Activist Investors — April 2015

April 28, 2015

Dow Jones Average: 18,038
S&P 500 Index: 2,109


Activist Investors

After the long, six year advance in stock prices it would be normal for the market to slow down or experience a price correction. Stock prices have been driven up by investors desperate for an alternative to zero percent money market funds, while corporate earnings have started to wilt under the intense heat of a super strong U.S. Dollar. High stock prices in the face of weaker corporate results are not a prescription for further gains. It would seem that the hour is late for the bull market party, but the revelers do not want it to end. In a world of zero percent interest rates, cashing out and going home is not a very appealing idea to most investors.

With the bull market showing signs of fatigue, many market participants are grateful that so-called activist investors (formerly known as corporate raiders) have become increasingly influential in keeping the market advance alive. The strategy of activist investors is to make things happen at a company, rather than wait passively for the normal ebb and flow of corporate results to affect stock prices. Activist investors believe that they can unlock value for themselves and others, even in a market that has been thoroughly picked over by legions of investors. They use capital, typically from a pool they are managing, to buy a large block of shares in a target company, and then pressure that company to take certain steps designed to boost its share price. The pool of capital available to activist investors has been steadily growing as central banks have pumped trillions of dollars of new capital into the financial system.

In this high stock market, the companies targeted by activist shareholders are already fully valued in the eyes of most investors. So it takes something fairly dramatic to enhance the share price further. Spinning off certain divisions, merging with another company, curtailing research that has no immediate profit impact, spending company cash reserves or going into debt to buy-in shares, are all common tactics designed to boost a company’s share price in the short term. While such actions can be deleterious to a company over a longer time frame, activist investors are primarily interested in extracting short-term gains for themselves or investors they represent.

The typical targets for corporate raiders of the past were small to mid-size companies that had some operational issues. Such companies were often unpopular with their own shareholders, and were not strong enough to fend off those agitating for an overhaul of the company. Conditions are
different in today’s market, with no company, regardless of size, able to fend off unwanted advances from activist investors. With vast pools of capital, much of it created in recent years by Fed policy, and more than 1400 billionaires in the world, there is more than enough capital floating around to pressure even the largest companies. In the past eighteen months, Carl Icahn, the world’s wealthiest corporate raider, pressured Apple Computer, the world’s highest valued company, to make certain share price enhancing moves. Even IBM, a company that has already engineered its results for maximum benefit to its share price, has enlisted the help of consultants to thwart potential moves by activist investors. It is ironic that IBM is concerned about the possibility that an activist group will try to further engineer its already highly engineered results. But these days nothing would be surprising. The party seems destined to continue on until the last drop has been tapped from the market keg.

Current Strategy

The stock market in the U.S. waffled back and forth in a narrow range during the first quarter of 2015. While the financial headlines seemed to be filled with news of possible mergers, tax inversions, and other forms of radical corporate restructuring, in reality only a tiny percentage of stocks were subject to such events. Filtering out the noise related to possible mergers and other transformative actions, investors were left with a market somewhat stalled out at a high level. The benefit from steady growth in the U.S. economy was largely offset by currency translation and economic weakness in many regions of the world.

Even though stocks are on the high side using historical indicators, there is still no attractive alternative to stocks. We believe that the best strategy in these challenging times is to hold onto a core of powerful companies that typically pay good dividends, and buy new positions after declines of twenty percent or so in individual stock prices. While the overall market indices have not experienced a price correction of any magnitude in a long time, there have been individual price corrections in some high quality companies. We took advantage of a few such buying opportunities in recent months. In our opinion, buying judiciously after a sharp decline in an individual stock price reduces the risk of committing money in a high market environment.

The fixed income market continued to offer frustratingly low yields to investors worldwide. Interest rates on the ten-year U.S. Government bond were below two percent for most of the winter. That was a high yield compared to Germany where rates on ten-year paper fell to about one-tenth of one percent. Investors in fixed income instruments have been oppressed by central bank policy, with Germans now holding the title as the most oppressed. In this historically low interest rate environment, we think that municipal bonds offer some of the more palatable yields for investors willing to buy paper that matures in ten years or longer.

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