The rise of activist hedge funds in the last few years has American companies looking over their shoulders to see if an investor boogie man is following somewhere close behind.
It's scary, but here's the thing — American companies brought it on themselves.
Looking back, it made sense that companies were afraid to use their cash after the financial crisis. The world was at a standstill. Demand was weak because unemployment was even higher than it is now.
As the economy rose off its 2009 post financial crisis low and battled thought the worst of the Euro crisis from 2010-2011, however, people started wondering: When are companies going to start reinvesting all the cash they've been sitting on?
Real estate mogul Sam Zell even said he needed an "all clear" sign before he would start putting his cash to work.
But that's not what he, or any other American company that has been hoarding cash for the past few years is getting now. Instead of an all clear, they're getting a warning shot from hedge funds hunting for cash fat targets. Those hedge funds want the companies to use that cash to buy back stock and make shareholders (the hedge funds and their investors) more money.
That, after all, is their job.
Here's a perfect example: San Francisco based fund Marcato Capital Management sent a letter to Sotheby's this week arguing that they should sell some real estate in London and New York to free up $1.3 billion in cash. Sure, Sotheby's could then invest that cash into expanding their Contemporary art offerings, as another activist on their tail, Dan Loeb has said.
But really, you can bet that if that real estate is sold, Marcato, the third largest shareholders of Sotheby's stock, will then push for a stock buy back. And who does that help? Sotheby's shareholders — Marcato.
Now, Sotheby's (like other cash rich companies) could've spent the money on R&D, it could've hired people (something that would help solve corporate Americas initial problem — lack of demand), it could've paid people a little more (you do NOT want to be a 25 year-old working at Sotheby's and trying to live in NYC or London without help).
Now, Sotheby's will have to worry about waging fierce, expensive fight to fend off investors that don't quit — guys like Third Point's Dan Loeb — that have no problem taking a company to war.
And the rest of Wall Street has caught on to this strategy because it works, and because there are targets everywhere.
This week, two veteran hedge fund managers — Jason Ader, of Ader Investment Management, and Andrew Wallach of Cumberland Associates — joined forces to start their own firm. Ader has a background in activism, but Wallach is a value guy.
"I've been frustrated over the years," Wallach told Business Insider. "I can't tell you how many companies I've tried to explain to share repurchase to. I'm tired of it."
The language hedge funds use to announce their targets almost boiler plate at this point, too. Check out this press release from Kerisdale Capital, a hedge fund founded by a young investor, Sahm Adrangi. He's going after Lindsay Corp., an irrigation company where Howard Buffett sits on the board.
Lindsay's management team boasts an enviable track record... Overall, we believe management's operating execution has proved exemplary.
However, on the issues that fall into the domicile of Board oversight, our assessment is less glowing. Lindsay maintains an overcapitalized balance sheet and its capital allocation plan is ambiguous. Over the past five years, Lindsay has accumulated$100 million of cash on its balance sheet, such that net cash currently comprises $150mm, or more than 15% of the company's market capitalization. Lindsay's cash balance has earned less than 1% annually over the past five years, while Lindsay's return on equity has ranged from 10% to 20%.
Management has suggested that the large cash reserves would allow the company to react quickly to a potential acquisition target. Yet Lindsay hasn't made an acquisition larger than $35 million in over two decades. That $35 million acquisition was of Barrier Systems, Inc. in 2006, a business that is currently break even and that we believe to have been a suboptimal use of capital and management attention...
Basically, if you won't put your cash to work, we will do it for you. Throw the word 'Apple' in there instead of 'Lindsay' and you can almost hear Carl Icahn talking on CNBC yesterday.
This isn't to say that every target isn't putting their cash to good use (with Apple especially, that is debatable) but lets be real — American companies are fat. They got that way because they were scared. Instead of putting their money to work for the good of the country, putting more Americans to work, or putting more cash in their pockets, American companies kept that cash for themselves.
And now Wall Street has come to repossess it.
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