Shareholder Activism Might not be Good for Shareholders
The hedge fund Beacon Light Capital* has been a patient owner of 1% of Jos A Bank for three years. They have seen the company execute reasonably well while their the market value of their shares languished. To rectify this, they wrote this (entirely typical) letter to the Board of Directors.
They level the following critique:
The Company has never paid a dividend or re-purchased any shares. As a result, the Company has a growing cash pile that reached a staggering $377 million at the end of the fiscal year ended January 2013. This equates to $13.50 per share or 32% of the Company’s market capitalization.
If the company paid the entire $13.50 per share out as Beacon Light recommends, it would go into the pockets of shareholders. The stock price, however, would drop. You might think it would drop $13.50, but you would be wrong. The stock would only drop perhaps $10, which is great if you’re a shareholder, right? You would make $3.50 overnight.
But there is something inherently unsustainable about making money in this way. The value to the customer is not increased. The business’s costs are not reduced. Instead, the business’s leverage increases (or its cash cushion decreases if there is no debt, which is effectively the same thing.)
If that were the whole story, it would be OK. Not inspiring, but still OK. When a company pays out cash though, its options narrow. The money is gone and cannot be recovered easily. In the case of Jos A Bank, it seems like they may have flexibility to spare, but the principle still applies.
Some years ago, Bill Ackman tried a similar tack with the conservatively-managed, Minnesota-run Target. Target owns its stores rather than leasing them like most other retailers. This provides Target with flexibility given that they have no landlord to pay, but it reduces Target’s return on equity, and some other metrics that the stock market responds to.
Ackman’s plan failed, but I suspect that if he succeeded, he would have made a good amount of money for his own investors.
But it could have easily ruined Target some decades in the future. A 75-year lease is nice in good times and a noose in bad. And any 75-year period will have some bad in it. It would have been long after Ackman had moved on though.
Of course, that was an example of the system working. Target’s shareholders supported management over Ackman, but it doesn’t always work like that. Sometimes the activist is more charismatic and convincing and management is mistrusted, and change happens. Often this can be good because management is in fact not trustworthy. Carl Icahn finally got Chesapeake Energy to fire its CEO, and that action is more likely to help the company than damn it.
Still, an ordinary, long-term shareholder should listen to both management and activist investors with a carefully calibrated cynicism.
* I wish to note that there is nothing peculiar or nefarious about Beacon Light Capital’s request. I have no wish to pick on them, and I could have just as easily picked letters from twenty other hedge funds about twenty different companies.
Disclaimer: This is not investing advice. I have no position in Jos A Bank or Target. I do have a long position in Chesapeake Energy.
Photo credit: Flickr user pagedooley