Category Archives: nasdaq

Beware Profiteers Masquerading As Activists

Activist investors are supposed to play a critical role in the economy. They identify underperforming managers or conflicts of interest that prevent a company from achieving its potential. A few activist investors genuinely do great things for companies, their employees and investors. There are, however, many more investors that masquerade as activists for shareholders when they are really just looking to create short-term gains for themselves. The first kind of activist can create significant value for your portfolio. The second kind tends to weaken companies in the long-term. It’s no secret we’ve been on the opposite side of Bill Ackman’s Pershing Square Capital on many recent stock picks, such as Herbalife (NYSE: HLF ), Mondelez (NASDAQ: MDLZ ), and, most notably, Valeant Pharmaceuticals (NYSE: VRX ). We believe Ackman typifies the activist behaviors that destroy, rather than create, long-term shareholder value. “Serial Acquirers” Valeant remains one of Ackman’s most prominent (and most value-destructive ) positions. Valeant has a long history of acquiring other drug makers . This serial acquisition strategy looks superficially accretive due to the high-low fallacy , which allows the acquirer to artificially boost earnings per share (EPS), one of Wall Street’s most hallowed metrics. Certain activist investors love serial acquirers because they can create the illusion of growth by indiscriminately acquiring other companies. The illusion is growth in revenues, EBITDA, or non-GAAP metrics that overlook the price paid for the acquiree, which, more often than not, is so high that the real cash flows of the deal are highly negative and dilutive to shareholder value. Case in point, Valeant’s debt has increased from $372 million in 2009 to $30 billion over the last twelve months (TTM). At the same time, its shares outstanding have more than doubled while its economic earnings , the true cash flows available to shareholders, have declined from $93 million in 2009 to -$685 million TTM. Valeant has finally given up on its serial acquirer strategy, but the massive debt load seriously limits the company’s strategic flexibility going forward, and the lack of cash flow from all the deals has it in trouble with its creditors . Figure 1: Increase In Debt And Share Count For Valeant Click to enlarge Sources: New Constructs, LLC and company filings. Activists such as Ackman love to tout the “platform value” of serial acquirers. They claim these companies can unlock value from the companies they acquire through superior management. While it’s true that some companies have this capability [just look at how Disney (NYSE: DIS ) has unlocked the value in Pixar, Marvel, and Lucasfilm], these cases are few and far between. Playing Both Sides Of the Deal Another favorite Ackman strategy involves buying up shares in one company while working to help another company acquire that position. We saw this with both Allergan (NYSE: AGN ) and Zoetis (NYSE: ZTS ), two companies that Ackman bought shares in while working with Valeant on an acquisition. Beware what you hear about companies where an activist is on both side of the deal. They may be more focused on getting a quick win to boost their performance, while long-term shareholders deserve much more. Shareholders would be better off if activists just left the company alone. Since 2012, ZTS has grown after-tax profit ( NOPAT ) by 20% compounded annually and increased its return on invested capital ( ROIC ) from 11% to a top quintile 17%. Pushing the company to accept an offer from a firm such as Valeant, with a history of value destruction, is a disservice to current shareholders not an unlocking of value. On top of that, these acquisition dramas create unnecessary distractions from the important work of running the business. Allergan’s CEO David Pyott told CNBC that fending off Ackman and Valeant was a full-time job . The run-up in Allergan’s shares netted Ackman $2.2 billion, but one has to believe the company would have been better off with the CEO devoting his time to running the company. Financial Engineering The Valeant/Allergan saga is far from the first example of Ackman extracting short-term value from a company while hurting it in the long-term. For another case-study, look at his 2005 investment in Wendy’s (NASDAQ: WEN ). Ackman convinced the fast food chain to refranchise a number of stores, sell off Tim Hortons-its most profitable business-and use the proceeds to buy back over $1 billion in stock. The move delivered short-term gains to shareholders, and Ackman booked a nearly 100% return when he sold his shares soon after during a feud with management. Wendy’s never recovered from the loss of Tim Horton’s. Its credit rating was cut, making it more difficult to fund investment through debt, and buying back all those shares used up resources that could have helped renovate stores and keep the chain competitive with McDonald’s (NYSE: MCD ), where Ackman tried and failed to push through a similar plan. Today, Wendy’s stock price remains mired below its level from before Ackman’s involvement, and the company consistently earns an ROIC near the bottom of its peer group. By focusing on financial maneuvers such as refranchising, spin-offs, and buybacks, Ackman successfully extracted short-term value from the company while hurting long-term shareholders. Bad Corporate Governance From Focus on Non-GAAP Earnings The use of non-GAAP metrics is something we have warned about many times. The biggest issue with non-GAAP metrics is that management has wide discretion to add income or remove expenses, which means they can easily manipulate the non-GAAP metrics. Unfortunately, activist investors gravitate towards firms that highlight their non-GAAP metrics because it becomes easier to hide shareholder destruction in the short-term. Unsurprisingly, Valeant was one of the biggest proponents of non-GAAP metrics. The company’s executives bonuses were tied to a non-GAAP metric they called “Cash EPS” that excluded costs related to acquisitions, as well as stock-based compensation. Valeant is far from the only example of lax corporate governance on non-GAAP issues. Take for example, Jarden Corporation (NYSE: JAH ), a firm Ackman voiced strong support for in May 2015. We put Jarden in the Danger Zone in October 2015 due in part to its use of non-GAAP metrics for executive compensation. As long as the firm pays executives based on “adjusted EPS,” which conveniently removes certain restructuring and acquisitions costs, JAH will continue to destroy shareholder value. Jarden also fits the description of serial acquirer and takeover target when it agreed to a deal with Newell Rubbermaid in December 2015. “Unlocking Value” Misses Opportunities Valeant might be in the news more of late, but one of Ackman’s most high profile positions might be Herbalife , about which he released details in a 342 slide presentation in late 2012. We highlighted the strengths of Herbalife’s business in August 2013 and despite continued criticism, the company continues to counter each of Ackman’s claims, as well as investigations by the SEC. Instead of going to $0/share, as Ackman predicted, HLF increased over 144% in 2013 and remains up over 80% since Ackman first announced his position. We noted the strength of Herbalife’s business in our report and the thesis hasn’t changed. Over the past decade, Herbalife has grown NOPAT by 15% compounded annually and increased its ROIC from 21% to a top quintile 32% over the same timeframe. Best of all, Herbalife remains undervalued. At its current price of $55/share, HLF has a price to economic book value (PEBV) ratio of 1.4. This ratio means that the market expects Herbalife to only grow NOPAT by 30% over the remainder of its corporate life. If Herbalife can grow NOPAT by just 7% compounded annually over the next decade , the stock is worth $80/share today – a 37% upside. Activists Should Play A Positive Role… But They Don’t There is no shortage of targets out for activists that truly want to unlock long-term value. Many companies have misguided executive compensation plans that push management towards acquisitions and other activities that destroy shareholder value. Just look at how misaligned executive compensation plans helped push profitable Men’s Wearhouse (NYSE: TLRD ) into the disastrous acquisition of Jos. A. Bank . Activists have more opportunity than ever to push back against misaligned executive compensation plans. The Dodd-Frank Act in 2010 requires all companies to allow “Say On Pay” votes where shareholders can make their voices heard on executive compensation. We’d love to see activists with the resources to take on big companies make a push to better align executive compensation with long-term shareholder value. We have compelling proof in the form of AutoZone (NYSE: AZO ) that linking executive compensation to ROIC can help companies deliver market-beating returns . Unfortunately, activists seem to be going the opposite direction. Between 2009-2014 , fewer activist campaigns targeted issues surrounding executive compensation and corporate governance. Instead, activists radically increased their demands for buybacks, spin-offs, acquisitions, and other feats of financial engineering. Activists also seem to be taking a short-term on their investments. 84% of all activist investments last less than two years, according to FactSet. The good news? These types of activists have underperformed this year . Ackman has led the pack downward. Even before Valeant dropped 50% in March, his losses in 2015 and 2016 had already erased any gains he made in 2014. Maybe this underperformance will push activists away from the financial engineering and towards more substantive changes that truly benefit shareholders. Until then, don’t listen to activist investors claiming they can unlock value unless they articulate a focus on ROIC and long-term cash flows. Look past the typical noise and focus on fundamentals. Find companies that consistently generate profit, earn a quality return on invested capital, and have a stock price where expectations for future cash flows are low. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

San Francisco Is A City Divided … By Technology

World-renowned San Francisco is a city of contrasts: Facebook ( FB )founder and CEO Mark Zuckerberg’s $10 million San Francisco home is less than a block away from territory claimed by a Latino street gang. A billboard near Zuckerberg’s mansion advertises starter homes priced in the “low $1 millions.” In a city of 850,000 people, 100,000 residents have no Internet access, and 50,000 have dialup. The average rent for a one-bedroom apartment is over $3,500 a month, the highest in the U.S. An entry-level software developer/programmer can earn $150,000, while the city’s minimum wage amounts to $25,000. City transit handed out 850 permits for a pilot program to use public bus stops for private commuter shuttles that ferry workers to and from Silicon Valley, while the city itself operates only 800 buses. San Francisco’s sharp divide is taking shape amid the financial euphoria and venture capital frenzy for game-changing startups such as Uber and Airnbnb. But this boom has a character that’s proved more divisive than those of the past. The tech bosses, money men and well-educated workers who have flocked to San Francisco have been called “some of the most ruthless capitalists around,” and they have transformed the city’s character in a few short years. “The historic power center, the traditional political interests in San Francisco have been destabilized by tech becoming very political in San Francisco,” said San Francisco Supervisor Aaron Peskin. “Historically, the landlord industry had power in the city, the traditional Chamber of Commerce had power. But all of them have been eclipsed by the tech juggernaut. It’s as simple as money.” Airbnb Playing Tough Politics Privately held Airbnb — a website that lets people rent their homes and apartments to travelers — is one such recent example of the tech industry’s political influence. During the last election cycle, the company spent more than $9 million to defeat a measure seeking to expand regulation over the firm’s activities in the city (illegal rentals make up 76% of the listings , according to a local news report). Its opponents spent less than $500,000. Ultimately the company defeated the legislation. And according to city data, Airbnb recently added $245,000 to its campaign war chest, days after elected officials announced another legislative effort to more tightly regulate short-term rentals — the bread and butter of Airbnb’s sales. The company did not respond to several requests for comment. Sf.citi, a nonprofit lobby group backed by tech companies and venture capitalists, also declined to comment. To be sure, Airbnb’s business model relies on friendly legislation more than most others do, but the dollar amount of the contributions has raised eyebrows. The tech industry was largely unwilling to discuss the issue on the record with IBD, though some firms issued prepared statements that pointed out charitable donations and volunteer work performed by the companies and their employees. Twitter ( TWTR ) declined to make executives available for comment but provided IBD with a written statement, as did Salesforce ( CRM ) and privately held ride-hailing app Uber. Like Uber, Twitter and Salesforce are based in San Francisco. Salesforce CEO Marc Benioff is a San Francisco native, and his father ran a chain of apparel stores. However, the company would not make Benioff available for comment. Cisco Systems ( CSCO ), Facebook,  PayPal ( PYPL ) and privately held companies Dropbox and Stripe are among those that, through spokespersons, declined to comment. S.F. Chamber Sees Divide, Less ‘Engaged’ Demographic But for people in certain jobs, it’s not easy to avoid commenting on a hot-button issue. Jim Lazarus, senior vice president of the San Francisco Chamber of Commerce, pointed to Salesforce’s charitable contributions as an example of how a number of tech companies are giving back to the community. (Salesforce.com, Alphabet ( GOOGL ) and many tech companies are members of the S.F. Chamber.) But he acknowledged that the younger people employed by tech companies are, in general, “not as engaged” in the community as some would like, though he expressed hope that would change. Lazarus concedes there is a divide, stemming from the significant wage disparity between those employed in high-pay tech and those not so employed. “That’s tech in California,” he said. Lazarus says it’s wrong to look at the divide solely through the narrow lens of technology. He says big job growth in sectors such as biotech, health care and education also contribute to the income inequality. And he notes that the services industries also bring some higher-paying jobs for lawyers, accountants and others. “There is a significant professional service economy,” he said. Google Buses Fuel Much Debate Regardless of the complexities of the divide, city residents often express frustration with the high cost of living by protesting — either in court  or on the street — one of the most visible symbols of the tech industry’s supposed hubris: the commuter shuttle. The shorthand is “Google buses,” but they are not just shuttles provided by Alphabet’s Google. “At least once a week, someone on the street makes an obscene gesture toward our shuttle,” Genentech employee Michael Stevens wrote to the Board of Supervisors in an email obtained through a public records request by IBD. “I don’t understand this, but I think that kind of behavior is typical of those who resent the shuttles.” IBD obtained more than 1,200 pages of documents about the shuttles, which included dozens of complaints from residents, unions and neighborhood associations. At their core, the idea of the shuttles is to reduce freeway traffic — which is legendary in Silicon Valley — as well as pollution, while also providing a perk to tech employees, of course. Google’s liaison to the San Francisco government, Rebecca Prozan, declined to comment, referring IBD to the press unit, which did not respond to multiple email messages. Of the buses, Lazarus says that they’re a sign that San Francisco is highly desirable place in which to live. “It’s a problem most American cities would love to have,” he said. The shuttles are often the target of derision , however, and longtime city residents say they helped change the character of the neighborhoods, along with the new residents who have moved in. “It’s a top-down, structured environment,” Erich Werner said, referring to how new communities are being planned. Werner is an electrical contractor who has lived in the city for 32 years. “What would keep a hamster happy? In this case, the hamster would need a restaurant, some place to party, some kind of light rail to take them there. All the attention is geared toward analysis and addressing perceived needs of a demographic. That’s conceptual and literal engineering.” More than changing neighborhoods, the influx of young, well-educated tech workers has created a new breed of tech companies that serve a niche of customers in a city that in many ways is not representative of the broader market. “There are a lot of products and services being created for San Francisco, and I’m not sure that’s sustainable,” said Myles Weissleder, who has lived in the Bay Area and worked in technology since the 1990s. He’s founder of SFNewTech, which puts together monthly networking events focused on technology. “Are there efficiencies in private transportation services?,” he said. “Certainly. But there are impacts on neighborhoods, there are costs — all of those little things are impacts, they are unforeseen consequences.” Despite increasing wariness among venture capitalists to fund startups, rents keep rising, and business carries on as usual. But even people connected to the technology industry feel some uncertainty. “These companies will run out of steam,” Weissleder said, “and I foresee some kind of shake-up as the money dries up.”