Milwaukee Private Wealth Management, Inc. (MWPMI) has made investments in companies of all sizes, across multiple industries and geographies using value oriented investment principles. We have found some companies to be very well managed by highly competent officers and directors. We have found and been surprised by a number of companies that have mediocre management, supported by directors that clearly represent a “family & friends” attitude. When we have pressed companies on these issues, we are frequently met with aggressive, hostile responses, often directed through the company’s legal office or outside legal counsel.
MPWMI believes that companies are owned by its shareholders and should act first and foremost in the interest of shareholders. Too frequently, those managers we refer seem to be operating to enrich themselves and preserve their roles with the company at the expense of its shareholder owners. MPWMI has increasingly adopted an investor activist role in an attempt to influence boards and senior management through best practices and operational change.
Value investors are those who strive to invest when a business can be bought for a fraction of its appraised value. Most value investors try to buy a dollar’s worth of business for fifty cents.
The principles that drive value investing are immeasurably sensible, yet, the vast majority of investors in the marketplace utilize a variety of other investment strategies. The cause of this is in part due to the long-term nature of value investing. Companies selling at a sharp discount often face problems that can only be resolved over time. In some instances market participants have simply become too bearish on a company, thus depressing shares prices, and creating an attractive buying opportunity.
As an investor in the capital marketplace it’s important to keep in mind that companies are run by people, and people are prone to make errors in judgment. When those errors occur they can be detrimental to a company, or create a ‘value investment opportunity.’
Common errors made by management and directors include strategy failure, financial overleverage, acquisition overpayment, failed execution, decline in employee morale and loss of key personnel, and of course simple mismanagement over time by an inept executive team. This list goes on, but the point is that many companies meet their ultimate demise through poor management over time.
Many of these errors can be rectified with a change in personnel or strategic vision. Most investors sell their shares when issues such as these arise, unwilling to see if a solution can be found and implemented. When circumstances change with a company, investors tend to sell en-masse. Selling often occurs over a short period of time – generally a few days to a few months.
The damage caused by managerial misjudgments may be substantial, but not all companies are permanently impaired. In fact, as many value investors will attest, the time to make the most attractive investment is at the moment of maximum shareholder pessimism. In the short-term, share prices are driven in large part by shareholder emotion – both positive and negative.
Value investors tend to think in terms of “Buying the Company” when evaluating stock purchases. They tend to think about a share of a company’s stock as representing a fractional ownership in that enterprise – which in fact it is, but investors frequently treat stock investing as though they were at a casino, making bets instead of intelligent and well informed investments.
Having an ownership mentality will cause an investor to make greater demands of a company’s Board of Directors and the senior management. The moment an investor takes assertive action, he or she enters the ‘activist’ domain.
An activist investor typically acquires a significant minority position in an undervalued company, with a view toward agitating for value enhancing changes in the leadership, governance, capital structure or strategy and operations of the company.
The logic of turning to a troubled company to seek solutions when it appears the problems are transitory in nature, or can be resolved with strategic, personnel or other remedies, is very powerful. An activist can make suggested changes that lead to sharp improvements in the company’s business operations with a corresponding increase in the value of the company’s share price.
Activists come in two general varieties: operational and financial. Generally speaking, operational activists seek change that involves fixing the business operations of a company. Solutions tend to be managerial in nature and often include new personnel and strategy. Changes typically begin with the Board of Directors and flow throughout the company.
Financial activists are generally concerned with managing financial statements and usually focus on improvements that are structural or organizational in nature. Goals typically include a “sum of the parts” analysis where divisions can be divested, recapitalized or merged. Additional debt is sometimes employed to improve returns on equity or to orchestrate shareholder friendly buybacks and dividends.
Few investors have either the skill or patience to be activists. As a result, investors often sell their shares at the appearance of the slightest problem with a company.
As long-term oriented investor, MPWMI can take advantage of this “Sell at the sign of trouble” mentality. When a company encounters challenges that are temporary in nature, their shares are often available at bargain prices. When an activist enters the picture the rate of change or improvement often accelerates. Investors face two challenges in these cases:
- Differentiating between those companies that can be repaired and those that cannot
- Evaluating the time frame required to repair the company
An analysis of the later is where an activist’s strategy is important. Left to its own, directors and senior management may be slow to identify the changes necessary to affect improvement. Activists are usually outside, independent investors who have the ability to accelerate the rate of change and are highly motivated to find good solutions. As a rule, the activist is not on the payroll and only enjoys economic benefit if successful.
Investors should welcome the appearance of an activist investor, as many times their presence will lead to near term share price improvement. Although the targeted company may not welcome the activism, experience shows that activists often work most effectively for all shareholders.
MPWMI believes shareholders are the ultimate owners of a company and are entitled first and foremost to its economic benefit. Many directors and senior managers have forgotten this historic arrangement and treat the company as if it were closely held and operated for their personal benefit, leaving the common shareholder in a subordinate position.
It is a tradition that a company should be run for the benefit of its owners, the shareholders, and that to them should go any profits that are distributed. Over ambitious mangers frequently lose sight of this tradition, necessitating MPWMI and other likeminded investors to embrace an activist approach to return control and economic rewards to shareholders.