are
paying off now.
Barington has owned a big stake in auto parts and service company Pep Boys
+4.71%) since at
least 2005, before the global financial crisis.
Mitarotonda, who is chairman
of Pep Boys’ board, helped bring in new management, while developing a new
strategic plan for the company.
Pep Boys has two main
businesses: the retail auto parts side and a service business where
customers bring in their cars to get oil changes and other work done.
The focus is now on growth
through the service side, which has higher profit margins. The auto-service
industry is highly fragmented, giving the company room to expand.
Pep Boys’ businesses used to
be operated independently of each other, which meant there was always a
retail store manager and a service group manager. These were meshed together
and the management structure was whittled down to reflect that.
Pep Boys is also opening new
service-only locations and these will buy products from the company’s
Pep Boys has also reduced
debt from about $600 million to $300 million under Barington’s watch.
“This was done from the
generation of free cash as well as from sale leaseback transactions
involving some of the real estate assets that Pep Boys has,” Mitarotonda
said. “Many of Pep Boys’ stores are owned by the company.”
Hedge fund leaps into
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WSJ's Daisuke Wakabayashi reports.
representatives joined the company’s board, Pep Boys has closed four
tranches of sale leaseback transactions involving about 100 store
properties. The company has also realized over $80 million in cost
“As a result of changes that
were made, the company has become much more efficient,” Barington Chief
Operating Officer Jared Landaw said.
“They are more profitable
than they were before the recession, and on significantly lower revenue,” he
added. “As sales increase, we believe that there’s an opportunity for the
company to generate above-market returns for its investors.”
Pep Boys shares plunged more
than 80% from the middle of 2007 to early 2009, in the depths of the
financial crisis. Since then, the stock has almost quadrupled.
Barington invested in plastics company A. Schulman Inc.
+1.67%) about four
years ago. About 30% of revenue was from North America and 70% came from
abroad — with all the profit generated overseas.
Mitarotonda joined the board
and a new chief executive started in January 2008. A special board committee
was set up to oversee the company’s operating budget and business plan.
“Costs were cut and capacity
was reduced in North America pretty aggressively,” Mitarotonda said. Now A.
Schulman’s North American business is profitable, after roughly a decade of
losses, he noted.
A. Schulman also used to
operate with about $150 million of net working capital. That represented
about 120 days of working capital, a chunk of which was used to finance big
Rivals had about 60 days of
working capital. The company it down to that level, partly by working off
inventory. That helped generate cash that could be returned to shareholders
or used for acquisitions.
Since representatives of
Barington joined the Schulman board, the company has also reduced selling,
general and administrative expenses, improved its gross margins, increased
“The company is now much
stronger,” Mitarotonda said. “We were able to do this during an incredibly
difficult economic environment.”
A. Schulman shares lost
about 40% from late 2006 to April 2009. But the stock has rallied almost 60%
Alistair Barr is a reporter for MarketWatch in San
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