bloggingbuyouts

When you look at the work of 13-D wielding activist investors, you usually find the following demands repeating themselves over and over:

• Try to sell the company to a private equity firm or strategic buyer.
• Buy back stock and/or pay a dividend.
• Get rid of the current management and/or board of directors.

The frequency of these requests has given many activists a reputation -- in my opinion largely undeserved -- as short-term oriented paper shufflers looking to pump up the stock price and move on.

Then there's Nelson Peltz, who focuses on that governance-oriented stuff too but is also unique in that he makes very specific comments about marketing: Wendy's isn't playing up its freshness in its advertising, Heinz's ketchup packets weren't good, Tiffany's was too focused on gifts, etc. This fascinating piece in Fortune looks at the investment methodology of this restaurant and branding expert.

Unfortunately, Mr. Peltz's publicly-traded company, Triarc (NYSE: TRY), has been a poor performer of late. But if you're sold on his ideas, it just might be a good time to take a look.

Recent data from FactSet's SharkWatch service demonstrates that activist investors are enjoying a remarkable level of success. Often the filing of a 13-D and a bit of saber rattling are enough to get companies to snap to attention: since 2006, activist shareholders have been awarded 218 board seats at public companies -- and only had to go through proxy fights for 28 of them. Most of the time, companies willingly offer seats as a truce.

The reasons behind this trend are interesting. It may be that, unlike the 1980s when there was great suspicion of "corporate raiders," most investors recognize that having outsiders with large paid-for-in-cash stakes on the boards is almost always a good thing; their interests are aligned perfectly with outside shareholders, and so big investors are willing to support them. Current executives know that and decide that it's better to concede than go through a proxy fight that will take up resources and, very possibly, lead to the ousting of the entire board.

In a column (subscription required) in The Wall Street Journal, Dennis K. Berman makes a bold prediction about where the future for activists might lead: "As power leaches away from the board room to the shareholder, much will travel along with it. That includes the relationships that form the basis of so much board room power. . . the incentives are changing for everyone, meaning that some investment banks will push ever closer to the best activist investors, dispatching whatever small stigma remains with such work. The same goes with the best executive talent, who may choose to align itself with a group of outside investors in the same way that private-equity firms develop a stable of top managers."

The irony here is that this is exactly the power structure that was developing in the 1980s when Michael Milken's junk bonds were fueling hostile takeovers. That era ended for all the wrong reasons when Milken was hauled off to jail on trumped up charges and a slew of bad deals collapsed amid excess, but it was the beginning of an important new world where the goal of increasing shareholder value is a reality instead of a myth. If top investment banks demonstrate a willingness to work closely with activists, shareholders and the economy as a whole will prosper.

I'm a big fan of shareholder activism on the part of small investors -- communicating with management and posting on message boards to let other investors know what you think. In an interview with TheDeal.com, I said that "I really believe that the internet is already starting to and will, much more so in the future, make it easier for very small shareholders to effect change through reasoned arguments on blogs and message boards. If you think about it, you really shouldn't need to be a 13-D filer to have your concerns heard. If your ideas make sense, they should be listened to."

Posting on a Yahoo! message board, an investor posting under the handle "daleysboy" describes the corporate governance outhouse that is Lenox Group (NYSE: LNX). The entire post is worth a read, but here are some samples:

That's 23 people acting in Executive positions, with a total 2007 average cost of $484,465 per Exec, and a total expenditure of $11,142,704 in 2007. Why did Lenox need 6 CMAG consultants supporting Marc Pfefferele, with them acting in Senior Management positions? Isn't that what the "real" Senior Managers were supposed to be doing, with Mr. Pfefferele directing their efforts? Lenox paid all of these Executives $11 Million plus, to lose over $15 Million on the bottom line in 2007 . . .

If anyone looks at the data released by Lenox, plus SEC filings, they will see it strewn with info on Lenox Executives, and CMAG, regarding wage compensation, consultant fees, buying and selling of stock, cash bonuses, long-term incentives, equity incentives, performance shares, success bonuses, retirement remuneration, perquisites, option exercises, pension benefits, golden parachutes upon termination, retention bonuses, and on and on and on. It appears that someone is preoccupied with placing a lot of emphasis and effort on Executive Compensation, as compared to current and future concerns for stakeholders, employees, and customers. Who are the ones financially protected if Lenox goes belly-up? . . .

The shareholders of Lenox need a true watchdog on the Board of Directors to scrutinize Lenox's, or CMAG's, plan for success. Proxy votes at the Annual Meetings just don't cut it.

I followed the Lenox Group train wreck for awhile back in March of 2007, and I took my own shots at the company's board of directors. Given the state of the company's balance sheet and the poor prospects for its business, it's probably too late for any activist to save Lenox.

But the fact is that former CEO Susan Engel walked away with millions after engineering the acquisition that destroyed the company. Since then, board members and turnaround executives have continued the looting, leaving shareholders out in the cold.

DealBook takes a look at the downside of activist investors: when their ideas lead to (or would have led to) disastrous results.

For example, thankfully for shareholders of Ameritrade (NASDAQ: AMTD), SAC Capital's and Jana Partners' call for the company to acquire E*Trade (NASDAQ: ETFC) went unheeded.

This raises an interesting question: what exactly are activist investors good for? Given that most are hedge funds or other financial types rather than operational managers, I would argue that the value-creating abilities of hedge funds are limited to basically a few well-tuned strategies that have demonstrated their ability to create alpha over the years:

• Forcing out executives or directors who have performed poorly.
• Pushing an undervalued company to buyback its stock to return cash to shareholders.
• Pushing an undervalued company to hire an investment bank to explore strategic alternatives.

In other words, I think that activist hedge funds do the most good when they take on stock value and governance-related issues, not operational management. If the company has operational deficiencies, a hedge fund can push out the management and bring in someone better.

But, to paraphrase the DealBook headline, beware of hedge funds bearing operational advice.

At long last, there is a whole book about the activist hedge fund managers who create some of the most interesting headlines in the financial press: guy like Dan Loeb, who sends letters to CEOs urging them to "Retreat to your waterfront mansion", and attaches them to SEC filings.

TheDeal.com's Ronald D. Orol brings us Extreme Value Hedging, a 338-page opus on activist investing that is a heck of a lot more interesting than its title makes it sound.

Through interviews with activist investors, traditional money managers, and even executives at target companies, Orol looks at how activists are changing the corporate landscape and making corporations more accountable to their outside investors.

He also looks at the future of activist investing, including forays into Japan and the Ukraine. Orol also predicts that blogs and YouTube will induce activist investors and corporate executives to take their battles to the internet, and may give retail investors a voice that we've never had. I've actually given this a try with my BloggingActivist series. Who knew I was on the cutting edge?

Extreme Value Hedging is probably longer than most readers will want, but it's a surprisingly entertaining read if you want to understand this phenomenon, and how it's impacting our investments.

The title of an article in the latest issue of Business Week sums it up: "Activist Investors Get More Respect." According to Patrick McGurn of Institutional Shareholder Services, this will be the most successful proxy season ever, and corporate executives and boards of directors are more responsive than ever to the concerns of shareholders. One of the most common corporate governance changes occurring this year is a move toward majority voting, which will require directors to receive at least 50% of the vote in order to be elected. In most companies, a simple plurality is all that is necessary. "Say on pay" proposals have also been filed with 66 companies this year, which seek to give shareholders an advisory vote on executive compensation, an area that most experts agree has gotten out of control in recent years.

The evolution of activist investing has been astounding. In the 1970s and '80s, it was raiders like Carl Icahn and Kirk Kerkorian who took on entrenched management teams. The battles were often filled with animosity, with the activists characterizing the managers as, to quote Gordon Gekko, "these bureaucrats, with their luncheons, their hunting and fishing trips, their corporate jets and golden parachutes" and the managers criticizing the investors for interfering with economic growth.

While many battles for corporations still have their share of animosity (what fun would covering markets be without that?), boards are increasingly realizing the validity of many of the arguments being made by activists -- and that's good for all investors.

As investors await the results of the annual meeting at Motorola (NYSE: MOT), I think it's an appropriate time to ponder what exactly Carl Icahn's motives are in his battle for a place on the company's board of directors. Motorola's CEO has publicly questioned Icahn's motives -- suggesting that he is more interested in a short-term profit than the long-term health of the company, an allegation that Icahn strongly denies. He has said he will hold his shares long-term if elected to the board.

With his net worth of 9.7 billion dollars putting the septuagenarian at #24 on the Forbes List, it's tough to imagine that he's motivated by pure profit, the way that he seemed to be in his heyday as a junk bond-fueled corporate raider in the 1980's. So what exactly is Icahn up to?

I would argue that he's battling Motorola management to cement his legacy as a shareholder activist, focused on dueling with greedy management, much like he has in his battle with management at Blockbuster. Partly because of management and media propaganda and partly because of the reality of his actions, Icahn's "activist investments" in the 1980's left him about as well-liked and respected by the average American as Ken Lay, or perhaps Sanjaya.

Now, he has replaced his motives of pure profit with, at least outwardly, a concern for the competitiveness of America going forward. In a February interview with Time Magazine, he responded to a question about whether his work accomplished anything other than making money: "America is going to lose its economic hegemony if we don't do something along the lines of what I'm doing, where you make managements accountable. Our companies are really not competitive with Asia, and this is the great new threat." He even expressed concern about executive compensation compared to the salary of the average worker, and frequently opines on the non-existence of corporate democracy.

Regardless of how you feel about Icahn's work in the 1980's, there can be no doubt that he's right about most of his complaints today. And if his battles with companies like Motorola continue to keep management teams on their toes, I would argue that his legacy will be a net positive. And I think that's the goal of his career today.