Turnaround Investing Blog

George Putnam, one of the country's leading turnaround and distressed investing professionals, shares his timely insight on the economy and turnaround investing opportunities.

Harnessing Activists to Help Find Turnaround Stocks

Activist investors—fund managers that hope to drive up share prices by actively changing their target company’s strategy—often produce attractive returns for their clients. If you’re not one of the fortunate few to be a client, you can still use their influence to help with your turnaround investing.

As a turnaround investor, you can harness activists in two ways: buy a position in a stock with the expectation that an activist will soon follow, or buy after an activist takes a stake.

While one of the many dozens of activist funds might find their way to selecting your particular stock, this approach is likely to be frustrating and unrewarding. Activists choose where and when to strike, while you are left guessing and waiting with a stock that might never get the call (and may continue to be a laggard). You have to wait for a catalyst, but activists are their own catalyst. If you find a stock with all the other turnaround traits you want, the potential for later activist involvement can bring an added appeal but it should not be the primary motivation for buying a stock.

A better approach is to buy after the activist makes their move. You will probably have to pay a bit more for your shares, but the outcome is more likely to be positive. Once an activist takes a stake in a company, how do you evaluate whether it is worthwhile to follow on? This is a bit of an art, but the primary criteria include the following:

1.    Stock is a laggard and/or undervalued. How badly has the stock lagged the market and its peers? How undervalued is the stock relative to its peers and its own history? The weaker and cheaper the shares, the strong the activist’s case that something needs to change and the greater the potential upside if their campaign is successful.

2.    Operating margins have decayed and lag peers. How weak are its operating margins compared to its past and to its peers? How long have margins been a problem? Chronically weakening margins can indicate weak management and provide more opportunity for improvement.

3.    Assets and cash flows are poorly utilized. Does the company have excess cash or overly-conservative amounts of debt? To what extent is cash being re-invested in low-return businesses? Are there mis-fit operations or clearly lagging divisions that should be sold or spun-off? All of these offer opportunities for activists to make improvements.

These first three criteria can be measured in hard numbers. Two softer criteria that can be just as important include the following:

4.    Undercurrent of grumbling among the shareholder base. To what degree has there been grumbling among shareholders about entrenched, weak or overpaid management? Company leadership is supposed to work for the shareholders, not reward themselves, so a combination of weak stock returns and weak accountability can grate on investors nerves. Similarly, a poorly articulated strategy, or one that sounds good but isn’t delivering, as well as a bloated cost structure, can imply a lazy or out-of-touch management team. All of these strengthen the activist’s case that meaningful change is needed and would boost the shares if implemented.

5.    Company leadership’s credibility relative to the activists’. The weaker the company’s share and operating performance, the weaker its leadership’s credibility. Spiffy anti-activist marketing blitzes, legal defenses like poison pills, and pure bluster have increasingly limited impact and can actually reduce management’s credibility. Similarly, activists gain credibility through the quality and detail of their research on the target, the merits of their arguments, their track record of successes in previous campaigns, their overall fund performance and their amount of assets under management. When the activist asks for support from mutual funds, pension funds and even ETFs, credibility is critical. As an extreme illustration of credibility: a shareholder gadfly at the annual meeting won’t get far, but if Warren Buffett shows up, his words are likely to be heeded.

What you are looking for is an activist campaign targeting a weak stock with a sound plan for large and obvious improvements that has a solid chance of being implemented. With these, the stock has the ingredients for meaningful gains.

In our next note on activists, we’ll evaluate two currently-running activist campaigns with these criteria.

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A Closer Look At Two Activist Campaigns

Watch to see if ADP’s CEO Carlos Rodriguez inadvertently helps Pershing, and his aggressive and sometimes personal stance against Ackman could backfire. Overall, because of the stock’s strong returns and Ackman’s weak credibility, we would give this activist campaign a low chance of making ADP a successful turnaround investment. For turnaround investors, the Trian campaign appears to have a win-win opportunity for investors--either Peltz joins the board and learns enough to re-invigorate P&G, or loses and management must either execute (boosting earnings and the shares) or they will face a more drastic proxy campaign with higher odds of success down the road. We think the P&G campaign could turn out well for shareholders.  Read More.

Warrants: A Solid Investment Opportunity

Warrants provide a valuable tool for the savvy investor. When selected and implemented well, they can be a smart addition to a diversified investor’s portfolio. Like options, warrants are not equity. They only convey the right to buy equity. As such, neither holder is entitled to dividend rights, pre-emptive rights, proxy voting or any share of any liquidation.

 

Value Investing

 

Warrants' return potential can be very high, but they also carry significant risks. Learn what they are, how they work, strategies to minimize risk and find profit with warrants.

Here's Why You Should Invest in Asset Managers

 

stock market advicex

 

This Forbes article cites a recent MoneyShow write-up that recommends investors take advantage of the strong stock market and potential interest rate hike by "putting some of your investment assets into the shares of asset management stocks."

 

The article praises The Turnaround Letter's OAK purchase recommendation and quotes George Putnam: "As the corporate debt binge that we’ve experienced since 2009 comes to an end, Oaktree will benefit from a growing number of restructurings and bankruptcies."  

 

Learn more about Putnam's investing success with turnaround stocks.