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Starboard Value Presses for Change at GCP Applied Technologies

On Jan. 13, 2020, activist investing fund Starboard Value sent a letter to the chairman of the board of directors at GCP Applied Technologies (NYSE:GCP).

Starboard Value LP is a hedge fund based out of New York City. Established in 2002 by Jeff C. Smith and Mark Mitchell, it has a long track record of success.

The letter announced that Starboard would try and install a slate of directors at GCP, in essence replacing the current board (to which the firm already supplied two members).

After reading the letter and taking a look at the company, I wanted to review the points made by Starboard and see if this is an interesting campaign to potentially tag along with a successful fund in the space. I'll go over the most important paragraphs in sequential order:

"Starboard Value LP, together with its affiliates ("Starboard"), currently owns approximately 8% of the outstanding shares of GCP Applied Technologies Inc. ("GCP" or the "Company"), making us one of the Company's largest shareholders. We continue to believe that GCP is deeply undervalued and significant opportunities exist within the control of management and the Board of Directors (the "Board") to unlock substantial value for all shareholders."

Starboard acquired a large stake, and Gamco Investors could potentially be supportive of these efforts as well.

"As you know, we have been shareholders of GCP for over a year. We invested in the Company because we believe that GCP has a strong product portfolio with differentiated capabilities and strong end market positioning."

I very rarely see activists bother when they don't like the product. They prefer to fix situations where the product is already solid.

"Furthermore, our research indicates that the Company has significant opportunities to improve revenue trends, operating margins, and free cash flow generation. However, despite this untapped potential, GCP has suffered from a prolonged period of disappointing operating and financial results, poor corporate governance, and excessive executive compensation."

Usually, activists do best with the operating margins and free cash flow generation.

"...we are nominating nine highly-qualified director candidates for election at the 2020 Annual Meeting, whom we believe can ensure that GCP takes the correct actions to improve performance and enact best-in-class corporate governance. This slate of directors, if elected, would represent a change in a majority of the Board, which we think is needed and appropriate given the severe issues at GCP."

Basically, this would take away control from the current board and management, so it's not surprisingly the board did not agree.

"Despite its recent problems, GCP is fundamentally a great company with promising future prospects. The Specialty Construction Chemicals ("SCC") business should be a market leader. Our research indicates that SCC has industry leading products with differentiated technology that should result in above market growth and profitability. We believe that with the appropriate focus and execution SCC can drive meaningful profitability improvements while continuing to drive improved revenue trends. Throughout our research process, we have not heard any feedback that indicates there is any structural reason for this business not to achieve higher operating profits."

This is the typical activist playbook and if focused there, they tend to be quite successful. It is with turnaround and spots where revenue needs to get fixed that activists get into trouble. Looking through the investor deck, I can understand Starboard isn't all too happy. The guidance is quite abysmal, estimating strong revenue declines:

I've compared the company to a number of peers, like W.R. Grace (WR), Ferro Corporation (NYSE:FOE) and Armstrong World Industries (NYSE:AWI), and Starboard has a point. Without having in-depth industry knowledge, I can see that GCP generates gross margins that are on the strong end of the range. Once we get to EBIT margins or net income margins, the numbers have deteriorated to the extent that the company performs at the lower end of the range.

"Our goal is to represent the best interests of all shareholders, and we believe that our nominees have the experience and track record to drive the much needed change at GCP that will put the Company on a path to significant shareholder value creation. We remain available to discuss this - and other topics - with you, and, of course, remain open-minded about reaching a mutually agreeable solution to put GCP on a better course."

They leave the possibility of management staying, but in that case the firm likely expects real action from management. This looks to me like a campaign that is very likely to be successful because there is a lot of back-up on the shareholder slate. The track record of the activist and the aim of improving margins is likely possible and can be effective in raising the share price.

The company does trade at 13 times EV/EBITDA, 30 times earnings and 20 times free cash flow. That's a bit on the high side, but it is likely in part due to the costly restructuring that's already ongoing. The current numbers look at least 30% below a cycle average. The one thing that worries me is that revenue isn't really trending in the right direction. Going activist at a melting ice cube doesn't nearly work as well unless it is a liquidation, but that's clearly not the aim here.

Disclosure: no positions

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This article first appeared on GuruFocus.