Open Letters - A Waste of Time?

This post first appeared at The Activist Investor Blog

About once a month, a PM calls us about some company, wanting to talk about the prospects for an activist project. We review the financials and the filings. Often we suggest the shareholder just move on - the business isn’t worth trying to turn around, or the board and management are too entrenched. Sometimes we suggest a plan. Once in awhile we move ahead with it.

Occasionally, and more often after we suggest moving on, the PM wants to write a strongly-worded letter to the BoD chair and the CEO. Confidence about the investment thesis and frustration about the current results and share price yields a long, detailed, and lively manifesto, an “open letter” to the board, management, and other shareholders.

At a minimum, this is a waste of time, energy, and money. Worse, it betrays a certain naive ignorance about activist investing.

Two Audiences

We can think of two audiences for such a letter, company leadership and other shareholders. As we noted before, the CEO and BoD don’t care what the PM thinks. They may say they care, but they really don’t. No letter alone, however thoughtful, will persuade executives to change course and do what the investor asks. We can’t think of a single instance in which the CEO reads a letter from an investor and says, “wow, this PM is a genius, let’s do it.”

Other shareholders might find such a letter at least a little interesting. It may express explicitly and succinctlytheir vague concerns about the company. It might affirm their doubts about leadership. It could even spur them to support the PM’s efforts to influence the company.

However, it will have that outcome only if, with a reasonable likelihood of success, the PM will back words with action, or the legitimate threat of potential action. The company and other investors must see that the PM has the means, knowledge, incentive, and will to escalate beyond an “open letter”.

Unentrenched and Legitimate Threat

In some situations, no amount of agitating for change will work. Not only is there no reasonable likelihood of success, the likelihood is approximately zero. The CEO and BoD are just too entrenched. They control substantial blocks of shares, enjoy dual-class share structures that give them control over the BoD, or benefit from staggered BoD positions stacked with friendly directors. You can write as many open letters as you want. They know they can safely ignore them.

An investor in Avalon Holdings (AVX) called recently, and motivated this thinking. The company has attractive assets that it has failed miserably to monetize. But, a dual-class share structure allows the current CEO to control the BoD, and makes any open letter futile.

In other situations, the shareholder does not represent a legitimate threat:

❖Means: the PM can’t or won’t spend even a few dollars on attorneys, travel, or other expenses needed to rally support from other investors

❖Knowledge: the PM and his or her advisors lack expertise about and experience with corp gov and activist strategy and tactics

❖Incentive: the PM owns too few shares to justify an activist project

❖Will: the PM worries about what others might think of an activist effort, or otherwise does not demonstrate the resolve to agitate for change at the company.

Even if the CEO and BoD aren’t entrenched, they know that the PM won’t escalate the effort beyond writing a letter. Unless and until the BoD thinks they risk their jobs through a proxy contest, they will ignore you.

Worse, other shareholders will see this, and won’t take you seriously. An open letter without the potential to escalate represent just an empty threat.

It doesn’t take very much to demonstrate the potential to escalate. It takes less than it used to, too. A PM can recruit credible director candidates, or even better commit to serving on the BoD. Own more than a few shares of stock. Show you know something about corp gov, Delaware law, and the company bylaws.

Finally, with means, expertise, incentive, and will, you don’t really need an open letter. Private communication among large shareholders is both legal and healthy. A thoughtful presentation backed by the credibility to escalate will get the attention of every other important investor every time.

JANA Partners failed: Becoming your own activist

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A couple of years ago Jana Partners started pushing for a split up of the specialty chemicals company Ashland. The company, with underperforming chemical and adhesive businesses, was due for a change. Ashland is most famously known for its Valvoline motor oil.

Jana closed out its activist position in May, ending a two-year holding period that to a 58.6% return from the day it was announced via a 13D to the day he closed it via a 13D/A filing - locking in a 25% annualized return. But, now that Jana is gone, Ashland could be its own activist.

The key driver? A sale of its prized business, Valvoline. This business includes close to 1,000 oil change shops and makes up over a quarter of sales. This isn’t a fit for a chemicals company, but still a very profitable business. Buyers could include oil producers that want to better compete on the lubricant front - note that some of the big players have a presence in this space - including Exxon Mobil with Mobil engine oil and BP with Castrol.

It could also spin the Valvoline business off. Management knows this asset is not a core part of the Ashland business and has said such. It’s just a matter of time at this point.

Older $ASH coverage - our 2013 piece entitled Jana Partners strikes again

Japan Activism: Sohn Conference edition

As a free look, here’s a sample of the things we’re doing with Activist Strategy - in addition to identifying activist targets, doing deep dives in activist targeted stocks and bringing to light catalyst driven stocks. Get the first 2-weeks of Activist Strategy free here - no CC needed.

With activism in Japan heating up, here’s a quick look at the pitches from the Hong Kong edition of the Sohn Investment Conference. The big trend has been the openness to increasing shareholder returns, but also exploring M&A - which has been notably lackluster in Japan over the last decade.

Yet, corporate governance changes are underway and companies in Japan have close to $2 trillion in cash that needs to be put to work. Some companies have already started, think: Fanuc, which was targeted by Dan Loeb, and shortly after put in place a buyback and higher dividend.

As far as Hong Kong Sohn goes -

Tybourne Capital pitched airport operators, namely Japan Airport Terminal, which is a bet on more Chinese traveling, driven by rising incomes. In Japan, airports are basically huge malls; more travel means more spending. Another Tybourne play is Shanghai International Airport, where that city will see a Disneyland resort open next year - increasing travel to the city.

Indus Capital is long Coca-Cola West on the belief that it will begin consolidation of bottlers across the Western part of the globe. The key is getting margins more in line with the number two player, Suntory Beverage, which will lead to higher dividends.

Oasis Capital was pumping Kyocera, which focuses on packaging for smartphones. The problem with Kyocera isn’t its packaging business, but its U.S. telecom business. This segment lost over $150mm while generating $2.8bn in revenues last year. It’s holding the company back, while there’s no hope for competing in the U.S. market. Kyocera could also do a YieldCo for its solar business. Recall that Oasis was involved with Nintendo last year to get into mobile games. He’s crushed it in Nintendo.

Balydasny Asset Management is long Suzuki Motor as a misunderstood play. One that needs to be unwound, where Volkswagen owns 20% of the company and Suzuki owns 1.5% of Volkswagen. Suzuki also owns Maruti Suzuki India, which is a pure play on the growing car market in India.

Graticule Asset Management fingered Chinese brokerage houses as top plays - including CITIC Securities, Haitong Securities and China Galaxy Securities. It’s a bet on higher trading volumes driven by monetary easing.

Saga Tree Capital called out Sun Hung Kai & Company given its exposure to the growing income levels in China. Its wealth management and brokerage businesses will thrive as the country becomes wealthier.