Why Activist Investors Matter

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I am here today with Ken Squire. He's the chief portfolio strategist for the 13D Activist Fund. We're going to take a look at activist investing and why individual investors might care about it. Ken, thanks for talking with me today.

Ken Squire: Thanks for having me, Jeremy.

Glaser: So let's talk a little bit about what is activist investing and why should individual investors care about it.

Squire: The type of activist investing that we follow is when a shareholder takes a greater-than-5% position in the common stock of a company and they intend to influence management. So, this is great for the average shareholder because generally [activist investors are] making management and the board more accountable to shareholders. They are a watchdog, so to speak, for the shareholders, and they are funding the entire expense of an activist campaign. And generally the shareholders will benefit equally.

Glaser: What kind of changes are these investors usually trying to bring about?

Squire: It could be anything from corporate governance, as far as getting new board seats, to replacing a CEO, to having the company use its cash more efficiently by either buying back shares or issuing a special dividend, spinning off a subsidiary. It really runs the gamut.

Glaser: How successful are these investors generally in getting what they want?

Squire: They are very successful in accomplishing their activist goals, so very rarely do they lose. More often than not these situations get settled. So they'll generally get the board seats that they want. They'll generally get some type of concessions from management, and this does translate into returns. The average 13D that we follow is a 15-month holding period, and during that 15-month holding period, there's an outperformance of 16% over the S&P 500; that's after the initial 2.65% bump that the 13D always gets generally on average on the day of the filing.

Glaser: So with that outperformance, how do you know which investors are actually going to be successful and which just might end up empty-handed?

Squire: That's a great question. You need to know the investors. You need to be able to analyze the situation, and that's exactly what we do. So, the 13D event, we'll look at who's the investor, what's its track record, what sector are they investing in, what's their track record in that sector, what strategy are they employing, and most importantly, what are their chances of success: Who are the other shareholders and are they likely to back them?

Glaser: Sometimes you're going to end up with situations like with Herbalife right now, where you have Carl Icahn and Bill Ackman on opposing sides. When you have two investors who've had good track records, how do you decide who is going to come out on top?

Squire: First of all, I've been doing this for seven years and this has never happened before, and I would make a bet that in the next seven years it won't happen again. But you're right, it's a great situation. You have Carl Icahn who has longed [Herbalife], who thinks it's a legitimate company. You have Bill Ackman who after 18 months of research is convinced that it's a pyramid scheme. And this is a situation to my mind that you stay away from. You have two very, very well-respected directors. One has an upside catalyst, which is what we like to see in the stocks. But Bill Ackman is putting a downside catalyst on it, and in that type situation we won't get involved.

Glaser: What are some other activists right now who are looking at companies you find interesting?

Squire: One activist that many of your viewers might not know of is an activist called Marcato Capital Management. Mick McGuire is the portfolio manager. He came from Pershing Square and one of his situations now is DineEquity, the Applebee's and IHOP franchises. The company just did a refranchising initiative. They are 99% franchised, so the company is essentially just a royalty stream of cash coming from the franchisees, and Mick is trying to encourage the company to pay a $6 dividend. At a 5% yield, which is not unheard of for companies like this, the stock would trade at $120 a share. Mick got involved when it was in the $60s. It's now in the mid-$70s, and we see upside from here.

Glaser: Any other situations?

Squire: Agrium is a situation. Jana Partners who is known as an activist, but they're really only activist in about 30% of their portfolio. They are very selective, and they have a lot of conviction when they go activist. They are trying to get Agrium to separate its retail and wholesale businesses. They also would like them to do cost-cutting, better working-capital management, better financial disclosure, and a bunch of other things to unlock shareholder value. They've nominated an all-star board slate to oppose Agrium's at the next annual meeting. It's a huge position for them and just [last week] they just increased their position even more.

Glaser: Ken, I appreciate you taking the time today.

Squire: Thanks for having me.

Glaser: For Morningstar, I am Jeremy Glaser.