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The winning – and losing – strategies of activist investors

Michael Santoli
Michael Santoli

Maybe we should call them hyper-activists. Those noisy, pushy, demanding fund managers known as activist investors have been unusually busy for the past year or so, and especially aggressive in recent months.

Few stocks appear outright cheap five years into a bull market  and the cheap companies usually have an obvious flaw or challenge. So hedge funds have increasingly attempted to catalyze investor-friendly changes and forcibly knock value loose.

Yet not every effort to buy a slice of a company and then publicly agitate for shareholder-enriching strategic or management changes is equally clever or effective. Here’s a rundown on some recent prominent activist campaigns and the lessons we can take from them.

When you think you’re holding an unbeatable hand, bet huge

In poker, it’s called “the nuts” – the best possible hand in a given deal of cards. Pershing Square Capital's Bill Ackman, one of the most widely tracked activists, found a way to approximate such an advantage, and wagered with gusto.

He began buying a big stake in medical-products maker Allergan Inc. (AGN) before formally teaming with Valeant Pharmaceuticals International (VRX) in a push by Valeant to buy Allergan for $45 billion, a deal contemplated by Valeant and fellow activist ValueAct Capital for some time.

By creating a fund to pool his clients’ capital and Valeant cash to amass a 9.7% effective stake before the bid spurred a 14% surge in Allergan shares Tuesday, Ackman booked an instant $1 billion gain on paper.

While Ackman had to delicately thread the legal needle to stay within the bounds of insider-trading and merger law, and he is taking on risk that no deal occurs (Allergan has put up a “poison-pill” defense), the tactic could be used in the future. It requires a willing corporate partner, hundreds of millions in cash and a suggested merger the market would applaud. No need to caution that you shouldn’t try this at home  because you couldn’t.

Don’t bring a Daisy Duck air rifle to an elephant hunt

Carl Icahn, the septuagenarian pioneer of the “get long and get loud” activist tactic, has done a pretty good job trading Apple Inc. (AAPL) stock, buying in around $440 last summer before disclosing his stake on Twitter, and adding to his position in late January at the 2014 low just above $500. The stock is now near $565 following an 8% surge after a solid earnings report, enlarged stock-buyback, boosted dividend and seven-for-one stock split announced Wednesday.

Still, Apple, now above $500 billion in market value, is simply too big to truly threaten, even for Icahn. And his specific suggestion – that Apple aggressively use its tremendous cash trove to buy back more stock and raise its dividend – was already underway on some level. Icahn withdrew his formal shareholder proposal in February.

Icahn can perhaps take credit for spurring CEO Tim Cook to escalate and accelerate the buybacks. Yet since Apple began emphasizing returning cash to shareholders, shares have been flattish and have trailed the other big tech stocks, so it’s hard to see it as a bottom-line victory.

Icahn was also thwarted by another mega-cap Nasdaq stalwart, eBay Inc. (EBAY), which he pressed to spin off its most valuable business, PayPal. This was another less-than-optimal target.

EBay founder Pierre Omidyar owns more than 8% of the company and, along with the rest of the board, solidly backs CEO John Donahoe in its current strategy of – for now – keeping PayPal and the rest of the e-commerce company together. Over time, PayPal’s superior growth and value have been implicitly recognized by the market. And Donahoe and his industry-insider board had credibility in arguing that spinoff made little sense just yet.

Don’t expect the help of Mom and Pop, and define victory narrowly

David Winters of Wintergreen Advisors boldly tried to rally Coca-Cola Co. (KO) shareholders, including Warren Buffett, to oppose the company’s long-term executive stock-compensation plan, which it deemed overly generous and dilutive.

He brought lots of attention to the issue, and did gain the support of some big institutional investors. But trying to turn a shareholder base of average folks and large, non-confrontational mutual funds against an American corporate icon is a tall order.

The Winters bid failed: The company’s plan was approved Wednesday, with 2.2 billion shares voting in favor, 444 million against, 407 million in abstention and 641 million “broker non-votes.” Buffett did, after the fact, criticize the plan as "excessive" but also noted he didn't cast his own vote on the issue.

Still, Winters said he was “pleased with the result,” pointing out that fewer than half of all shares outstanding were cast in favor of the company plan, versus 65% for the last similar vote in 2008.

Do your homework, and hire a ringer

Starboard Value took a stake in Darden Restaurants Inc. (DRI) last year and wants the casual-dining company to slash operating costs, revamp restaurant management and unlock the value of is real estate. Its plan was carefully and soberly presented. Darden responded with a defensive maneuver, saying it would spin off its Red Lobster division.

Starboard took its case to the Street, asking for a special shareholder vote to block the spin, and enlisted former Darden executives Brad Blum, who ran the Olive Garden division and was considered a possible Darden CEO, and his former colleague Bob Mock, as advisors.

Shareholders voted in favor of the nonbinding proposal to stage a vote, and now the company – long criticized for subpar margins and sluggish restaurant performance – must schedule one.

Other activists have proposed alternative breakup schemes for Darden. One way or another, this situation seems headed in a direction that makes a shareholder-friendly outcome likely.

Be careful what you wish for

Activist hedge-fund manager Jason Ader, a former Wall Street gambling-industry analyst, waged a nasty proxy fight in early 2013 with struggling slot-machine maker International Game Technology Inc. (IGT), trying to get three representatives on the company board.

One was elected about a year ago – only to resign eight months later. The resignation was said to be related to Ader’s firm joining with Cumberland Associates to form Owl Spring Asset Management.

Yet it’s also pretty clear a single director couldn’t do much to sway strategy, and IGT has continued to endure a tough slot-machine market, just this week reporting a large earnings decline; in March they announced a layoff-heavy restructuring plan.

IGT shares, which once traded near $50, went from the mid-teens a year ago to a high above $20 in September, but are now sagging below $13. The company is deeply out of favor and appears quite cheaply valued based on its cash flow and profits, but with few obvious catalysts for a rebound.

In fact, the company looks like activist bait again, based strictly on the numbers. Any takers?