Effective Activism, on the Cheap - Update
|September 7th, 2012||
|Contributed by: Michael R. Levin, The Activist Investor|
|In 2010, we set out to determine a way to improve the odds of success, and to lower the cost, of activist investing.|
Then, we put together an analysis that, with some standard and novel screens, identifies 36 undervalued companies that fit the profile needed to pursue what we’ve come to call “Effective Activism, on the Cheap.”
We’ve now updated that analysis, and identified 26 new companies that fit the criteria.
What happened since 2010?
In 2010, some of the results surprised us. A simple valuation model indicated that on average the share price for the 36 companies could appreciate 75%. Also, the companies sat firmly in the small-cap space, with an average market cap of $375 million.
Since then, investors undertook activist projects at eight of the companies. Another two were acquired.
❖6 companies increased in value over the 75% increase implied by the simple valuation method
❖13 companies increased in value, up to the 75% level
❖17 companies decreased in value.
For the 10 companies that were acquired or otherwise became activist targets, results varied widely, from increases of 155% to decreases of 60%.
What’s new in 2012?
We used the same criteria for another analysis today:
❖highly-undervalued, measured by current net worth and book value relative to market capitalization
❖good activist candidates, measured by low insider ownership and high ownership among the top ten institutional investors
❖potential value appreciation, measured by a simple valuation using free cash flow and current net worth.
In this way, we identify 26 new companies, with a similar profile as the 36 from 2010. On average, at these companies:
❖current net worth of 115% of market capitalization
❖book value of 126% of market capitalization
❖insiders own 4%, and the top ten institutions own 58%
❖discount to potential share price of 36%, implying 57% potential share price appreciation.
Relative to the 2010 analysis, the value potential is slightly greater, while the potential price appreciation is slightly smaller.
The analysis also illustrates how this approach can make a different to investors, particularly fund managers that collect fees for management and performance. Spending relatively little, say under $100,000, on an activist project, makes a vast difference relative to the standard cost of $500,000 - $1 million or more. Assuming 57% share price appreciation, an average investment of about $10 million, and customary fees, we estimate that the effective approach, on the cheap, can eliminate cost as an obstacle to an activist project.
Now, the strategy isn’t objectively easy – no activist program is. Management still holds many of the cards. They can spend company (shareholder) money to seek support from shareholders outside of the top ten investors, and can communicate with shareholders in ways that investors cannot.
Still, for the right companies (such as these 26, and perhaps others) this approach should make it easier for an investor to have an impact.