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 argued this was silly and suggested what amounted to a sale-and-lease plan in which Target would no longer own its stores but have 75-year leases on them.
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
Semi-OT:
How do you feel about activists who use stock ownership and investments to promote socially responsible practices?Report
I don’t have a problem with that. I don’t know how often those attempts change behavior though. I guess at a minimum it gets someone to pay attention to those issues every once in a while though.Report
The right amount of cash cushion is a balancing act that makes sense once you start looking into the Modigliani-Miller failure modes. Obviously too little cash increases risk and could require going to the capital markets to raise funds when it might be costly or difficult to do so. Too much cash, though, runs into (1) agency problems wherein the shareholders are not confident the funds won’t be squandered on management perks and (2) the time value problem in that it is probably not earning an appropriate rate of return and would be better for shareholders to be put into their pockets, now rather than later.
Finding that right balance is tricky and non-obvious, especially if you do not have full information about the firm’s situation and prospects (investment opportunity set). So, yeah, listen to both sides.Report
In fairness to Beacon Capital, their letter mentions both of those issues. They say Jos A Bank is creating its own fiefdom and is likely to waste their excess cash on an overpriced acquisition in the future.
The rate of return issue is something I tend not to worry so much about as a long-term investor personally, but the market seems to care very much about such things.Report
I think the whole problem with share-holder value is that its measure might too often be calculated as financial value, without consideration of other potential valuations. Good will, for instance. Or investment in R&D. Corporate responsibility.
CEO pay reflects this, too; a pay scale too often based on short term valuation at the expense of those other values.
So that make you’re whole conversation. . . fraught. Yes, if the only value worth considering is short-term shareholder profits, you’re probably correct. In that scenario, share-holder activism will often be an effort to garner short-term profits before liquidating the stock; and I think that’s what you might be getting at.
The problem here is setting up a sensible structure for determining value other then just profit$. And there, I don’t think there’s enough shareholder activism, not by two shakes of a lambs tail.Report
My claim is really just that almost all shareholder activism we have now is about increasing leverage and one way or another accelerating payouts to shareholders rather than improving the actual operating business in any meaningful way. Most shareholder activists are startlingly unimaginative.
I’m on board with the idea that other types of shareholder activism are lacking though.Report
So what we’re really discussing is that share-holders interested in short-term gains, not on-going financial health of the company, are more likely to get jiggy with things; to try and influence the company’s direction, and often at the expense of long-term investors.
It’s sorta like regulatory capture.
I wonder: is there a term for this phenomena?Report
> share-holders interested in short-term gains, not on-going financial health of the company
Yes, though I framed it as short-term shareholders vs. long-term shareholders. Then again, the guys I mention as being “short-term” are still holding on to their stock for a few years in most cases. For a lot of investors, that would be considered long-term.
> term for this phenomena?
I don’t know that there is a domain-specific term. To be honest, I’m not sure anyone other than me thinks this is a problem for it to be given a name.Report
@vikram-bath , I think it a problem worthy of a name to help people recognize it when they see it.
So that makes two. Lovely agreeing with you.Report
You can add a third vote in there.Report
Check out Stephen Bainbridges blog: http://www.professorbainbridge.com/
He talk a lot about it.Report
It doesn’t seem like he uses a specific term in his paper. He labels the broader category “Shareholder Interventions” though. Here’s a recent post of his for anyone who’s interested: http://www.professorbainbridge.com/professorbainbridgecom/2013/08/on-the-need-to-manage-hedge-fund-interventions.html
I used to read him occasionally in my prior life though my academic work is not in his area. Thanks for the reminder.Report