Have you ever seen a shark in the wild?
Great White Shark off South Africa. Photo: Hermanus Backpacker Hostel. Source: Wikimedia
I never have, and I hope that I never do. They’re scary enough at the aquarium! Their successive rows of teeth, all angling back, seem designed to rip and tear. These “predators of the sea” seem tailor-made for horror movies, like Jaws or Open Water.
Predatory investors can be scary, too. On one hand, these investors are exercising their rights as company owners to have management release some of the value inherent in a company’s franchise. On the other hand, they often seem to be looking for short-term gains that can come at the expense of a firm’s long-term prospects. For predatory investors, holding a position for more than a year is rare. They want to get their money and then get out.
These investors target companies where revenue growth is stagnant or falling. Lately, the market has had a large premium on long-term growth, so disappointments on the top line hit share prices hard. That’s when activists come in, suggesting capital allocations like debt-funded share buybacks, or division sales, or massive cost-cutting to support big dividend increases. When Apple stumbled in 2013, activist investor Carl Icahn took a $3.6 billion stake in the company and proposed that they purchase over $150 billion of their own shares – about a third of the company’s market cap.
In the end, growth returned to Apple, the shares rebounded, and the company never acted on Icahn’s plan. But the larger point is this: activists target cash-rich slow-growing companies. Their proposals usually focus on paying more money to shareholders, though, not reigniting growth. To a hedge fund with a spreadsheet, the market looks like a capital allocation problem. But the path to a company’s long-term returns usually involves making good investments, not distributing capital.
That’s why activists have also target slow-growing giants like Nestle, Proctor & Gamble, BHP, and even GE. Such targets would be unthinkable if the shares were zooming. After all, shareholders are unlikely to upset the apple cart when management’s strategy seems to be working. But GE’s sales have been declining for years. They’ve been a soft target.
There don’t seem to be that many other GEs out there, though. Predatory, activist investors depend on finding sick, weak companies that they can lever-up and extract cash from. They’re not so much predators, as scavengers. And when there aren’t enough carcasses available, scavengers tend to fight with one another. Witness Icahn’s fight with fellow-activist Bill Ackman over the company Herbalife.
After all, sharks don’t swim in schools.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”